Operation Twist

The lack of reaction from the U.S economy is causing the international financial market to pressure the U.S. Federal Reserve to take new steps. It’s what many international analysts are anxiously expecting to be announced tomorrow, around the same time when the Fed will announce the results of another meeting dealing with interest rates.

Since June, the standard demand was that the Fed, headed by Ben Bernanke, could again buy bonds from the U.S. Treasury in the secondary market, in what is conventionally called quantitative easing.

This operation consists of issuing new money and buying bonds with it. The objective is to inject money in the market so there is a credit expansion and with it, an expansion in consumer spending, production and other economic activity.

Other than the US$1.7 billion already issued to rescue private bonds that haven’t had liquidity since 2008, when the crisis broke out, the Fed did two quantitative easing operations, which was a total of US$900 billion. The result was weak, almost nonexistent. Instead of re-lending to the private sector, the banks chose to deposit the resources back into the Fed itself, because they understood that the market was already excessively in debt.

After repeatedly trying new quantitative easing operations and seeing little results, analysts now want the Fed put into play the so-called Operation Twist. The name comes from the first time it was used, in 1961, when the “twist” was a popular dance.

It’s the exchanging of short-term Fed bonds by long-term bonds. From the viewpoint of the monetary authority, this operation has two major advantages over the former one. First of all, it doesn’t increase the Fed’s bonds portfolio; in other words, it doesn’t require the issuing of new printed money. Second, it creates a demand for long-term bonds in the same exchange ratio. The expected consequence is a reduction in long-term rates, which in turn tends to expand the horizons of companies, thus stimulating new investments. The Fed has about US$500 million in Treasury bonds in its portfolio with a predicted maturity date of less than three years.

The financial market puts excessive trust in this operation, most likely due to the lack of choices at hand. If the intravenous injection (quantitative easing) didn’t produce the expected results, these pain killer pills won’t do get the job done either.

There is no lack of resources. It’s quite the opposite; there’s never been so much liquidity. However, the banks are not willing to lend to their clients, nor are clients willing to go deeper in debt. In the housing market alone, the private sector in the United States faces foreclosures that are well over the US$12 trillion mark.

And stating here again what was mentioned before: A way out would be an operation that could reduce the debts of borrowers within a certain time frame, creating room for new debts. Apparently, what stops that from happening is the opposition from the Republican Party, always ready to explore the argument that it is unfair for some people (those who have paid off their mortgages) to pay for those that would be benefited by a certain pardon that deep down carries some electoral motives.