Trump Talked, the Fed Listened: Let’s Shrink the Balance Sheet, Bullard Says

Even a Fed dove! This could get interesting.

The Dow is titillating the entire world by verging for days within a hair of 20,000 without actually getting there. Hitting the Big One would be another reflection of what Trump had called during the campaign an “artificial stock market” in a “very false economy,” created by the Fed that had kept rates low “for political reasons.” The crowds ate it up.

He pointed out that “the only thing that’s strong is the artificial stock market,” which was “only strong because it’s free money because the rates are so low.” But there’d be a hitch: “At some point the rates are going to have to change,” he said.

“They’re keeping the rates down so that everything else doesn’t go down,” he told reporters when they asked him about a rate hike in September.

And the Fed listened. Now the Fed has raised the fed funds rate, after flip-flopping vociferously an entire year, and is playing with the idea of three more rate hikes next year. Even Fed doves are suddenly getting antsy, after luxuriating in eight years of ZIRP and six years of QE.

On Friday, it was St. Louis Fed President James Bullard’s turn. In an interview, he told the Wall Street Journal that the Fed should consider shrinking its $4.5 trillion balance sheet in 2017; it “possibly might be a good time to play that card,” he said.

During its five years of QE, the Fed has acquired $2.46 trillion in Treasury notes and bonds and $1.75 trillion in mortgage backed securities (MBS). As these securities mature, the Fed buys similar securities as a replacement to keep the balance sheet from shrinking. Thus, the Fed continues to be a powerful buyer in the markets.

This certainty that the Fed is buying assets infuses confidence into the markets and inflates prices. It lures investors into chasing yield in ever riskier assets with ever lower returns, resulting in low cost of capital for Corporate America. It has created what Trump called the “false economy” and the “artificial stock market” where financial engineering has taken precedence over investment in productive activities that would actually move the real economy forward.

That was the idea from the beginning. It’s the foundation under today’s dizzying asset prices.

Bullard would start by allowing maturing securities to roll off the balance sheet without replacing them with new asset purchases, he said. That would shrink the balance sheet. And it would make financial conditions more restrictive.

Shedding assets accumulated on the Fed’s balance sheet is the ultimate form of tightening. It would pull liquidity out of the markets and force them to stand on their own wobbly feet.

And he’s a dove! He sees only one rate hike next year. Until recently, he saw only one rate hike, period – the one we just got – and no additional hikes over the next few next years. But he’s ogling the balance sheet.

If shrinking the balance sheet is too radical for now, the Fed could replace longer term securities as they mature with short-dated securities, he said. This would make unwinding the balance sheet easier, once the decision is made. These short-dated securities could just be allowed to mature without replacement. It could go pretty quickly.

“My preference would be to allow some runoff in the balance sheet,” he said. But before markets could spiral into a paroxysm, he added that he didn’t think efforts to shrink the balance sheet were “imminent.”

He has been a voting member of the Federal Open Market Committee, which makes the decisions on rates, QE, and balance sheet shrinkage. But next year, he’ll rotate into a non-voting slot. So he’s just setting some trial balloons adrift.

A few Fed heads have dared to suggest that they’d want to shrink the balance sheet eventually, possibly after everyone’s life expectancy expires. They’d want to raise rates first, and if the economy hasn’t fallen into a recession or worse by then, it might be time to think about letting the balance sheet contract.

But the economy might never get to where there are some sort of normal rates without a recession. And a recession would start the whole process of rate cutting and perhaps QE all over again, and the balance sheet might never be shrunk in this scenario.

Bullard doesn’t want to wait that long. For good reason. QE has caused enough distortions.

Shrinking the balance sheet by allowing bonds to roll off, while keeping the fed funds rate relatively low, for example at 1.5% by next year, would cause long term rates to rise sharply while keeping a lid on short-term rates. It would steepen the yield curve. In this scenario, the 10-year yield – at 1.38% in July and now at 2.6% – might go to 4% or beyond.

It would have an epic impact on Trump’s “artificial stock market.” It would cause all kinds of mayhem, because Trump was right: The epic bond market bubble and the stock market rally that has pushed all conventional metrics off the charts have been fueled by the Fed.

The effects of removing, to use Trump’s term, the “artificial” elements from the stock market could be interesting. We’d have to avert our eyes from the carnage in the bond market. And Housing Bubble 2, with 30-year fixed-rate mortgages at 6%? That’s historically low and worked just fine ten years ago (it helped create Housing Bubble 1). But with the inflated home prices of today, it would mark a big reset.

Today’s equations won’t work at these interest rates. The fireworks could be astounding. But in the big picture, it would just unravel some of the excesses of the past few years, bring a hue of normalcy to the markets, and refocus attention on the real economy instead of wild financial speculations. Trump, as he was talking during the campaign, should appreciate that. Trump, as mega-investor, might get queasy. And Trump, as President, would be more than embarrassed to see financial markets sag under his watch.

The Fed already has plenty of reasons to move. Businesses expect their input prices to jump by 4.6% in 2017. Read…  No Demand, No Problem: Inflation Pressures Surge

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  104 comments for “Trump Talked, the Fed Listened: Let’s Shrink the Balance Sheet, Bullard Says

  1. Willy2 says:

    – Nope. The FED FOLLOWS what a person called Mr. Market demands. The FED follows the 3-month T-bill rate.
    – Shrinking the FED’s balance sheet means that the US government needs more (tax payer) money to redeem those T-bonds. Rising taxation, any one ?

    • Kam says:

      Incredible ! The Fed follows the 3 month T-bill rate ? I guess all that buying of debt- pushing up bond prices and suppressing interest rates have no effect.

      Interest rates are set (low) by Central Banks to rob from (poor) savers to enrich the Too Big Too Fail crowd. Too Big Too Fail being a marketing term for Too Irresponsible to take your own losses from your own wallet.

      Free market in interest rates ? Beyond laughable… that is a cruel joke.

      • Willy2 says:

        – Right !!! In the 1960s the FED executed “Operation Twist”. The FED/government wanted to push rates lower and started to agressively buy bond out the market. But it didn’t work. Rates simply kept rising.

      • Willy2 says:

        – Cruel joke ? Far from !!! A LOT OF people assume that the FED sets (short term) interest rates. And that’s a false assumption.
        – Because in the crash of 1873 short term US rates also went down to almost zero. That couldn’t have been done by the FED because the FED opened its doors in 1913.

