By Steven K. Beckner
(MNI) – Large-scale purchases of mortgage-backed securities should
be at “the top of the list” of options if Federal Reserve policymakers
decide that additional monetary stimulus is required, Federal Reserve
Governor Daniel Tarullo said Thursday evening.
Tarullo made clear he is prepared to support fairly aggressive
additional Fed easing measures to address what he called a “shortfall of
aggregate demand” and said the best channel through which to do so is by
bringing down mortgage rates to try to revive the housing market.
He largely rejected contentions that much of the high unemployment
is due to “structural” factors and impediments to economic growth and
hence that further monetary stimulus would be effective.
He said there is “ample room” for the Fed to do more to spur
laggard demand in unusually blunt remarks prepared for delivery at
Columbia University in New York City.
Tarullo strongly suggested that he would back fairly aggressive Fed
action, including quantitative easing via MBS purchases, even if the
economy does not improve. Other policymakers have spoken in terms of
needing to see further deterioration in economic conditions and/or price
stability before they would support a third round of quantitative
easing.
The Obama appointee did not specify the timing for additional Fed
easing, as a Nov. 1-2 meeting of the Fed’s policymaking Federal Open
Market Committee rapidly approaches. But he said, “in the absence of
favorable developments in the coming months, there will be a strong case
for additional measures.”
He was speaking on a day when the National Association of Realtors
reported a worse-than-expected 3% drop in September existing home sales.
In its first round of quantitative easing, the Fed bought roughly
$1.5 trillion in mortgage agency securities and agency-guaranteed
mortgage-backed securities. But the $600 billion QE2, approved last
November, was devoted entirely to purchases of longer-term Treasury
securities, and the FOMC has stated a long-term goal of returning to an
all-Treasury portfolio.
At its Sept. 21 meeting, however, the FOMC took a significant step
toward reinvolvement in the MBS market when it announced that it would
reinvest principal payments of maturing securities in MBS, rather than
in Treasuries, to keep the Fed’s balance sheet from shrinking from $2.9
trillion.
Tarullo made clear he is prepared to go much further.
“Within the FOMC and in the broader policy community, there has
been considerable discussion of possible additional accommodative
measures, from communication strategies such as forward guidance on the
likely path of the federal funds rate to additional balance sheet
operations,” he observed.
But he added, “I believe we should move back up toward the top of
the list of options the large-scale purchase of additional
mortgage-backed securities.”
After expressing alarm by the level and duration of unemployment,
Tarullo said, “There is need, and ample room, for additional measures to
increase aggregate demand in the near to medium term, particularly in
light of the limited upside risks to inflation over the medium term.”
Far from merely going through “soft patches,” Tarullo said a
“better metaphor is of an economy slogging through the mud and
occasionally hitting stretches of dry pavement.”
He conceded that “neither monetary nor fiscal policy will be able
to fill the whole aggregate demand shortfall quickly,” but he said
“appropriate policies could surely boost output and employment.”
He also conceded that the amount of debt overhang and other factors
could limit the effectiveness of additional Fed easing, but said,
“aggregate demand policies are still important.”
While better government policies in other areas could help, Tarullo
argued that “the absence of such policies cannot be an excuse for the
Federal Reserve to ignore its own statutory mandate.”
“The Federal Reserve Act requires that the FOMC promote the goals
of maximum employment and stable prices,” he said. “The statute does not
qualify that mandate by saying that we should promote these goals only
if all parts of the government–or, for that matter, the private
sector–are acting just the way we think they should.”
“In other words, we have to take the world as we find it and adjust
our actions accordingly,” he added.
Rejecting arguments by some of his colleagues that buying MBS
amounts to “credit allocation,” Tarullo argued that the Fed could have
more impact by purchasing MBS to narrow MBS-Treasury yield spreads and
lower mortgage rates than by just buying Treasuries in any future
large-scale asset purchase program.
Acknowledging that many people who have negative equity in their
homes would not be able to take advantage of lower mortgage rates by
refinancing their mortgages, Tarullo suggested that additional,
non-monetary measures might well need to be authorized by Congress.
“Any proposals that could sensibly and effectively be implemented
would increase the effect of an MBS purchase program,” he said. “For
example, action could be taken to bring the benefits of refinancing to
underwater borrowers.”
“In principle, borrowers with mortgages that are guaranteed by
government-sponsored enterprises (GSEs) such as Fannie Mae and that have
loan-to-value ratios of up to 125% can refinance through the Home
Affordable Refinance Program,” he explained. “In practice, though,
numerous obstacles have kept the program from helping many potentially
eligible borrowers. Underwater borrowers whose loans are not guaranteed
by GSEs are essentially unable to refinance at all.”
Tarullo conceded that dealing with these “underwater” borrowers
would not be a snap. “Policy changes directed at this last, larger group
of homeowners would have to be carefully designed so as not to transfer
credit risk from private investors to the government, and could well
require legislation.”
He granted that “an MBS repurchase program will not cure all that
ails the housing market, much less fill the whole aggregate demand
shortfall.”
“There is a host of other problems, including continuing issues in
mortgage servicing, uncertainty as to when house prices will have
bottomed out in local markets, ambiguity about the scope of putback risk
for securitized mortgages, and the substantial part of the underwater
mortgage problem that cannot be solved by refinancing,” he continued.
“But I believe that MBS purchases are worth considering as a
monetary policy option precisely because they carry the promise of
addressing the feature of the current aggregate demand shortfall that
differs from typical recessions and recoveries,” he said.
Summing up his call for additional stimulus, Tarullo said, “Even
the acute problems reflected in today’s grim employment picture cannot
be reversed as quickly as in past recoveries.” However, “the fact that
these problems cannot be solved quickly does not mean there is nothing
to be done.”
“Without more, the harm to the unemployed and their families
continues, and the risks of longer-term harm increase–both to the
unemployed and to the country as a whole,” he went on. “A shortfall of
aggregate demand is the most important factor behind those dismal
statistics.”
“Particularly if we take account of the unusual nature of the
current shortfall in fashioning policy responses, there is much that
government policy–including monetary policy–can still do,” he
concluded.
Those policy comments were prefaced by a grim appraisal of the
labor market.
Tarullo said the official 9.1% unemployment rate understates the
extent of joblessness. He also pointed to the decline in labor force
participation to 58%, lowest since 1983 and the six million people out
of work more than six months — highest since unemployment duration data
started to be collected in 1948.
“Even more dispiriting than this snapshot of the employment picture
is that there is so little momentum toward improvements in labor market
conditions,” he said. “The pace of job growth in recent quarters has
been barely enough to absorb the increase in the labor force and wholly
insufficient to produce meaningful declines in unemployment. The number
of new claims for unemployment insurance suggests only modest gains in
employment in coming months, while measures of job vacancies seem to
have turned down.”
Tarullo maintained that, at most one percentage point of
unemployment can be explained by “structural” factors. There is “a
fairly strong presumption that insufficient aggregate demand is the most
significant factor.”
Tarullo warned that the longer people remain out of work the more
unemployment could become “chronic” or persistent, not just cyclical.
And he said, “if anything, this possibility argues for more aggressive
policies to reduce unemployment sooner.”
** Market News International **
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