Thursday, September 22, 2011

The Twist

Monetary policy is twisted. Operation Twist is supposed to push bond yields closer to zero, which should reduce mortgage rates and revive housing activity. QE-1.0 was supposed to do the same thing. But it didn’t work. Housing remains in a depression even though the Fed purchased $1.24 trillion in mortgage-related securities from November 25, 2009 through the end of March 2010. Operation Twist is supposed to force investors to buy riskier securities, especially stocks, with the expectation that will somehow stimulate economic growth. QE-2.0 was supposed to do the same thing. But it didn’t work either, which is why the Fed is doing the twist.

Ten-year Treasury yields and mortgage rates were already at record lows before yesterday’s Operation Twist announcement. Yet housing remains depressed. The mortgage applications index for both new and existing home purchases remained at the lowest levels since 1995, based on 4-week average. It is actually 8% lower than a year ago and 42% lower than two years ago despite the drop in mortgage rates. The housing problem can’t be fixed with record low mortgage rates.

Actually, the Fed isn’t sure how Operation Twist will work to boost the economy. And how do we know this? The Fed said so in its FAQs: “The maturity extension program will provide additional stimulus to support the economic recovery but the effect is difficult to estimate precisely."