Fed bonds

These are extraordinary times at the Fed. Looking back, the years under Alan Greenspan now seem almost quaint. Fulfilling the Federal Reserve’s dual mandate of full employment and low inflation was relatively easy. There were a couple of scares, but for the most part Mr Greenspan’s job involved the odd 25 point move followed by a speech, or perhaps lunch.

Today, however, the Fed is up to its neck in the nastiest economic crisis since the Great Depression. Its role of maintaining financial stability has brought its balance sheet to bare underpinning a range of asset markets as well as bailing out the odd mortgage company. For an institution that is technically private (its shares are owned by member banks), the Fed’s lengthening tentacles are already alarming some on Capitol Hill. But the mooted idea of the Fed issuing its own bonds for the first time may well prove an initiative too far.

It is not a stupid plan. One way for the Fed to raise money is for the Treasury to hand it the proceeds of bonds sales. Another way is for the Fed to increase bank reserves. The trouble with this second approach is that only banks can participate and they are saturated with deposits to the point of preferring Treasury bills yielding nothing to earning 50 basis points at the Fed. By issuing its own debt, the Fed could theoretically target lenders beyond the banking sector, while at the same time reducing excess reserves. This would also help bring the overnight rate and the Fed’s target rate back into line.

But under current laws the Fed cannot issue its own bonds. And an independent central bank borrowing on behalf of the government would muddy the waters. This is not about the money – the Fed’s balance sheet is already limitless – but about monetary fine tuning. It is strange, though, that a measure that would suck funds from the system is being proposed just at a time when the rest of government is pumping as hard as it can.

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