    • ambrose bierce says:

      How do you tax people who have no connection to productivity?

      • Willy2 says:

        – Create a level playing field for national taxes.
        – Close all the taxloops.
        – Introduce a nation wide VAT (Value Added Tax).
        – Get rid the Obamacare exemption for municipal bonds.

        • d says:

          “Get rid the Obamacare exemption for municipal bonds.”


          Munis Treasury’s and various other state/federal bonds should be tax exempt, as the rates are generally low, especially in good times and investors need to be encourage to invest in them.

          p45 infrastructure expenditure could be easily fully funded, by tax free bonds, particularly if they were anonymously owned and in smaller denominations..

        • Willy2 says:

          – Nope. Rates for Munis are so low just because they’re tax exempt (both income & Obamacare).
          – Investors see the word “Tax exempt” and/or “tax deduction” and then lose their ability to think rationally/critically.
          – Same story for deductions on interest payments for mortgages. That system of deductions have pushed real estate prices (much) higher.

      • d says:

        Municipal taxes, Sales taxes, Poll taxes, Import taxes, Etd, Etc.

  2. Raymond Rogers says:

    What course would Wolf Richter take 8f he had a chair at the FED?

    • NotSoSure says:

      -5% loan for the Wolf Media Empire. +20% for everybody else …. :)

    • Wolf Richter says:

      Glad someone asked, finally…

      1. Fed Chair Wolf Richter would have NEVER done QE in the first place, period. QE was a terrible thing.

      2. During the Financial Crisis, when credit froze up, the Fed acted as lender of last resort to large financial institutions and big companies that had finance branches (GE, CAT, etc.). This was done under different programs, not QE. I would have done that too, but at PUNITIVE rates (i.e. 5 percentage points above CPI).

      3. The fact that banks paid record bonuses in 2009, the year they got the Fed bailout money, shows how obscene crony capitalism and the banker cabal really are. I would have made sure the FBI investigates every executive of a bailed-out bank for criminal violations of some kind. As bank regulator, I would have made sure they got fired, along with the entire board. “Or you lose your banking license….”

      4. Fed Chair Wolf Richter would have never reduced the fed funds rate below the rate of inflation. I would have put an end to financial repression.

      5. I would have pressured congress to pass a modern version of the Glass-Steagall act, during the bailouts when Congress was eager to keep the US financial system from collapsing. During those days, I would have had a lot of leverage with Congress, and I would have used it.

      6. I would have made clear that “price stability” = 0% inflation as per CPI (not 2% inflation as per core PCE), and that 0% would be the target. If you borrowed too much money and want inflation to help pay off your debts, tough. Think again. Default, etc.

      7. If I were appointed Fed Chair NOW:

      – I would announce in my first press conference that QE would be reversed, come hell or high water, at a rate of $75 billion a month. At this rate, it would take nearly 4 years to bring the balance sheet down to $1 trillion.

      – I would raise the fed funds rate to just above the rate of inflation (i.e. 12-month CPI) in increments of 0.25 percentage points a month.

      But FAT CHANCE that I would ever become Fed anything – with this sort of attitude :-]

      • d says:

        people who would be good at jobs, never get them especially Govt ones.

      • Jimbo says:

        AMEN to that brother!

      • pete says:

        You’re tough Wolf — but can I say sensible…PJS

      • walter map says:

        With that kind of thinking the debacle never would have occurred in the first place.

        Which is why that kind of thinking is avoided. Proper regulation prevents catastrophes so horrifically expensive messes don’t have to be cleaned up afterwards. All perfectly doable, but unfortunately they’re hugely profitable to TPTB so recurring catastrophes have always been established policy.

      • nhz says:

        many good points.

        maybe add to (3) and investigation why all the big banks paid 1% of their TARP money to the Clinton Foundation, and 3% in case of Goldman Sachs (despite betting on the wrong horse, they seem to have won the presidential race anyway …).


        • TCG says:

          While I don’t love the Clintons agenda for globalization and continuing the business as usual for the financial industry, you don’t get a pass on just making things up.

          The figures of what went to the banks under TARP are available at . The Clinton foundation has taken in $2 billion in donations over its history (check Wikipedia, for example).

          A cursory check shows your “numbers” don’t add up and a 1% donation from tarp funds would be well over the amount they’ve taken in over nearly 20 years. All these numbers have had public scrutiny and are well known.

          One thing I value about Wolf Street is that there are valuable perspectives and Wolf does research and presents figures to support his questions, claims and thoughts.

        • nhz says:


          I haven’t seen a credible denial of the leaked data that list the ‘campaign contributions’ and the TARP money received by these contributors. Probably not all the banks who got TARP money paid their fair share ;-)

          I don’t remember if this money went to the Clinton Foundation or the DNC (nor does it matter IMHO). Until proof of the contrary I’m assuming the amounts are correct, because I haven’t see any example yet where the leaked email data proved false.

        • nick kelly says:

          There are two main charity watch dogs- both give the Clinton Foundation their best grade- 5.
          One of them, Charity Watch, reports that it gives out 90 % of its
          donations, an unheard of ratio that puts to shame most TV charities. There are a LOT of flaky charities.

          But few as flaky and possibly criminal as the Trump Foundation.
          To begin with (there is no end) it is NOT EVEN A REGISTERED CHARITY. It’s been masquerading as one and soliciting donations illegally for years .
          Some of its expenditures include hundreds of thousands in Trump’s legal bills, a six foot- high painting of The Founder, and 7 (seven) dollars for his kid’s scout fees.
          But it has made donations. It gave 150K to the Palm Beach Policemans Ball- a worthy cause.
          They then ‘decided’ to hold the gala at Mar-a-Lago, for which Trump billed them 350K.
          Note: other people’s money makes donation- Trump gets rent.

          A lawyer with 20 years experience defending dubious charitable donations ( often from IRS objection to deduction) says it is the ‘most blatant case of (illegal) self- dealing I’ve ever seen. ‘
          Erich Schniederman AG NY State has been busy preparing for the Trump U fraud trial, settled at the last moment. He has only had time to issue the Trump Foundation a Cease Order.
          But there is much more to come on this file, the question is will the complaint be civil or criminal.

