What are Open Market Operations?

[Rshermr]

Yes? And? There is still no authority by the GAO to audit the monetary policy, foreign transactions or FOMC operations. I provide balance sheets too. But if I was given the ability to hide my market transactions, I could cook things up in all kinds of splendid ways.

As I said, there is currently no authority to audit the federal reserve's FOMC operations.

Federal Reserve System Audited Annual Financial Statements

The Board of Governors, the Federal Reserve Banks, and the consolidated LLCs are all subject to several levels of audit and review. The Reserve Banks' financial statements and those of the consolidated LLC entities are audited annually by an independent audit firm retained by the Board of Governors. To ensure auditor independence, the Board requires that the external auditor be independent in all matters relating to the audit. Specifically, the external auditor may not perform services for the Reserve Banks or others that would place it in a position of auditing its own work, making management decisions on behalf of the Reserve Banks, or in any other way impairing its audit independence. In addition, the Reserve Banks, including the consolidated LLCs, are subject to oversight by the Board.

The Board of Governors' financial statements are audited annually by an independent audit firm retained by the Board's Office of Inspector General. The audit firm also provides a report on compliance and on internal control over financial reporting in accordance with government auditing standards. The Office of Inspector General also conducts audits, reviews, and investigations relating to the Board's programs and operations as well as of Board functions delegated to the Reserve Banks.
From the fed itself. Sorry, lost the link. Could find it if you have any problem with the authenticity of this quote.

 

[Kimura]

Yes? And? There is still no authority by the GAO to audit the monetary policy, foreign transactions or FOMC operations. I provide balance sheets too. But if I was given the ability to hide my market transactions, I could cook things up in all kinds of splendid ways.

As I said, there is currently no authority to audit the federal reserve's FOMC operations.

There is still no authority by the GAO to audit the monetary policy, foreign transactions or FOMC operations.

So what? Look at last weeks sheet, look at this weeks sheet.
You can see what they bought or sold.
What do you feel they're hiding from you?

I posted the GAO audits for him from 2009-2013 in another thread. Apparently, he never read them.

 

[TakeAStepBack]

And yet, after all that flap yap, the open market operations of the federal reserve aren't up for audit. Ever. There is no authority granted to anyone to audit those areas listed above.

 

[Kimura]

Well....there's some half truths in the article.

First of all, QE is an asset swap, not money printing. All the FED really does is buy Treasuries and sells the dollars it creates. After this asset swap happens, the primary dealer that sold the Treasuries to the Federal Reserve now has cash as opposed to bonds, and the Federal Reserve now has Treasuries as opposed to cash.

In other words, QE is a change in the overall asset composition of government sector liabilities (and term structure). There isn't an increase in non-government net financial assets.

First, I congratulate you for a clear and concise description of OMO. I'd like to follow it up with a comment that goes to the heart of current monetary policy debates. In the usual economy we are used to, an increase in the banking sector "cash" is really an increase in the bank's deposits at the Federal Reserve. Treasuries are not part of the bank's reserves, but deposits at the Fed are. This means that OMO allow the Fed to increase bank reserves (the "monetary base"), and that banks can then lend out more money, creating an increased money supply and hopefully, increased economic activity. This is the traditional description of monetary policy.

Keynes great insight in monetary theory was that in some circumstances a "liquidity trap" is created where the additional reserves are not lent out, but sit as excess reserves in the banking system (about $2 trillion currently). Thus there is very little economic stimulus to OMO in these conditions. Whether or not we are in a liquidity trap is a question of fact, and the existence and growth of excess reserves seems to me to be determinative. If the Fed is buying Treasuries and increasing the monetary base, but that increase is mainly sitting in excess reserves, there will be little economic stimulus, growth of GDP will lag, unemployment will not be reduced, and inflationary pressure will not build up. There is no reason to believe that inflation or interest rates will rise in these circumstances, so forecasters who have been famously wrong in predicting large increases in interest rates and/or inflation as a result of the Fed's OMO ae wrong because they have ignored the implications of the liquidity trap.

