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Portfolio > Asset Managers

Fed Favors 5-Year Payoff of $1.2 Trillion in Mortgage-Backed Assets

By James J. Green, Joyce Hanson

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With estimates for U.S. growth in 2010 raised and diminishing concern about unemployment and inflation, a majority of Federal Reserve policymakers are in no hurry to raise interest rates or sell off the central bank’s $1.2 trillion in mortgage-backed securities (MBS) holdings.

Reducing the size of the Fed’s balance sheet, which grew enormously in response to the nation’s financial crisis, will take place gradually over five years as the central bank sells off its housing-related assets, according to the April 27-28 Federal Open Market Committee (FOMC) meeting minutes released on Wednesday, May 19.

Fed watchers have criticized the central bankers for their relative lack of experience dealing with the impact of asset sales on financial markets. As a result, this month’s FOMC minutes were eagerly awaited.

According to an economic forecast released with the FOMC minutes, the Fed currently predicts that the economy will expand from 3.2% to 3.7% this year, with the 2011 forecast unchanged at 3.4% to 4.5%. Central bankers in January forecast 2010 growth of 2.8% to 3.5%.

At the April FOMC meeting, a majority of Fed board members wanted to delay selling the assets until after the central bank lifts its interest rate target.

“Such an approach would postpone any asset sales until the economic recovery was well established and would maintain short-term interest rates as the Committee’s key monetary policy tool,” the FOMC minutes said.

Kansas City Fed President Thomas Hoenig was the lone dissenter in the April FOMC vote that kept interest rates at between 0.0% and 0.25%.

While most Fed members said a slow sale of assets over five years would allow markets time to adjust, others favored a faster three-year approach.

“Most preferred that the agency debt and MBS held in the portfolio be sold at a gradual pace that would complete the sales about five years after they began,” the minutes said. “A couple of participants thought faster sales, conducted over about three years, would be appropriate and felt that such a pace would not put undue strain on financial markets. In their view, a relatively brisk pace of sales would reduce the chance that the elevated size of the Federal Reserve’s balance sheet and the associated high level of reserve balances could raise inflation expectations and inflation beyond levels consistent with price stability or could generate excessive growth of credit when the economy and banking system recover more fully.”

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