Bernanke’s Turn at Bat

BEN GOES TO THE HILL

All eyes and ears will be on Ben Bernanke today as he testifies in front of the House Financial Services Committee at 10 a.m. Topics beyond the economic outlook, which remains murky, will be the Fed’s planned exit strategy in detail and what last week’s hike in the discount rate symbolized. The Fed has implemented no fewer than 10 different facilities as part of its rampant balance sheet expansion since the TALF was unveiled in late 2007. Dismantling this infrastructure will undoubtedly be complicated and take time to evolve.

What was interesting, and a possible sign that the Fed will be slow to withdraw from its QE program, was the announcement by the Treasury that it will revive the Supplemental Finance Program that was initiated during the peak of the financial crisis. The program was used as a means to get the Fed cash/liquidity quickly to fund the programs it used during the liquidity crisis. As the Fed (as of now) does not issue bonds, the program worked as follows — Treasury issues short term debt and moves the cash onto the Fed’s balance sheet as reserves. The short term debt is issued to the primary dealer community and the cash is placed on reserve at the Fed in the Treasury’s account. The cash can be used now to fund continued purchases of MBS from the GSEs (as there is still $200 billion left to be purchased) and this is done without printing more money (raises the debt level of the Treasury, but does not increase the circulation of the fiat currency).

In addition, as the primary dealers are taking Treasury debt for cash there is less cash in the system. In effect, this can permit the Fed to raise capital to buy GSEs, RMBS, and drain some cash from the primary dealers — this may involve tightening of conditions in the primary dealer area, but allows the Fed to continue to support the housing market by maintaining its MBS purchase program. In any event, Bernanke has a tough task ahead of him, which is to explain in simple terms just how monetary policy is going to be shifting in the near future but without any move in the Fed funds rate.

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