U.S. Federal Reserve Chairman Ben BernankeJASON REED
A growing number of U.S. Federal Reserve officials want to begin dumping the roughly $1.2-trillion (U.S.) portfolio of mortgage securities it acquired during the financial crisis.
The central bank bought those assets to prop up financial markets and keep credit flowing into mortgages, doubling its balance sheet to $2.2-trillion.
Now as the economy recovers, Federal Reserve chairman Ben Bernanke and his colleagues on the central bank's open market committee are grappling with the question of how and when to sell those assets, according to the minutes of the committee's Jan. 26-27 meeting released Wednesday.
Committee members know they have to shrink the balance sheet to more normal levels eventually. But the minutes suggest there's a fierce debate on how soon to begin and what impact the sales would have on mortgage rates and the economy.
Some Fed members clearly don't want to do anything that would worsen conditions in the battered housing industry, which is still facing falling prices and a wave of foreclosures.
Others want to begin selling off those assets almost immediately to avoid causing a new housing bubble.
"Several thought it important to begin a program of asset sales in the near future to ensure that the Federal Reserve's balance sheet shrinks more quickly," the minutes said.
The Fed's asset purchases were designed to keep credit flowing into the housing market and keep interest rates low. Selling those assets - including mortgage-backed securities and bonds issued by mortgage lenders Freddie Mac and Fannie Mae - could lead to higher lending rates and stall a potential housing recovery.
Data released Wednesday by the U.S. Commerce Department suggests the housing market is still weak. Housing starts rose 2.8 per cent in January to an annual pace of 591,000 units - barely a quarter of its boom-time peak.
Nomura Securities economist Zach Pandl said the minutes may have been superseded by Mr. Bernanke's commitment last week not to go ahead with asset sales "in the near term" and only after it has begun pushing up interest rates.
"We take Bernanke's statement to be the consensus view and believe other opinions can largely be ignored," Mr. Pandl said in a research note.
The Fed has traditionally held mainly government Treasuries, and last week Mr. Bernanke said the Fed wants to return to that practice.
In remarks prepared for a postponed Congressional hearing, Mr. Bernanke said the Fed plan is to gradually shrink its balance sheet to more normal levels and get back to holding strictly government Treasury bills as those securities mature.
Mr. Bernanke also laid out his preferred options for reducing its balance sheet, including reverse repurchase agreements, offering term deposits to commercial banks, and redeeming or selling securities.
"Reverse repos and the deposit facility would together allow the Federal Reserve to drain hundreds of billions of dollars of reserves from the banking system quite quickly, should it choose to do so," he said.
At its January meeting, the Fed pledged to keep its benchmark overnight interest rates near zero for "an extended period."
The Fed has modestly upgraded its forecast of economic growth this year. The minutes said the central bank expects the economy to grow 3.2 per cent this year, compared with a November forecast of 3.0 per cent. The central bank also expects inflation to remain subdued.
Bernanke's exit strategy
Paying interest on excess reserve: By raising the rate it pays on bank reserves, the Fed essentially creates a magnet for banks to keep those reserves with the Fed rather than lend them out into the financial system.
Large-scale reverse repurchase agreements: The Fed could arrange large-scale reverse repurchase agreements (reverse repos), with financial market participants. They would temporarily drain reserves from the banking system and reduce excess liquidity at other institutions.
Term deposit facility: The Fed has proposed creating a new "term deposit facility" for banks, similar to certificates of deposit that banks offer retail customers. This would reduce the supply of funds banks have available to lend to each other.
Asset sale: The Fed could sell a portion of its securities holdings into the open market.