Kansas City Federal Reserve President Esther George has encouraged her colleagues to accept “earlier than later” plan for the U.S. central bank to leave the mortgage-backed securities (MBS) market and be more clear on how bond purchases will be featured in future monetary policy.
“You can’t just wake up one day and say, ‘hey, we’re going to get out of this business,'” George, who is retiring from her role at the end of January, told Reuters in an interview published on Monday.
She observed that Fed officials agree in general that the central bank’s securities portfolio should only comprise those assets issued by the U.S. Treasury – not those backed by home mortgages – but don’t have a plan to achieve that.
The Fed currently has about $2.6 trillion of mortgage-backed securities as part of its almost $8 trillion securities portfolio. That is nearly a quarter of the total MBS market, what George called an “enormous” share that sparks questions about the appropriate extent of the central bank’s presence.
George, whose last day before retiring is Jan. 31, will not take part in the Jan. 31-Feb. 1 policy meeting. She talked to Reuters before the beginning last Saturday of the “blackout” period that hinders Fed officials from making public remarks about policy in the run-up to meetings.
The Fed is trying to prune its balance sheet overall as part of the plan to tighten monetary policy, and is allowing up to $35 billion a month in MBS and $60 billion in Treasury securities to mature and “run-off” from its holdings.
In theory, that puts growing pressure on long-term interest rates by diminishing demand for those assets.
However, in the case of mortgage-backed securities, high-interest rates also reduce the pace of the run-off since it limits both the home sales and the refinancings that, because existing mortgages get repaid, reduce the principal of MBS faster than would happen only through monthly payments by homeowners.
‘NOT IN MY DNA’
Since the Fed started to let its balance sheet shrink in June, its MBS holdings have slumped by about $67 billion, or about 2.5%, a pace that would leave the central bank in the mortgage market for years to come. Some Fed officials have said the central bank will ultimately need to sell its MBS holdings.
George said she did not have a particular plan in mind, but felt her colleagues should start to work on one.
“At some point, people will have to address: is that the footprint we want in the mortgage market?” George said of the current holdings. More important than the details of any plan “is just to say how will we go about doing that earlier rather than later. There could be many combinations of things that get you there.”
George, 65, has been chair of the Kansas City Fed since October 2011. She has been one of the central bank’s more persistent dissenters, and a notable skeptic of both quantitative easing – the use of bond purchases to shore up markets and the economy – and the 2% inflation target adopted soon after her arrival.
“I’ve never felt comfortable saying we should want inflation. It’s not in my DNA,” said George, whose roots are in Midwestern family farming, an industry that was extremely destroyed by the high-inflation, high-interest-rate environment of the 1970s and 1980s.
‘OUT OF THE BOX’
George said she thinks the Fed’s balance sheet continues to receive “too little attention” in terms of how the central bank’s slow exit from long-term securities markets could, for instance, influence the yield curve given the fast increases in U.S. short-term interest rates delivered in 2022.
The Fed raised its benchmark overnight interest rate by 4.25 percentage points last year to curb inflation that had soared to 40-year highs. It is widely anticipated next week to lift that rate by a quarter of a percentage point to the 4.50%-4.75% range.
More broadly, George said, after twice launching bond purchases to shore up the economy, once following the 2007-2009 financial crisis and recession, and again at the start of the COVID-19 pandemic after interest rates were lowered to the near-zero level, she said the central bank should formulate clearer guidelines for when the purchases are to be used, and what impact on the economy they are perceived to have.
Buy Crypto NowDuring the pandemic, for instance, the Fed was purchasing mortgage-backed securities and, in theory, knocking down mortgage rates, even though house prices were soaring.
Given that the Fed now uses its balance sheet to control the short-term policy rate of interest, George thinks it would be hard, at the least, to return to the limited holdings the Fed had before the 2007 housing market meltdown.
But she said her time on the central bank’s policy-setting Federal Open Market Committee has not persuaded her that bond purchases have much impact beyond inflating asset values – something future policymakers should address.
Quantitative easing “is out of the box and now future committees will have to think about how to manage it,” George said.
“I think economists have a lot more work to do on understanding this instrument. I think a lot of time was spent defending what its benefits were. I think too little attention has been paid to its consequences.”