        • nhz says:

          @ nick kelly:
          Oh please, do you really believe the nonsense you are writing??
          “give out 90% of donations”, the facts lead to a completely different conclusion (if I remember correctly it is just 3%).

          Probably the fact checking watchdogs you rely on are funded by Soros?

          And don’t make me laugh, you are crying wolf about a 350K problem with the Trump organization?? With the Clintons we are talking about billions, and most of that is illegal collusion by common moral standards (of course, as things work nowadays in the USSA everything done by the Clintons and their ilk are by definition legal and charitable, after all the Wapo and NYT etc. say so so who would dare to doubt it).

        • Chicken says:

          Yes of course, the Clinton foundation is the best charity ever to have graced the planet. There’s just no argument or discussion about how wonderful the Clintons and their policies are.

          Globalism is far from fair trade, it’s been a mechanism for elites to stuff their pockets has led to exacerbated global climate change and insane military spending.

          Consider what got us to where we are now, all our best thinking?

      • DH says:

        Sounds good to me!

      • polecat says:

        Dear Mr. Richter, your hypothetical solutions are on point, and were absolutely needed to regain confidence by the public, of our governing & regulatory institutions ….. unfortunately this is a ‘fake news’ site …. and thus in need of censure by those grasshoppers who would continue to screw all those little, worthless ants . ….. ‘;[

      • rich says:

        Wolf, your initial post was dead on, but your follow up comment makes me wonder. After Jackson become President, he was so bothered by speculation that he shut down the Second Bank of the United States in 1933. He went to “real money” (gold and silver) rather than paper. This ultimately resulted in almost half the US banks failing, massive unemployment, dependence on the Bank of England for loans (and the BOE doubled the interest rate from 3% to 6%), a 25% drop in cotton export prices, bringing many States to the brink of insolvency and ultimately to the Panic of 1837. If it weren’t for the 1849 California Gold Rush, who knows when the US economy would have started to boom again.

        High mortgage rates destroy cap rates, and it would kill both residential and commercial real estate values. If it weren’t for this ponzi real estate recovery, there wouldn’t be much happening at all on Main Street. Your wishes for the Fed would resort in extreme austerity for the general public. With over 75% of Americans already living from paycheck to paycheck, a government austerity program would crush them.

        We have an economy totally dependent on the Government. Close the US Military bases, and major towns and cities all over the country would collapse financially. Do away with government-backed mortgages (which could happen anyway), and house buying would collapse. Do away with food stamps (SNAP), and 25% of the country’s children would be begging for food. We’ve all ready got 94% of Americans out of the work force. If you got what you wished for, that number would grow dramatically. We know that this growth driven US economy will die, as both you and I shall die, but don’t we want as much time as we can get in the mean time?

        • Emanon says:

          Enough of your facts are obviously wrong, and this casts suspicion upon the correctness of your conclusions.

          First, it was not 1933 but 1833 when Jackson removed federal deposits from the Second Bank of the US. The bank shut down for good in 1841.

          Second, 94% of Americans are not out of the workforce. That implies an employment rate of 6% of the population. That is obviously wrong. The stats for November 2016 show 152.085 million employed, almost half of the total population.

        • nick kelly says:

          The 1933 was so obviously a typo I didn’t bother to correct it.
          People who denigrate obvious typos are being silly.

      • Maximus Minimus says:

        Well, what can I say: Wolf Richter for the FED chair. The post is available no later than 2018. But it will never happen if you are one who celebrates Christmas.

        • jdubyah says:

          LOL, yeah.

          I always admire the clarion ring from a statement of veracity.

        • rich says:

          Replying to Emanon:

          “Enough of your facts are obviously wrong, and this casts suspicion upon the correctness of your conclusions.

          First, it was not 1933 but 1833 when Jackson removed federal deposits from the Second Bank of the US. The bank shut down for good in 1841.”

          If you have a modicum of intelligence, then you knew that the “1933” was a typo, and that I meant 1833. As far as you shut down date, that is largely symbolic, because the banks was not Federally re-charted in 1836. That was followed by the Panic of 1837.

          “Second, 94% of Americans are not out of the workforce. ” Again a typing mistake. The 94% was supposed to read 94 million. I believe if you research that number, you will find it to be in line.

      • Raymond Rogers says:

        It’s nice to see you weigh in a bit more. I imagaine most of us come to this site because we don’t work in finance, and want alternative viewpoints. The answer even answered my next question as to what you would do now.

        So, I’ll ask this. How much of a priority would you make raising interest rates (so that the FED has a tool in the box for the next recession)? Do you see a necessity in this or is too much weight given to interest rates?

      • jb says:

        spoken like a true Austrian ! The original intent of the
        federal reserve was to be a lender of last resort . That is,
        to provide liquidity when things got tough. However ,
        now the feds role is a funding mechanism to enable excess government debt . The really disconcerting
        thought is that the cheap cost of capital has not resulted in a corresponding increase in plant , property and equipment investments for america. Qe is feckless , we have reached the limits this model can provide .

        • d says:

          “The really disconcerting
          thought is that the cheap cost of capital has not resulted in a corresponding increase in plant , property and equipment investments for america. Qe is feckless , we have reached the limits this model can provide .”

          The real disconcerting thing is that the Globalised Vampire Corporates allied with china. Have taken this cheap American QE Funding and invested in the cheap environmentally and industrially, dirty, unsafe country’s. Exploiting the local populations, whilst milking the America tax payer, and the American consumer.

          You are blaming the FED for the action’s of these Globalised Vampire Corporates allied with china. The FED cant mandate how the QE is spent.

          That’s like locking a dog inside for days, then complaining because it made a mess.

          These Globalised Vampire Corporates allied with china, want labour rates to be the same everywhere $0.00, then they will complain that goods are not selling in any volume.

          It is time for the cheap environmentally and industrially, dirty, unsafe country’s. To be tarried based on their low labour standards and conditions, total pollution, and lack of Enviromental standards.

      • Maximus Minimus says:

        8. Restrict money supply to a quasi gold standard. Interest rates should be dictated by supply and demand and not on bogus inflation number. You can be irrationally exuberant, but it would cost you.

      • wkevinw says:

        The parts about how to treat the banks are basically the same as what FDIC Chair Sheila Bair was saying back then; which I agree with. She got laughed at by the Bush Admin cronies.

