The economy stinks. You and I know it, and the Federal Reserve knows it, too. That’s why they announced Operation Twist earlier this week. Operation Twist? What’s that, you say? It’s yet another attempt to drive interest rates down in hopes of spurring economic activity.
This time around, they’re targeting 10-year bond Treasury rates because lots of interest rates, including mortgage rates, are tied to the 10-year bond rate. In short, they’re planning on selling some of the shorter term bonds that they’re holding and using the proceeds to buy longer term bonds.
More specifically, over the next nine months, they intend to sell $400B in short-term government bonds and use the proceed to buy longer-term bonds. As demand for these longer-term bonds rises, their interest rates will fall. This makes sense, as you don’t have to pay as much interest to find buyers in a high demand market.
So… The big question is whether or not this will work. In this case, we can actually look to the past, as the Fed has tried this once before. In the 1961 rendition of Operation Twist, the Fed succeeded in bringing longer-term interest rates down 0.15%. Not much, but more than nothing.
For his part, Fed Chairman Ben Bernanke has previously downplayed the strategy’s potential as a tool for reducing long-term interest rates. So why bother? I guess when you’re running out of ideas, you’ll try anything. The bigger question to me is whether or not an interest rate reduction will have a meaningful economic effect.
Consider for a moment the housing market…
Do you honestly believe that there are legions of prospective homebuyers sitting on the sidelines because mortgage rates are just too darn high? With 30-year fixed rate mortgages hovering around 4% and 15-year fixed rate mortgages below 3.5%, mortgage money is already dirt cheap. What difference will it make if rates drop a bit further?
While the housing market is just one piece of the puzzle — albeit a big one — rates are low across the board and we’re still struggling. Maybe if the Feds would start paying people to borrow, we could get the economy back on track… Then again, in inflation-adjusted terms, they’re practically doing that already.