The Federal Reserve yesterday announced $725 billion in new purchases of Fannie Mae and Freddie Mac securities to hold up housing finance, along with plans to buy $300 billion in Treasury securities. Before this latest program, the Fed was already running the most expansionary modern monetary policy since the Weimar Republic. On top of $2 trillion in guarantees for a broad range of private securities, the Fed has been gunning the monetary base at an extraordinary rate. Consider the following: The Fed normally expands the monetary base, which forms the basis for credit and the overall money supply, by an average of 1 to 2 percent per-month. In September and October of last year, they expanded that base by 58 percent; in November and December, they increased it another 50 percent.
The Fed was right to do all this, in a deliberate if desperate attempt to push enough juice into a severely strained and strapped financial system, to enable it to get back on its feet — or at least to not slip into a coma. It hasn’t worked so well yet, because the financial system and economy are sicker than anyone thought. And now we’re caught in a vicious circle: The financial system’s woes pushed the economy off the cliff, which then took most other economies in the world with it; and now the problems of our economy and everyone else’s are intensifying the financial system’s weaknesses.
And the Treasury is out in the markets every day selling the government’s securities, even when the Fed’s not buying. And like some titans on Wall Street, they may be making a bad bet with your money. The bet here is that inflation will be nothing to worry about for another decade; and if that’s wrong, taxpayers will pay a big price. At issue here is what’s called Treasury Inflation-Protected Securities, or TIPS, securities which pay those lending to the government a set interest rate, like any other Treasury security, but one figured off a principal amount that adjusts upward every six months to take account of inflation. At the price TIPS are now fetching, the market is betting that inflation will be nothing to worry about for another decade. And the Treasury is backing up that bet by selling TIPS at very low prices.
The market and the Treasury backing it up are almost certainly wrong this time. Here’s what may well be happening: When markets heat up or melt down, they have a tendency to assume that their conditions will persist for as far as they can see (or invest). That can explain what’s happening in the TIPs market: They’re selling at a rate and return which assume that today’s extraordinary deflation will just keep on going, for years into the future. That’s possible — but it’s very, very unlikely. The economy eventually will stop contracting; and when it does, prices will stop going down. In fact, through the booms and busts of the last 50 years, the U.S. inflation rate has consistently averaged about 2.5 percent per-year over any extended period.
Moreover, once the economy recovers this time, the extraordinary steps we’re taking to bring about that recovery will almost certainly produce strong inflationary pressures. First, we’re currently embracing the most expansionary, fiscal policy in our history (at least for peacetime), with multi-trillion-dollar deficits — and necessarily so for an economy contracting at a six to seven percent rate. And on top of that is the Fed’s unprecedented monetary expansion.
Whatever White House or congressional leaders say about education, climate or health care, the economy and the financial system, and only that, will remain the President’s central focus and task for the rest of this year and well into 2010.
Eventually we will succeed — and when we do, our wildly expansionary (if necessary) fiscal and monetary policies will extract a cost. One principal cost is almost certain to be higher than normal inflation — and that’s when the TIPS issue will bite us. If inflation is much higher five years from now than the TIPS market expects today — and you can bet on that — people who bought TIPS when everyone expected very low inflation will end up making a killing as the value of their securities is adjusted way upwards for the higher-than-expected inflation. We estimate that will cost taxpayers from $50-$70 billion in additional debt-service costs. Fortunately, there’s an easy answer: The Treasury can buy back the outstanding TIPS and reissue the debt in conventional securities. Current TIPS holders would get the current value of their securities, and taxpayers could save enough to finance an awful lot of college assistance, health care for children, or R&D in climate-friendly fuels and technologies.
At a time when nearly everywhere we turn, it costs us all billions or even trillions of dollars, wouldn’t it be satisfying to save some real money — and without raising anybody’s taxes or cutting anybody’s program?
For more information, see the new study, “The Benefits to U.S. Taxpayers from an Open Market Buyback of Treasury Inflation-Protected Securities,†at this site.
Tags: $50-$70 billion, Fannie Mae and Freddie Mac securities, Federal Reserve, financial system, inflation, monetary base, Open Market Buyback of Treasury Inflation-Protected Sec, TIPS, Treasury Inflation-Protected Securities, Treasury securities, U.S. inflation rate
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Dear Dr. Sharpiro,
You are right about Americans being angry with AIG but to be honest, no one understands the real crisis yet.
I have quite a bit of evidence that the Social Security Trust Fund has been sent to Fidelity Investments , which is part of AIG.
Unfortunately, I am the only person in America who has been on disability for a lifetime illness , voluntarily returned to my RN job for eleven years, then got sick again and successfully got back into the system.
As a result, I have proof someone collected Social Security money in my name for around fifteen years. When my benefits were restarted after waiting almost four years, loosing two long term income producing disability policies and having my original 1987 disability award mentioned, an SSI account was created. My documentation shows this account paid in the year 2006.
2006 is the year I started getting proxy notices from Fidelity. I was shocked to find out after calling because of one of these notices that Fidelity had an account in my name.
Eventually they actually paid me $3189.95 , in the calendar year 2006.
So in October of 2008, it was again a surprise to get a 2007 1099 for this same amount of money. Fidelity put in writing they did not send this 1099.
My former employer, a catholic non profit, HR office staff told me in January of 2009 that ” the loan for 3189.95 was being repaid”.
Fidelity wants me to get a subpoena to get information about this account but I called ” check mate” and filed an identity theft complaint with them.
You see, on March 13,2009, Stephanie Pezar and Craig Nelson , employees of Fidelity told me that the 401 A, was ” social Security money”.
Yes, Fidelity is draining the Trust Fund using surrendered and terminated accounts.
I have evidence of another terminated account out of the same office my claim was handled in that is still paying someone other than him at the twenty year mark. Funny how that London AIG office opened about that same time.
Dr. Sharpiro, all investigations were stopped. Retaliation has been well documented .
No Trustees were on the Trust Fund Board last year either….
So when AIG says there will be a historic crisis if they don’t get their next bailout, you know why… all entitlement programs are history.
I’ve got over 2200 pages of documents if you’re ever more interested than Obama’s new DOJ.
He truly needs to replace his US Attorneys so the Justice System can be restored …
and the financial mess resolved.
As it looks now, he is just one of em, and you can tell him I said so. I believed in change.
Elizabeth Collier Shepherd
1733 Budon Court
Columbia SC 2924