Talking Points on the Federal Reserve Bank’s “Operation Twist”

Key points:

– New Fed Reserve Bank policy will push down long-term interest rates to encourage consumer and business borrowing and spending.

– Mortgage rates are expected to drop to lowest on record.

– Lower mortgage rates are conducive for refinancing: current mortgage holders can refinance to a lower rate and free up additional cash.

Yesterday, the Federal Reserve Bank announced a new plan aimed at supporting conditions in mortgage markets.  The Fed’s new stimulus plan focuses on current mortgage rates by shifting $400 billion from its short-term holdings into long-term government bonds. It plans to reinvest principal payments from its holdings of debt and mortgage-backed securities from government-sponsored enterprises Fannie Mae and Freddie Mac into agency mortgage-backed securities. The program, which begins October 3 and will run through June will finance the purchase of longer-term Treasury securities with remaining maturities of six years to 30 years through the sale of shorter-term Treasury securities with maturities of three years or less.  The Fed hopes that this program will put downward pressure on longer-term interest rates; rates are already at record lows but with slow growth in the economy, further rate reduction is the only tool available to the Fed.

General reaction to this program has been mixed: some economists believe this shift in the Fed’s portfolio could provide modest help by reducing borrowing costs and perhaps raising stock prices.  Others warn that refinancing may be difficult with stricter lending requirements making less consumer eligible and that there may be increases in inflation and short-term interest rates.

Sapna N. Patel

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