Economics is not an experimental science and it is rare that we see a test of a theory as definitive as the last five years on the issue of whether or not a liquidity trap exists. It is even rarer that the evidence is so overwhelming in favor of one model. The opposite view has been forced into what can only be called intellectually dishonest arguments. Feldstein blames the failure of his hyperinflation predictions on the Fed paying 0.25% interest on excess reserves, soaking up all that inflationary pressure. If inflation is that easy to solve, we need never fear it again! Others (including many on this board) have gone into denial and argue that hyperinflation is happening, we just don't see it because suddenly the statistics no longer reflect the true "reality". Somehow the statistics magically became unreliable at exactly the right time, never mind that alternate measures of inflation produce pretty much identical results to the official measures.

So in a nutshell, this is what the debate over monetary policy has become. The world is either filled with confidence fairies and bond vigilantes and other magical characters or it is not. The discussion is now out of the realm of economics and into the realm of abnormal psychology.

By the way, if we look at what's transpired, QE hasn't decreased rates towards the long end of the yield curve. Mortgage rates have increased and housing has seen no tangible benefits in my estimation.

One of the best explanations of QE I've seen is by Professor Randall Wray.

Demystifying Quantitative Easing

 

[TakeAStepBack]

Goldman Sachs Calls For Higher Bond Yields? What It Really Means To Your Money - 24/7 Wall St.


Many investors do not realize the price risk in long-dated Treasury and other bonds because bonds have been in a secular bull market for so long. The real risk is if interest rates rise 150 basis points, 200 basis points, or even more. Most long-term Treasury investors are not really prepared for that sort of move. Most would even feel like they had been duped by the Fed and the government if the value of their long-term bond portfolio is suddenly worth 10%, 20%, or even 30% less than what they paid.



Uh huh....

 

[oldfart]

The federal reserves open market operations aren't up for audit. So we dont know what they're actually doing there. Contrary to the belief of some.

They post their balance sheet every week.

Compared to gold reserves which apparently are audited about twice a century.

 

[oldfart]

So, being truly old, my economics schooling was back at a time when the term "you can not push on a string" was commonly used relative to discussions of monetary policy and recessions where the underlying issue is DEMAND. Is this where you see us today, as I am inclined to?

What I find both exciting and frightening is that we have two liquidity trap episodes in modern history (three if you want to count Japan starting in the 90's). The first in the 30's was ended by WWII. No one knows how long the downturn would have gone on absent the military buildup begun in 1939--40. I fear that it could have become permanent, the "new normal". The second case, Japan, has not yet shown a clearly successful recovery from a liquidity trap/inadequate demand situation. The third is the one we are in.

So we have no clear cut example of how to short of war end a liquidity trap, and no real guidance on how to handle the transition phase when excess reserves begin to diminish and increases in demand to result in more inflationary pressure. Do we see a replay of 1937 America and fall back into depression? Do we overshoot and end up with the need for another anti-inflation Volker recession? Is there a way to thread the needle and avoid both dangers? Find a convincing answer, and you have my nomination for for the Sveriges Riksbank Prize!

 

[OohPooPahDoo]

I'm trying to learn about the process of money creation, and I'm not quite getting this.
Perhaps someone could point me toward a good book about it?

Its simple. The Federal reserve buys things on the open market - usually obligations of the U.S. Treasury - in exchange for the federal reserve notes it issues. The thing it buys then sits on its balance sheets to balance the liability of the issued note.

Say investor A sells $1000 worth of treasury notes to the Federal reserve. This will change the federal reserve balance sheet as thus -

ADD $1000 worth of treasuries to the balance
SUBTRACT $1000 worth of liabilities issues in the form of federal reserve notes (currency) or deposits.


The transactions cancel and the effect to the fed balance sheet is zero. As interest on the bond is paid, if the fed generates a net profit after expenses, it goes back to the treasury for the the U.S. general budget.

