ABA Banking Journal - March 2014 - (Page 8)

the economy BY ROB STRAND AND BECKY WEISSMAN Janet Yellen's Catch-22 In economics, there is a term called Pareto effi- Federal Reserve Balance Sheet ciency-named for its Italian creator, Vilfredo Pareto. It is an economic state in which there is $ Trillion Feb. 12, 2014: no way to improve the situation for one person $4.1 Trillion $4 without disfavoring someone else. Unfortunately for the Federal Reserve, there is no Pareto effi$3 cient policy going forward. Any change from the current state hurts someone. The question is, which non-Pareto optimal path Janet Yellen will $2 take as the new head. MBS & Under its quantitative easing program that Treasuries began in late 2008, the Fed has been buying up $1 large amounts of long-term Treasury bonds and Liquidity mortgage-backed securities (MBS) with the aim Programs $0 to push down long-term interest rates. Under 2008 2009 2010 2011 2012 2013 the third phase of the program, QE3, which Source: Federal Reserve began in fall 2012, the Fed purchased $85 billion a month of these assets. The program's goal was achieved: ten-year Treasury bond rates declined from a high of near 4.0% to willingness to buy appliances, cars, under 2.0%, and 30-year fixed-rate mortgage rates fell from over 5.0% to under and homes. Moreover, emerging 3.5%, between spring 2009 and spring 2013. nations, like India and Brazil-already Questions have arisen skeptical of the benefit from billions of dollars of federal fraught with financial turmoil-would asset purchases years after the financial crisis passed. Specifically, steady recovery likely be hit as capital flows back to of the mortgage markets created doubts about the need for continued large-scale the United States for higher interest intervention. Furthermore, many have questioned whether massive Fed purchasrate returns. While the Fed is charged es of U.S. Treasuries are an appropriate response to unsupportable federal budget with protecting domestic-not fordeficits. While lowering interest rates can spur investment and economic activity, eign-economies and markets, the near-zero interest rates leave no room to drop further. The Fed has lost a key polresult could place downward pressure icy tool. Of concern, the low rates have hurt individuals living on fixed incomes, on exports to these nations and less and have driven many to look to riskier assets for higher returns to live on. support for the U.S. economy. Last December, after seeing improvements in the economy and labor markets, The Fed has begun QE tapering, the Fed, under former chairman Ben Bernanke, began tapering the asset purheading back toward normalcy, and chases by $10 billion at each Federal Open Market Committee meeting. After cannot turn back. Any path poses the December and January meetings, monthly purchases are now down to $65 dangers. The challenge will be to pick billion. (Note: The Fed's balance sheet is still growing, but at a slower pace.) the path of least pain. Yellen is sailing Tapering is not without risk. As the Fed reverses purchases of long-term into uncharted waters. assets, long-term interest rates will continue to rise. There was a sharp jump in long rates last July when the Fed did no more than lay out a plan to begin Rob Strand is an tapering later; 20-year Treasury bond rates rose 4% in the day following the economist and announcement. The Fed will be challenged to manage this unwinding without Becky Weissman is inflation and interest rates taking off. a research associate in ABA's Office of the The Fed has to judge whether rising rates will overwhelm consumers' Chief Economist. 8| ABA BANKING JOURNAL | March 2014

Table of Contents for the Digital Edition of ABA Banking Journal - March 2014

Chairman's View
Editor's Column
The Economy
Bank Notes
Picture This
Basel III a bad fit for smaller banks
Tech Topics
Mortgage reboot
5 revenue ideas for the real world
Compliance Clinic
Compliance Inbox
ABA At Your Service
First Person

ABA Banking Journal - March 2014

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