        I agree with the details of your post!

      • KatoNokto says:

        “– I would raise the fed funds rate to just above the rate of inflation (i.e. 12-month CPI) in increments of 0.25 percentage points a month.”

        I had never considered that obvious option… Smart Idea!

      • ambrose bierce says:

        They fought fire with fire, fighting deflation by inflating the monetary system. There is global overcapacity in consumer goods, when coupled with a policy to devalue the currency, the result is too little money chasing (too) few goods, which is deflation. No money and nothing to buy with it and no real need to buy it. Then President Trump has a series of stimulative business policies to further the imbalance.

    • Tom kauser says:

      Take the easy way out and transfer the 4.5 trillion fed balance into social security trust fund and welcome our cyborg work force to replace the rest of our burden.

  3. Trumpet Tooter says:

    Trump the candidate could take aim at the artificial stock and bond markets promulgated by the Fed.
    What about Trump the President? Does he wants a brutal market burst on his watch, with consequential negative impacts on the economy; perhaps even a recession?
    Perhaps this is the way that the Fed is getting back at Trump: a double dare?

    • Tom kauser says:

      He wanted a meltdown and be careful what u wish 4?

      • RepubAnon says:

        Sounds like the normal takeover artist strategy: force as many losses as possible right away, blame them on your predecessor, take credit for any subsequent gains.

    • Jerry says:

      Perhaps even a recession!!!!!

      You need to buckle up right now.

    • Kent says:

      It worked for Reagan…

    • nick kelly says:

      I wonder when it’s going to occur to Trump’s folk that he hasn’t the slightest idea about any of this.
      How long are you going to tie yourself in mental knots: ‘Gee, he criticized the Fed for its low interest rates- so does he want higher rates? Isn’t that strange in a real estate guy? Is the Fed trying to ‘get even’ by giving him what he asked for? ‘

      Or suggesting that US policy re: Taiwan and One China was a trade issue.
      Which by the way offended both of them and should offend Americans.
      We always known Trump’s friendship is for sale- is yours?

      And on and on. Asking about Trump’s views on macro-economics is like asking why Candy Crush was hot and now it’s not.

  4. d says:

    A clandestine shrinking would be a better weapon, that too many rises too fast.

    There is plenty of money out there willing to moved from junk to treasury’s if they can get them.

    I would rather see the FED reduce its MBS and various other paper mountains, ( effectively cra p it should really have) before Treasury’s.

  5. Greatful again says:

    The Fed backing off the markets would probably just reveal how bad the real economy really is….and then we’d be into a recession pretty fast. Inflation expectations seems a rather weak justification for bringing down the works. But hey, maybe it’ll all be ok.

  6. Paulo says:

    Regardless, as a ‘saver’ I wouldn’t mind at least some kind of return. In our family we aren’t buying much these days, anyway. These low rates are a total distortion and I’m not sure that they can be ‘normalized’ without creating outright havoc. It will be interesting to see Trump’s reaction when/if the Market tanks. Of course it will all be someone elses fault.

    • nhz says:

      Yes, same story in Europe.

      There is plenty of evidence by now from official reports that most people are saving MORE, not less, because of NIRP and other Central Bank distortions. Which of course means that people are spending less and as a ‘saver’ I do that too, always have. And I’m certainly not going to spend more because the government is doing all it can to jack up prices, I will try to hold on until prices (for those things I am not forced to buy/pay) are sensible again. The only people who are spending more are those who are spending OPP, debtors and all the new migrants.

      Fixed rate 10-year mortgages are below 1% now in my country, they used to be 6-8% not too long ago and 12% in the early nineties. Can’t wait to see rates revert to at least 6%, this would be an extremely valuable lesson for much of the population. Probably the whole country would go bankrupt and hopefully that would teach politicians, banksters and citizens a lesson. I fully hope that when that happens our elite have much of their money stashed in high end RE ;-)

      • nhz says:

        P.S.: when that happens, of course they will blame Russian hackers or Mr. Putin personally.

      • Mark says:

        When mortgage rates head back up toward 6-8%, I’m positive that they’ll roll out the 50, 75, 100 year mortgages out. More games to keep monthly payments affordable, yet allow current homeowners to maintain the illusion that their home’s value really is that high.

        My wife and I both are professionals in our early 30s – no kids – and we make a very comfortable combined income. We save around $5k/month after taxes. A nice condo runs maybe $800k here, and a SFH over $1M. We are finally getting to the point where we have enough saved that we could make a downpayment on a home, but we probably won’t. We’ll probably rent a few more years and try to buy all-cash when prices come down 50%. One can dream.

        • nhz says:

          Funny that you still need a down payment in the US; if they required that in the Netherlands it would start a revolution. Homeowner organizations are already crying wolf because next year the ‘maximum’ (= standard) mortgage amount will be 103% instead of 104% now. 103% covers all the closing costs here.

          It depends a bit on the type of mortgage, but e.g. 30 or 50 year mortgage makes little difference for the monthly payments. It has been tried in my country but apparently it doesn’t work; I think Japan has tried it too with also relatively little effect.

          I will buy all-cash but only when prices come down a lot more than 50%; maybe -75% would start to get me interested and even then most properties would still be hugely overvalued; getting back to the longterm trendline would require about 85% down.

        • JB says:

          I am with you. Now is not the time to buy a house.
          We are at maximum asset valuation courtesy of
          the FED. some valuations exceed prebust 2008.
          Cash is king ! Place excess earnings in 6 month
          cd’s . Avoid the mega banks. Join a credit union.
          they have better rates on almost all products.

          keep your powder dry . there will be a better chances to buy a home .

  7. Johnny Reb says:

    Excuse my ignorance, but where do the mortgage back securities “roll off to?” Do they just disappear or does some other sucker buy them?
    “Bullard would start by allowing maturing securities to roll off the balance sheet without replacing them with new asset purchases, he said.”
    The more I learn about economics the less I understand.
    Thank you for any info.
    J. Reb

    • Wolf Richter says:

      When securities “mature,” they’re paid off by the issuer. In other words, the Fed gives the MBS back to the issuer, and in return it gets their face value in cash from the issuer. So now the securities are gone from the balance sheet (they “rolled off”). And the Fed extracted their face value in cash from the markets (this is done via its “Primary Dealers.” This reverses the QE process when the Fed bought the MBS.

