We have been looking for an out-of-the-box move from the Fed, but this was not what we had expected.
The obvious game changing move would have been for the Treasury and the Fed to make an arrangement in which the Fed is able to purchase Treasury debt directly without subjecting it to an auction in the public market first. This is known as 'a money machine' and is prohibited by statute.
But as usual the Fed surprises us all with their lack of transparency. They are asking Congress about permission to issue their own debt directly, not tied to Treasuries.
This is known in central banking circles as 'cutting out the middleman.' Not only does the Treasury no longer issue the currency, but they also no longer have any control over how much debt backed currency the Fed can now issue directly.
If the Fed were able to issue its own debt, which is currently limited to Federal Reserve Notes backed by Treasuries under the Federal Reserve Act, it would provide Bernanke the ability to present a different class of debt to the investing public and foreign central banks.
The question is whether it would be backed with the same force as Treasuries, or is subordinated, or superior.
There will not be any lack of new Treasury debt issuance upon which to base new Fed balance sheet expansion. The notion that there might be a debt generation lag out of Washington in comparison with what the Fed issues as currency is almost frightening in its hyperinflationary implications.
This makes little sense unless the Fed wishes to be able to set different rates for their debt, and make it a different class, and whore out our currency, the Federal Reserve notes, without impacting the sovereign Treasury debt itself, leaving the door open for the issuance of a New Dollar.
What an image. The NY Fed as a GSE, the new and improved Fannie and Freddie. Zimbabwe Ben can simply print a new class of Federal Reserve Notes with no backing from Treasuries. BenBucks. Federal Reserve Thingies.
Perhaps we're missing something, but this looks like a step in anticipation of an eventual partial default or devaluation of US debt and the dollar.
Wall Street Journal
Fed Weighs Debt Sales of Its Own
By JON HILSENRATH and DAMIAN PALETTA
DECEMBER 10, 2008
Move Presents Challenges: 'Very Close Cousins to Existing Treasury Bills'
The Federal Reserve is considering issuing its own debt for the first time, a move that would give the central bank additional flexibility as it tries to stabilize rocky financial markets.
Government debt issuance is largely the province of the Treasury Department, and the Fed already can print as much money as it wants. But as the credit crisis drags on and the economy suffers from recession, Fed officials are looking broadly for new financial tools.
The Federal Reserve drained $25 billion in temporary reserves from the banking system when it arranged overnight reverse repurchase agreements.
Fed officials have approached Congress about the concept, which could include issuing bills or some other form of debt, according to people familiar with the matter.
It isn't known whether these preliminary discussions will result in a formal proposal or Fed action. One hurdle: The Federal Reserve Act doesn't explicitly permit the Fed to issue notes beyond currency.
Just exploring the idea underscores many challenges the ongoing problems are creating for the Fed, as well as the lengths to which the central bank is going to come up with new ideas.
At the core of the deliberations is the Fed's balance sheet, which has grown from less than $900 billion to more than $2 trillion since August as it backstops new markets like commercial paper, money-market funds, mortgage-backed securities and ailing companies such as American International Group Inc.
The ballooning balance sheet is presenting complications for the Fed. In the early stages of the crisis, officials funded their programs by drawing down on holdings of Treasury bonds, using the proceeds to finance new programs. Officials don't want that stockpile to get too low. It now is about $476 billion, with some of that amount already tied up in other programs.
The Fed also has turned to the Treasury Department for cash. Treasury has issued debt, leaving the proceeds on deposit with the Fed for the central bank to use as it chose. But the Treasury said in November it was scaling back that effort. The Treasury is undertaking its own massive borrowing program and faces legal limits on how much it can borrow.
More recently, the Fed has funded programs by flooding the financial system with money it created itself -- known in central-banking circles as bank reserves -- and has used the money to make loans and purchase assets.
Some economists worry about the consequences of this approach. Fed officials could find it challenging to remove the cash from the system once markets stabilize and the economy improves. It's not a problem now, but if they're too slow to act later it can cause inflation.
Moreover, the flood of additional cash makes it harder for Fed officials to maintain interest rates at their desired level. The fed-funds rate, an overnight borrowing rate between banks, has fallen consistently below the Fed's 1% target. It is expected to reduce that target next week.
Louis Crandall, an economist with Wrightson ICAP LLC, a Wall Street money-market broker, says the Fed's interventions also have the potential to clog up the balance sheets of banks, its main intermediaries.
"Finding alternative funding vehicles that bypass the banking system would be a more effective way to support the U.S. credit system," he says.
Some private economists worry that Fed-issued bonds could create new problems. Marvin Goodfriend, an economist at Carnegie Mellon University's Tepper School of Business and a former senior staffer at the Federal Reserve Bank of Richmond, said that issuing debt could put the Fed at odds with the Treasury at a time when it is already issuing mountains of debt itself.
"It creates problems in coordinating the issuance of government debt," Mr. Goodfriend said. "These would be very close cousins to existing Treasury bills. They would be competing in the same market to federal debt."
With Treasury-bill rates now near zero, it seems unlikely that Fed debt would push Treasury rates much higher, but it could some day become an issue.
There are also questions about the Fed's authority.
"I had always worked under the assumption that the Federal Reserve couldn't issue debt," said Vincent Reinhart, a former senior Fed staffer who is now an economist at the American Enterprise Institute. He says it is an action better suited to the Treasury Department, which has clear congressional authority to borrow on behalf of the government.
