Insights & Advice


Let’s Twist Again


This week the Federal Reserve Bank extended “Operation Twist” until the end of the year. The markets shrugged off the announcement as simply more of the same kind of stimulus that has failed to generate a lasting recovery in the past. Some say the Fed has run out of options, but I wouldn’t be so quick to count the Fed out.

“Operation Twist” is the Federal Reserve Bank’s third attempt at quantitative easing in as many years.  It was intended to lower long-term interest rates by selling short-term U.S. Treasury bonds that it owns and using the proceeds to buy longer-dated Treasury bonds. It worked fairly well, as far as declines in long term rates are concerned, but did little for the economy or to spur additional lending.

“Twist”, like QE I and QE II, was intended to jump-start the economy by adding cheap dollars to the economy thereby lowering interest rates but has resulted instead in what I call our stop and start economy.

As I have written before, the problem is not with interest rates. Lending rates are at historically low levels. The problem centers on getting banks and other lenders to loan those cheap dollars to those who really need it. Whether we are talking about companies or consumers, those who need the money the least find they can borrow the most. AAA rated companies can easily refinance their debts and take advantage of these low rates. Likewise, wealthy people with a  lot of equity in their homes and high credit ratings can also take advantage of low rates.

But those consumers and small business owners with questionable credit ratings are simply unable to borrow, or if they can, the rates of interest they must pay are prohibitively expensive. This is a situation that has been with us since the financial crisis and nothing the Fed has done yet seems to be able to break that logjam.

Some critics say that “Operation Twist” has made the situation worse. By driving 20 and 30-year interest rates down, the Fed has actually discouraged banks from mortgage lending. Taking on the risk of a 30-year consumer mortgage loan at an interest rate below 4%, for example, does not provide the bank with a great deal of reward for the long-term risks they are taking. As a result, banks will tend to ration the money they loan, only selecting borrowers on the top of the credit scale and even then cutting down the amount they are willing to lend.

Unfortunately, there are no easy answers in convincing lenders to lend. The old adage of ‘you can lead a horse to water but you can’t make it drink’ applies here. The economy is sputtering once again. The housing market is still a problem waiting to be addressed. Foreclosures, while declining, are still at historical highs. Millions of mortgage holders are still underwater and no one in Washington or elsewhere seems to even want to address the problem, let alone provide a solution that could work.

Federal Reserve Chairman Ben Bernanke has made it clear that monetary policy is not the end-all solution for saving the economy. He has repeatedly urged both Congress and the White House to do something, anything, except bicker about who did what to whom. Still, if things get bad enough, I suspect the central bank has a number of arrows left in its quiver, but it might be some time before the Fed is ready to make a move. In the meantime, good luck with getting the politicians to do anything.


Posted in Macroeconomics, The Retired Advisor