      The MBS on the Fed’s balance sheet were issued by the housing agencies (Fannie Mae, etc.). So they pay off the Fed when the MBS mature.

      • Johnny Reb says:

        Thanks’ Wolf,

        Wolf Street is COOL!

        J. Reb

      • nhz says:

        … and so the housing agencies will need a lot more tax payer money ;-)

      • Mel says:

        Yes, thanks from me, too. I was just about to ask this, to check whether I’d decoded all those drygoods metaphors about shrinking and unwinding right. That was the answer I needed.

      • Justme says:

        I’m going to be devils advocate(?) here for a moment. Yes, Wolf describes the mechanics of bond redemption correctly. But there is more going on behind the curtain. What happens to all the payments (principal and interest) that get made by people whose mortgages back the bonds (say, using MBS bonds as example)?. Well, the bond issuer (or their designated loan servicer) collects those, but what do they do with these payments?

        Well, that depends on the type of bond. If it is a bond with “interest coupons”, then each bondholder will get the interest payment each month (or whatever agreed-upon cycle) by submitting such a coupon. This could be done electronically, and not with a paper coupon, of course, although at some point all interest coupons were a physical paper coupons and perhaps some still are). At the end of the bond duration, the bondholders, if all goes well, have received all the interest payments and the bond issuer has received all the principal payments. At which point the issuer is obligated to pay the principal back to the bondholder. However, in the meantime, the bond issuer very probably is re-lending out the incoming principal payments as new mortgages and creating new bonds that are the claims on the mortgages.

        So, the bond issuer is not sitting on “cash” for 15 years (or whatever) waiting for the pile to grow big enough to pay off the bondholder in the end. Nor does the bondholder get periodic (monthly) principal repayments. However, at the end of the 15 years, the bondholder will receive payment, in the form of a credit to their bank account, which is in turn an IMMEDIATE (not sometime in the future) claim on that banks posted reserves at the centralbank. Reserves being essentially “cash” for practical purposes.

        My guess is that only a very small fraction of the population have ever thought about how this actually works.

        I’ve got to do something else, so I will leave the so-called “zero-coupon” case as an exercise for the reader.

        • Wolf Richter says:

          Yes, this is what occurs with nearly all bonds and issuers, corporate and government alike. Companies and governments don’t save up money to redeem the bonds. They simply “roll them over.” In other words, they issue new bonds to pay off old bonds. That’s why the total balance of bonds outstanding only grows and doesn’t diminish. And that’s why companies and governments that can’t control the currency in which they issued the bonds (= Greece, Argentina, Detroit, etc) default when they cannot issue new bonds at reasonable rates: because they cannot raise the money to pay off the old bonds.

      • JB says:

        thanks for straightforward explanations of FED
        policy. But mr. richter ,can one infer that the massive
        asset devaluation that came from the 6 million home foreclosures last recession (i.e. the losses/write downs)
        on MBS paper occurred on the feds balance sheet ?
        This paper will never be rolled and constitutes a permanent increase in the money supply ?

    • d says:

      Think man.

      MBS = Morgage backed securitys one way or the other eventually all the loans GET CLEARED.

      various other bonds all have maturity dates.

  8. Neil says:

    Da Fed, and its company of BS artistes and film-flammery quacks! Believe in them at your peril.
    Sir Josiah Stamp said it best! “Banking was conceived in iniquity and was born in sin. The bankers own the earth. Take it away from them, but leave them the power to create deposits, and with the flick of the pen they will create enough deposits to buy it back again. However, take away from them the power to create currency, and all the great fortunes like mine will disappear, and they ought to disappear, for this would be a happier and better world to live in. But, if you wish to remain the slaves of bankers and pay the cost of your own slavery, let them continue to create deposits.”
    These psychopathic parasites (bankers) need to be rooted out and jailed — until their behaviour is completely arrested.

    • Frederick says:

      Couldnt have said it better myself Neil Bravo brother Where the heck is Jon Corzine?

      • polecat says:

        He’s not behind BARS …that’s for sure !!

        …But hey, he’s a good, bundling demrat … right !

    • nhz says:

      Agree, why would anyone listen to clowns like the Bullard.

      Inflating the money supply, creating money out of nothing is all the FED knows. They are never going to take the punch bowl away, they would rather crash the whole world economy.

  9. Bob says:

    No matter what Trump does, he’s screwed. Bush and Obama left him a bag.

    • nick kelly says:

      Not as bad as the one Bush left Obama- GM bust ( Bush signed the first bail out for it and the banks, but more was to come) A housing crash.
      Two lost wars- one of them, Iraq, costing 1.5 trillion and creating a huge vacuum in the ME.

      By comparison Trump is getting a bowl of cherries.

      • Bob says:

        No way, I disagree. Bernanke and Yellen have run up asset prices across the board to obvious bubble territory. Assets had largely taken the hit by the time Bush left office during the last bubble.

        I voted for Obama, but his lack of economic knowledge and his “hands off” attitude allowed bankers to re-establish their crony capitalism in short order. I don’t think I’ve ever been more upset than when bankers paid record bonuses during Obama’s bailout. He didn’t have the savvy to make necessary corrections when he had them over a barrel. He means well, but there is too much incompetence there. He naively thought he could bring everybody together to agree on basic matters. That was impossible, and he should have known it. Worst case is he knew bankers were exploiting the system and he did nothing because of campaign contributions.

        • polecat says:

          Obama indeed had knowledge … a grifter’s knowledge !!

          …. in my best Yoda Voice : CONniving he is …. Innocent he is NOT !

        • nick kelly says:

          Reread the chronology of 2008. Obama was handed a situation where the world’s financial system was on the verge of collapse.
          Banks had stopped lending to each other.

          Ya- everyone’s upset about the bonuses- but it’s not the big picture.
          It’s easy to say let them all go broke but it wasn’t a looming recession that had Fed guys sleeping on cots at the office and making phone calls at 3 AM.

          Wanna give the 2007-8 crash a name? It was the Greenspan Crash- the bursting of the Greenspan Bubble.
          Not created on Obama’s watch, or Bernanke’s – they just got the burst.
          There was never going to be a tidy clean up when that much shit hit the fan.