The federal reserve note or deposit is essentially representative of the assets of the fed. In the old days of banking, each bank issued its own notes, and the notes represented a share of the assets of that bank. So if you sold gold or treasuries or whatever to the bank, they printed up currency to give you in exchange. This represented a legal share of the assets held by the bank

 

[OohPooPahDoo]

That sounds about right from what I've been reading, but what I'm particularly curious about right now is whether The Fed tends to gain or lose on these trades. Does it buy securities at a premium or a loss? Surely the securities would not be placed on the market if they were expected to not profit.

Since The Fed has incentive to trade other than profit, wouldn't this place it in a weakened bargaining position? (i.e. more likely to take a minor loss to meet it's goals of inflation or deflation)

Since they are exchanging bank notes that bear zero interest for treasuries that pay interest, they will gain on the treasuries. Any net profit they have to send back to the government, though.

They may lose on some of the mortgages they buy.

If the fed ever took an annual loss Congress would have to make up the difference.

 

[OohPooPahDoo]

Yes? And? There is still no authority by the GAO to audit the monetary policy, foreign transactions or FOMC operations. I provide balance sheets too. But if I was given the ability to hide my market transactions, I could cook things up in all kinds of splendid ways.

As I said, there is currently no authority to audit the federal reserve's FOMC operations.

If you're going to lie on your balance sheet you'll lie on a transaction report as well.

 

[OohPooPahDoo]

Yes? And? There is still no authority by the GAO to audit the monetary policy, foreign transactions or FOMC operations. I provide balance sheets too. But if I was given the ability to hide my market transactions, I could cook things up in all kinds of splendid ways.

As I said, there is currently no authority to audit the federal reserve's FOMC operations.

There is still no authority by the GAO to audit the monetary policy, foreign transactions or FOMC operations.

So what? Look at last weeks sheet, look at this weeks sheet.
You can see what they bought or sold.
What do you feel they're hiding from you?

Perhaps he thinks he should get to know the names of the private individuals and businesses the fed sells and buys assets from.

 

[OohPooPahDoo]

Goldman Sachs Calls For Higher Bond Yields? What It Really Means To Your Money - 24/7 Wall St.


Many investors do not realize the price risk in long-dated Treasury and other bonds because bonds have been in a secular bull market for so long. The real risk is if interest rates rise 150 basis points, 200 basis points, or even more. Most long-term Treasury investors are not really prepared for that sort of move. Most would even feel like they had been duped by the Fed and the government if the value of their long-term bond portfolio is suddenly worth 10%, 20%, or even 30% less than what they paid.



Uh huh....

If most long term bond investors are that stupid they deserve to take a big short term loss.

 

[OohPooPahDoo]

So we have no clear cut example of how to short of war end a liquidity trap, and no real guidance on how to handle the transition phase when excess reserves begin to diminish and increases in demand to result in more inflationary pressure.

Its not the blowing up of buildings and the destruction of enemy armies that caused the economy to recover after WW II - it was the money that the war effort put in people's pockets.

If we hadn't had to go to war - and instead spent the same amount of money on bridges, roads, schools, parks - whatever - we would have been better of, as we'd have the same economic stimulus and have bridges, roads, schools etc in addition to that rather than a bunch of craters in Europe and Japan.

Unfortunately the government doesn't have the will to actually spend enough to get us out of it.

 

[Toddsterpatriot]

That sounds about right from what I've been reading, but what I'm particularly curious about right now is whether The Fed tends to gain or lose on these trades. Does it buy securities at a premium or a loss? Surely the securities would not be placed on the market if they were expected to not profit.

Since The Fed has incentive to trade other than profit, wouldn't this place it in a weakened bargaining position? (i.e. more likely to take a minor loss to meet it's goals of inflation or deflation)

Since they are exchanging bank notes that bear zero interest for treasuries that pay interest, they will gain on the treasuries. Any net profit they have to send back to the government, though.

