This massive foray of the fed into the mortgage

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This massive foray of the Fed into the mortgage market, even if unavoidable in its war on the great panic, raises serious issues about how and when the Fed can retrench from the expansion. This may also curtail its freedom to raise interest rates and mop up the liquidity that it has injected in the economy. Ironically, we will argue, the more that the Fed gets caught up in the rest of the federal government’s expansion into mortgage finance, the more likely it is that its future monetary policy will not be independent and will be largely driven by the need to monetize government debt. We provide some suggestions for unwinding by the Fed, which ultimately needs a restart of the private mortgage markets (for which we propose reforms in Chapter 8). We also discuss whether the special status that is enjoyed by the GSEs in various Federal Reserve operations – in normal times and in emergency – is desirable and how to restrict or eliminate this special status so that the Fed can avoid its current dilemmas in the future. 6.1. Putting out the fires As described in Chapter 4, on July 13, 2008, Treasury Secretary Henry Paulson announced an effort to backstop (“conserve”) the GSEs, in coordination with the Federal Reserve. Besides the direct support from the Treasury through a line of credit and ownership of Fannie and Freddie’s equity, the September 7, 2008, conservatorship plan introduced a consultative role for the Fed in a reformed GSE regulatory system. The same day, the Fed announced that it would have the right to lend to the GSEs as necessary. Effectively, the Fed was to be the lender of last resort not just to the private financial sector but also to the GSEs. 40
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77 Figure 6-1 shows the evolution of the Federal Reserve’s balance sheet. It shows the dramatic rise in total securities that were held outright by the Fed, as well as the rise in two of its components: Agency debt and mortgage-related assets, with the remainder being Treasuries held by the Fed. The Fed originally announced that it would purchase up to $100 billion in debt from Fannie Mae, Freddie Mac, and Federal Home Loan Banks, and up to $500 billion in mortgage-backed securities (MBS) issued by Fannie Mae, Freddie Mac, and Ginnie Mae. The Fed embarked on its massive purchase program in January of 2009. But on March 18, 2009, it raised its intended purchases of agency debt to $200 billion (a $100 billion increase) and of agency MBS to $1,250 billion (a $750 billion increase). It made its last MBS purchase on March 31, 2010, having fully exhausted its $1,250 billion target capacity. It also purchased $172 billion in Freddie and Fannie debt, between December 2008 and March 2010. Though we used the terms “last purchase” and “capacity”, the Fed actually has discretion over the size and composition of its balance sheet. With regard to the composition of its balance sheet, the Federal Reserve Act (FRA) of 1913 limits the range of assets that the Fed may acquire directly. This range is considerably narrower than the range of assets that the Fed may accept as
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