  10. Bob says:

    Why all the focus on the Fed’s balance sheet? Bullard is pretending. He knows the bonds are permanently retired to offset the natural deflation in the economy from shrinking labor force, aging, automation, etc. Those trends are irreversable for several decades. It’s much more likely the Fed will be increasing its balance sheet in the future to offset the continued natural deflation that lies ahead.

  11. Tom kauser says:

    Massaged message meme?

  12. david kopriva says:

    This article is confusing because the data is confusing. If the U.S. unemployment is at 4.6 percent, what’s the worry? The U.S. economy is ticking away at full speed at that rate is it not? Interest rate hikes should be a no brainer. Then there is this idea of a roll over of Fed purchased securities that are based on mortgages falsely packaged 8 -10 years ago? Where the assets of These mortgages are worth maybe 1/2 of their original value? Then, there is the idea that the Fed needs to buy government treasury bonds because no one else will? Am I understanding this correctly or am I missing a lot of assumptions in this article?

    • Wolf Richter says:

      David, I think you’re missing a few things. Let me address a couple of points:

      >>> “Where the assets of These mortgages are worth maybe 1/2 of their original value?”

      The Fed bailed out MBS during the Financial Crisis in general. That was one of the reasons it did what it did. So the MBS listed on its balance sheet are good. They were issued by the federal housing agencies. The bad MBS and other bad assets were in separate funds named “Maiden Lane” on the balance sheet. But most of those assets are now gone (written off or sold at a loss). What’s left of those bad assets is now in this line on the balance sheet: “Net portfolio holdings of Maiden Lane LLC” (down to about $1.7 billion).

      >>>> “Then, there is the idea that the Fed needs to buy government treasury bonds because no one else will?”

      The article didn’t address that at all. In fact, the Fed has NOT bought Treasurys since early 2015. However, the Fed WILL buy Treasurys if no one else will. It will not let the US go into default, if that’s what you mean. But that wasn’t addressed in the article. And Trump didn’t bring it up either. And it’s not happening now.

      • JB says:

        so the write down of the 6 million foreclosed on
        mortgages post 2008 hit the feds balance sheet ?
        is it correct that a write down of a fed asset represents
        money that cannot be removed from the money supply ?

  13. michael engel says:

    -FED assets were drifting down even before the recent rate increase.
    -When interest rate rise, bond prices fall.
    -Corp. bonds are corp. debt. And it’s high. When their
    value fall, net worth increase.
    -That’s a healthy medicine for companies loaded with debt.
    -True, they will have to pay more, when they issue new debt,
    but the biggest lever is on the improvement of their
    balance sheet.
    -When interest rate rise from 1.40% to 2.80%, it’s similar to
    an increase from 3.00% to 6.00$ or 8.00% to16.00%.
    -So, a tiny raise of 0.25%, really magnify it’s effect on price, when it start from a very low base.
    -An increase in constant increments of 0.25% will have a
    diminishing value.
    -Interest rate increase affect the $USD and money flow.
    -It will have a horrible effect on China and other EM, loaded
    with ($) debt. There will be an automatic response.
    -The international pipeline networks, of wholesale credit,are
    already in a bad shape, corroding, even leaking.
    -($)’s are hard to get. ($)’s loans even harder.

  14. Mike R. says:

    The Fed is starting to believe it’s own BS: That they can get out of their own created painted in corner before the paint has dried.

    The paint hasn’t dried yet.

  15. Uncle Frank says:

    What ever one thinks will occur may be undone by the tentacles of Goldman Sachs.

  16. Ishkabibbile says:

    I posted the following comment on the “Yellen speaks…….” article, but I think it’s important and relevant to this great piece, so I’m posting it again.

    “I guess Janet did indeed raise the IOER along with the ‘overnight’ interest (fed funds) rate, as she did a year ago.

    Notice the following from the above:

    ‘The Board will continue to evaluate the appropriate settings of the interest rates on reserve balances in light of evolving market conditions and will make adjustments as needed.’

    In other words, the Fed fully intends to keep manipulating “the market”. The question is: for what purpose? The answer is to keep the “excess reserves” exactly where they are.

    I wonder if this will be the pattern for future overnight rises. It’s another experiment that won’t be allowed to fail.”

    Wolf, why do you think the Fed is raising the IOER at the very same time and by the same amount that it raises the fed funds rate? Specifically, what would the owners of those excess reserves do with their “money” should the Fed NOT raise the IOER after it raises the overnight rate and continues to do so in the future (allowing the “spread” between the two rates to increase ever larger as time goes on)?

  17. Greatful again says:

    So the MBSs on the Feds balance sheet , at face value, will be sold for their stand amount? To whom? FNMA? The market?

    • Wolf Richter says:

      So far, as the MBS matured, the Fed received face value for them. And the market for MBS (bonds) has been doing just fine in recent years, buoyant actually, both for commercial and residential MBS, all part of the bond bubble (though cracks are now appearing). So if the Fed wanted to sell some of them now, it could, no problem, though it would put pressure on the still buoyant prices and raise yields, and thus mortgage rates.

      • Greatful again says:

        Matured? So the underlying mortgages were all performing and coming to the end of their term? Sorry, I don’t know the MBS product very well. Thanks

        • Wolf Richter says:

          No, the underlying mortgages don’t need to be perfect for MBS to perform. These are “structured” securities (bonds). There are tranches that take the first loss.

  18. JZ says:

    No matter what ever FED does, what will remain same is that it is still a wealth transfer device under the name of “helping wealth creation”. When rates drop, wealth will be transferred to “those” people. When rates rise, wealth will be transferred to the same group people.
    If we follow sound principles, the fed should be shut down, rather than speculating what it will do so that the wealth will be transferred to myself.

  19. michael engel says:

    -There is no money in “Excess Reserves”. It’s a phantom money
    that banks are supposed to have. Just Zanet bookkeeping.
    -If we will face a recession, the FED will slow down the negative
    momentum, allow some kind of “catch your breath” period,
    enable the big guys to sell stocks to the little guys, who are
    condition by all experts, for years, that every vector down is an
    opportunity to buy at a bargain and from that point price will
    move higher, as usual. Everybody agree. For 8 years.
    -The FED will stretch the length of the downturn, but will not
    be able to prevent it, or reverse it.
    -It will just soften it, until people will wake-up and panic.