They may lose on some of the mortgages they buy.

If the fed ever took an annual loss Congress would have to make up the difference.

The Fed could lose money on their bonds, as prices drop (rates rise).
The MBS they buy are guaranteed, so they wouldn't lose on the principle/interest, only on price.

 

[Toddsterpatriot]

Goldman Sachs Calls For Higher Bond Yields? What It Really Means To Your Money - 24/7 Wall St.


Many investors do not realize the price risk in long-dated Treasury and other bonds because bonds have been in a secular bull market for so long. The real risk is if interest rates rise 150 basis points, 200 basis points, or even more. Most long-term Treasury investors are not really prepared for that sort of move. Most would even feel like they had been duped by the Fed and the government if the value of their long-term bond portfolio is suddenly worth 10%, 20%, or even 30% less than what they paid.



Uh huh....

It's true, bond prices can go up or down.

 

[OohPooPahDoo]

That sounds about right from what I've been reading, but what I'm particularly curious about right now is whether The Fed tends to gain or lose on these trades. Does it buy securities at a premium or a loss? Surely the securities would not be placed on the market if they were expected to not profit.

Since The Fed has incentive to trade other than profit, wouldn't this place it in a weakened bargaining position? (i.e. more likely to take a minor loss to meet it's goals of inflation or deflation)

Since they are exchanging bank notes that bear zero interest for treasuries that pay interest, they will gain on the treasuries. Any net profit they have to send back to the government, though.

They may lose on some of the mortgages they buy.

If the fed ever took an annual loss Congress would have to make up the difference.

The Fed could lose money on their bonds, as prices drop (rates rise).
The MBS they buy are guaranteed, so they wouldn't lose on the principle/interest, only on price.

Yes, but the loss on the bonds would be only temporary ('temporary' of course being as long as 30 years ) as they pull to par.

 

[Rshermr]

So, being truly old, my economics schooling was back at a time when the term "you can not push on a string" was commonly used relative to discussions of monetary policy and recessions where the underlying issue is DEMAND. Is this where you see us today, as I am inclined to?

What I find both exciting and frightening is that we have two liquidity trap episodes in modern history (three if you want to count Japan starting in the 90's). The first in the 30's was ended by WWII. No one knows how long the downturn would have gone on absent the military buildup begun in 1939--40. I fear that it could have become permanent, the "new normal". The second case, Japan, has not yet shown a clearly successful recovery from a liquidity trap/inadequate demand situation. The third is the one we are in.

So we have no clear cut example of how to short of war end a liquidity trap, and no real guidance on how to handle the transition phase when excess reserves begin to diminish and increases in demand to result in more inflationary pressure. Do we see a replay of 1937 America and fall back into depression? Do we overshoot and end up with the need for another anti-inflation Volker recession? Is there a way to thread the needle and avoid both dangers? Find a convincing answer, and you have my nomination for for the Sveriges Riksbank Prize!

Well, I think we can assume that we will not learn to keep major recessions from happening again. Assuming we had the recipe, there is just too much desire to make it big during upturns with little concerns about future results.
So, maybe we can at least take a shot at what is the worst of the results. Stimulus that may result in too much demand and resultant inflation. Or lay off the stimulus and keep on with high unemployment and tepid economic growth. L

Looks to me that there is an opportunity to utilize some careful stimulus that could have a good result relative to employment increases, and good results on the economy over time. In that vein, perhaps proper infrastructure improvement aimed at both employment AND long term help with the economy. New energy areas, perhaps. And in general improvement in transportation for both business and safety reasons. And, I am of the strong opinion that we need to do something in the area of education, particularly aimed at providing the work skills and business development skills that we will need assuming we do not want to flip burgers and change money off into the future.
I have seen way too much of the need in our country to import talent from other countries to fill the high skilled positions of our economy. Seems to me we need to get serious about educating our own folks to fill as many of those positions as possible in a competitive way.
Seems to me we spend way to much time trying to reinvent wheels when, if we care to look around the world carefully, we could see some things we could do to help our economy be more successful.