    • bob says:

      People are getting a dose of the smelling salts now. They are starting to see some good news about the pension crisis. In my opinion, the impossibility of fulfilling retirement and medicare promises is the issue that wakes up the population. When you add up the benefits people think they will get and compare that to what the system can provide, there is a huge gap there. To date, that gap hasn’t received a lot of system, but we’re now starting to see pension issues rise to the surface. This reality will also come to roost no later than two years out when fiscal deficits are set to rise to the $1T threshold again. At that point, the reality is hitting people in the head with a sledgehammer. That is when people get scared and hard decisions can no longer be put off and there is some form of system reset.

  20. Frederick says:

    Again END THE FED

  21. Ishakabibble says:

    “-There is no money in “Excess Reserves”. It’s a phantom money that banks are supposed to have. Just Zanet bookkeeping.”

    IOER policy is, IMO (and, more importantly, Ben and Janet’s), even more important than the fed funds rate. I can’t explain why any better than this person does:

    From the above:
    “So when the Fed on December 16 (2015!) established a range of 0.25-0.50% for the federal funds rate, it also announced a new procedure designed to keep the federal funds rate from falling below 0.25%. The new procedure is to conduct overnight reverse repurchase agreements (ON RRP) with the Home Loan Banks (as well as with banks, other GSEs, and money market mutual funds, which are important lenders in short-term markets).

    ON RRP is an imposing-sounding term, but reflects a relatively simple process: the Fed sells government securities to the financial institutions on one day and then buys them back the next. The financial institutions are essentially making an overnight loan to the Fed, with the securities as collateral.

    But here’s the point: the money the Fed pays to buy back the securities is not only a repayment of the original loan. It also includes an interest payment. And the Fed plans to pay interest at 0.25%, the bottom of its target for the fed funds rate, thus giving the Home Loan Banks an incentive not to lend at less than 0.25%. Although it plans to use ON RRP as a secondary tool to its main focus of paying interest on bank reserves, it anticipates that both of these tools will keep the fed funds rate within its target range of 0.25-0.5%.

    It seems that the Fed has backed itself into a corner, where the only way to raise the federal funds rate is to increase its payments to financial institutions. With reserves held at the Fed equal to $2.6 trillion, even a 0.5% payment to the banks would cost $13 billion. And, of course, including the expense of the ON RRP program and increasing the fed funds rate in the future would add even more to the cost.

    To add insult to injury, 25 minutes after the Fed’s announcement on December 16, Wells Fargo Bank reported that it is raising its prime rate (an interest rate tied to business and consumer loans) by 0.25% but not the rates it pays to depositors. Later in the day other large banks, including JP Morgan Chase and Bank of America, made similar declarations.”

    And the Dec. 2016 rise in the fed funds rate, and the rise of the IOER in lockstep with it, instantly raises the following question. If the fed funds rate is gradually raised to say 4%, does the Fed intend to raise the IOER to at least 3.75%? If it does, “things” are going to get very interesting very fast.

    • Chicken says:

      “It seems that the Fed has backed itself into a corner, where the only way to raise the federal funds rate is to increase its payments to financial institutions.”

      These financial institutions (elites) own stock in the FED, the y are the FED’s master. 90% of MSM is owned by 6 multinational companies, thus if you express resistance against the agenda you might be a fake news working class deplorable.

      Neither the democratic or republican parties have done squat to stop the monopolization, they’ve supported elitist agendas.

  22. TJ says:

    The sticking point is #6 – You can’t have 0% inflation for any length of time because that means 0% growth. I suppose you could have half of our economy’s participants lose money and the other half make money (an oversimplification, I admit. It could be a different ratio of winners/losers) so it nets out to zero inflation, but that’s picking winners and losers, is it not?
    Even under a classical gold standard you had inflation, except in depressions/contractions, so under our current fiat/floating rates regime it’d generally tend to be worse.

    • Wolf Richter says:

      Inflation and economic growth are not cause-and-effect. That’s a myth propagated by inflation apologists. Inflation is when the currency loses value (purchasing power). It does NOT CAUSE economic growth. There can be plenty of economic growth without inflation – and there has been in the US until the Fed was created.

      • TJ says:

        Inflation, per se, does not cause economic growth but economic growth DOES cause inflation. How could it not? As people bid up the prices of things those dollars buy less. A dollar (or yen or euro) that never fluctuated in value never existed – and never will. The Fed came into being in 1914, do you mean to tell me there was no inflation throughout the 19th century? How can a unit of any currency (or precious metal) be 100% stable (0% inflation) when everything around it fluctuates? The question then becomes “stable in relation to what?” How can any producer raise their prices without someone having to take an equal and opposite loss to keep inflation at 0%?

        • Wolf Richter says:

          There should be DEFLATION in goods due to rising efficiencies and automation. Things should get cheaper. And occasionally, goods do get cheaper (tech products), but not nearly enough. Things getting cheaper due to technical innovation and efficiencies in manufacturing stimulates economic growth not economic decline! It’s called productivity. It is a big driver of growth; it brings down costs and allows competitors to cut the price (and make a profit) and stimulate the market for this product.

          What causes inflation is a number of things, including the expectation that there will be inflation (yes, part of it is psychological, and behavior, hence the fixation by the Fed on “inflation expectations” by consumers and the markets), monetary inflation (which over the past few years in the US has caused asset price inflation, rent inflation, and the like), monopolies or oligopolies, commodity price increases, and plenty of other things — but economic growth does not per se cause inflation, though both can occur simultaneously, just as there can be “stagflation” (high inflation and economic decline or stagnation).

        • rex says:

          I believe inflation is correctly identified by the expansion of money supply in excess of what is needed to fund increases in either production or population.

        • Tim says:

          For centuries, innovation has lowered the production costs, technology is deflationary for production. That is why we do it. Who would invest in higher cost production??? Well, it does happen, but it is commercial suicide. High cost production = margin squeeze.

          Economic rent extraction is a principle source of inflation. It has nothing to do with the technologically necessary costs of production, transport, capital investment.

          Public infrastructure is another area that is also deflationary on production, development and innovation. The product of public infrastructure? Improved productivity, development and innovation. Economic growth isn’t necessarily inflationary.