 

[oldfart]

By the way, if we look at what's transpired, QE hasn't decreased rates towards the long end of the yield curve. Mortgage rates have increased and housing has seen no tangible benefits in my estimation.

Since you seem to like the deep water, here goes!

QE is pretty straightforward in that monetary policy only generally affects the short end of the yield curve, i.e. the yield on short-term Treasuries (under 3 years). In 1961 and again in 2011 the Fed tried "Operation Twist" (yes, named after Chubby Checker's hit song and dance craze). The Fed bought long term Treasuries to force the price up and the yield down, using sales of short-term Treasuries acquired in the course of QE to avoid printing money. Re-evaluation of the 1961 episode lead to a conclusion that Twist had been more effective than thought at that time and that another attempt might be worthwhile.

The problem was that the amount of short-term Treasuries on the Fed balance sheet was inadequate to carry out the level of operations thought needed. So the QE/Operation Twist experiment did not meet expectations. Since there was really no downside, I'd call it a success.

Currently the Fed says that it's long term inflation goal is 2%. If credible, I think this puts a floor on the long-term Treasury rates. I think we are in the situation of states that have legalized casino gambling and a lottery. Both generate revenue, but not as much as you would expect by adding projections together. Both are tapping the same pool of money. Similarly, the more tools we deploy (at least monetary tools) to lower interest rates as a stimulus measure, the less effective the combination will be. These things are simply not additive.

IMHO the best policy is to restrict Operations Twist to availability of short-term Treasuries in the Fed portfolio. We are stuck with the yield curve that does not flatten sufficiently, but I do not see a policy that would make this better without dire side effects. The announced inflation goal is a better tool. The Treasury--TIPS spread has gone from 1.5% to 2.2% over the last half year or so. I have no statistical evidence, but my gut tells me that the markets are becoming convinced that the Fed is serious about the long-term inflation target and that is at least contributing to the rise in market inflation expectations.

Now if we could only figure out how to take those mortgage-backed agency securities the Fed has been buying up in QE and dismantle the tranches so the underlying mortgages can be resolved........

 

[oldfart]

Many investors do not realize the price risk in long-dated Treasury and other bonds because bonds have been in a secular bull market for so long. The real risk is if interest rates rise 150 basis points, 200 basis points, or even more. Most long-term Treasury investors are not really prepared for that sort of move. Most would even feel like they had been duped by the Fed and the government if the value of their long-term bond portfolio is suddenly worth 10%, 20%, or even 30% less than what they paid.

Uh huh....

Spot on! The value of EXISTING long-term bonds is inversely related to the changes in the CURRENT level of interest rates. If long-term rates on the spot bond market rise, regardless of reason, the value of bond portfolios declines. People who forget that are going to get burned, and then they will cry that the Fed is "devaluing" their bonds.

The remedy is that the Fed has to stand ready to sell long bonds to moderate the rise in interest rates ( God knows they have enough in inventory!).

You've made an important point, thanks.

 

[Toddsterpatriot]

Since they are exchanging bank notes that bear zero interest for treasuries that pay interest, they will gain on the treasuries. Any net profit they have to send back to the government, though.

They may lose on some of the mortgages they buy.

If the fed ever took an annual loss Congress would have to make up the difference.

The Fed could lose money on their bonds, as prices drop (rates rise).
The MBS they buy are guaranteed, so they wouldn't lose on the principle/interest, only on price.

Yes, but the loss on the bonds would be only temporary ('temporary' of course being as long as 30 years ) as they pull to par.

The MBS are trading over par at the moment.
They also have huge unrealized gains on the bonds they hold that they'd have to lose first.
Even if they did sell at a loss, Congress wouldn't have to make up the loss, they just wouldn't send any earnings to the Treasury until they made up the loss.