        • nick kelly says:

          Do you ever watch any of those American Picker shows?
          There was so little inflation up until the 60s -70s that vending machines would have the price permanently stamped or cast into the metal.
          (the opposite of this would be Venezuela, where PA’s in the store announce that all prices have just increased 10%)
          The 50’s had high growth but little inflation.
          The idea that stuff will cost more next year just because is quite recent. A bottle of coke was 10 cents for 50 years.
          During the emergence of the US an industrial power there was little inflation.
          ‘Do you mean to tell me there was no inflation in the 19 century?’
          During the Civil War the South had massive inflation, but that was an extreme exception.
          England had almost no net inflation for 200 years.
          But there was a cycle, a period of inflation would be followed by contraction, and sometimes deflation.
          ‘People would bid up prices…”
          Until industry created too much stuff- then came an inventory recession, and had to lower prices.

          Note: if everything rises by say 5 % including wages, we are in exactly the same position as if nothing had risen.
          Also: despite some fairly bizarre comments: inflation has a monetary cause- it is caused by excess credit or money creation.
          Whatever the faults of a gold standard, there will be little net inflation, because un-backed money can’t be printed.

      • Smingles says:

        “There can be plenty of economic growth without inflation – and there has been in the US until the Fed was created.”

        While there can be growth without inflation, most growth periods in the 19th century were accompanied by inflation while the bust periods, with few exceptions, were almost always deflationary. There were some growth periods that had 0% or mild deflation, but that was the exception not the rule.

        • Wolf Richter says:

          In my entire adult life (covering six recessions), there were only two quarters of deflation. It started in October 2008, as a result of the mayhem caused by the Lehman bankruptcy. In total, the consumer price index fell 3.4%, from 218.9 just before, to 211.4 in December 2008, before it picked up again. It came as a RESULT of the Financial Crisis (and not as a cause). Things got a little cheaper, and folks started buying more to take advantage of the deals. Lower prices propped up consumer spending in 2009 and helped turn retail sales around!

          The rest of the time when CPI dipped (very rarely), it was for a month or so, before bouncing back up, recession or no recession. In other words, recessions occurred despite inflation, and the one mini-deflationary period we had was the result of the Financial Crisis, not the cause.

          So the idea that inflation is a requirement to economic growth has been obviated by events long ago.

          However, inflation helps debtors (esp. over-indebted businesses, governments, and individuals) pay off their long-term debts if income goes up in tandem (or more) with inflation. That’s the only reason why economists keep spouting off about the benefits of inflation – at the expense of the creditors. From a debtor’s point of view, inflation is a good thing. From a creditor’s point of view (bondholders, savers, pension fund beneficiaries, etc.), inflation is a scourge.

    • d says:

      “You can’t have 0% inflation for any length of time because that means 0% growth.”

      NO you can have real growth, which is and expanding economy, with constant prices.

      You do not need inflation to make a profit.

      But you do need it to make a profit on fixed assets simply by holding them.

      The Qe wealth effect, do nothing, add no value, yet make a profit..

  23. Mike R. says:

    The Fed has no intention of signficantly reducing its balance sheet. Buying these assets is how they ‘printed’ these trillions into the economy to raise the general price level (e.g., create inflation).

  24. ambrose bierce says:

    Fisher proposed reducing the balance over a year ago. John Hussman gave it a long study, and the upside is they could disgorge 1/3 of their holdings without impacting interest rates. Yellen had zero interest in the plan (pun). What to make of that is unclear, unless it wouldn’t make a whits worth of difference. She understands that the grand plan is to blow the lid off the thing, with Qualitative Easing, when you paint yourself in a corner expand the room. Selling assets can’t possibly help and it would cause short term volatility.

  25. Joe says:

    If the CPI reflected actual housing costs rather than the Fed’s fantasy of “Owner equivalent rent,” Greenspan would have been forced to raise interest rates drastically starting in 2003 or 2004, instead of having 20+ straight Fed meetings where they raised rates by .25% in a process that took four years. Raising rates by 3% in 2004 and 2% in 2005 would have snuffed out the housing bubble long before it reached the “if you can fog a mirror you can buy a million dollar house” stage, and the 2008 Great Recession never would have happened!

    So by inventing ways to screw retirees by “tweaking” the CPI to the point where it no longer bears any resemblance to reality, the Fed warped one of their primary tools so that the CPI lost any value it ever had as a signal that interest rates should be raised quickly! (or cut I suppose, although that’s generally done as a knee-jerk reaction to the stock market since the Greenspan Put was invented.)

    Strangely enough, I DON’T see” propping up the stock market” in the
    Fed’s dual mandate -“price stability and maximum sustainable employment”! Making those who own stocks even richer doesn’t help the country at large, since the wealthy receive by FAR the largest benefits from a rising stock market. So QE and ZIRP have just screwed savers and the same retirees who are screwed by an artificially low CPI while trying to survive in retirement while they can’t find any SAFE investments that offer a decent return.

    And since “maximum sustainable employment” wasn’t part of the Fed’s mandate until 1977, the fact that the dollar has lost roughly 96% of its value since the Fed was founded proves that it can’t manage to achieve its PRIMARY purpose of maintaining “stable prices!” As the secret lender of last resort it’s doing a bang-up job of ensuring the survival and enrichment of the TBTF banks, who can borrow from the Fed, send that money back to the Fed as “Excess Reserves,” and pocket the interest. Plus they get billions in fees acting as “broker dealers” by selling bonds created out of thin air by the Fed and loaned to the US government! Why the Fed pays interest on “excess reserves” is beyond me, since those reserves allow the banks to loan out 9x more money than they have on deposit with the Fed!

    How any bank could get in trouble when it can loan out 9x more money than it actually has deposited with the Fed at WAY more than 9x the interest they pay their depositors is beyond me. A 3% mortgage would actually pay a 30% return if I have the math correct, since 90% of the loan was never owned or possessed by the bank, but came into existence when they issued the mortgage – yet the bank gets to collect 3% on the 90% of the loan they printed out of thin air. Unbelievable! (And if I have this wrong, please point out how fractional reserve banking and the Fed’s deposit/loans requirements don’t allow these sort of shenanigans.)

    Nice work if you can get it. When the system collapses, I fear we’ll see “torches and pitchforks” crowds rather than “Occupy Wall Street!” :p

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