[msandford]

Holding them to term is actually a bit of a joke if you think about it. The Fed is buying bonds. The government is selling them. As long as the Fed keeps buying them, the government can keep selling them. If the Fed holds them to maturity, where will the money come from to pay back the mature bonds? From the government selling even more new bonds which the Fed will have to buy.

It's not a Ponzi scheme or a pyramid scam but it can't help but be compared to them. It's in a similar boat to Social Security. It has the veneer of legitimacy because "it's the government" but underneath it's a bit unseemly.

[preempalver]

The fed is buying bonds on the secondary market i.e not directly bidding and taking down auctions at treasury. This may sound minute but is a huge point. See http://pragcap.com/understanding-quantitative-easing

[msandford]

Yeah I get it, they're not shoving everyone out of the way immediately.

But would the banks have all originated subprime loans had they not been able to repackage them and sell them? By selling the loans they were kept off the bank's balance sheet.

If the Fed is buying up all kinds of bonds and the banks know this, there's nothing preventing them from selling their older bonds which were purchased at a time when interest rates were higher (and thus bond prices were lower) and selling them at a profit to the Fed. They then need to do something with the money, why not buy some new bonds?

Just because the Fed isn't participating in the primary auction doesn't mean that they're not influencing the Treasury market in a huge way.

[preempalver]

The original comment was to reflect that the Fed is not monetizing the government, which is different than influencing the treasury market. The fed is influencing the market by effecting the "rate" not the "size". Just by influencing the treasury market you cannot make the logic leap that they are creating $ for the government to spend (recklessly?), or forcing the government to create more UST in order to pay back older maturing UST.

[msandford]

I think I see what you're saying there. I just disagree with it. I would argue that "rate" affects "size" in a real way.

For example, Greece was getting killed on their bonds: they had to pay 8%, 10%, 12% on them. Which means that in order to raise $10B now you had to promise $20B (or more) at maturity of 10 years. That was because they didn't have a central bank to buy their bonds on the secondary market and effectively reduce the supply, thus driving their price up and the interest rate down.

Here what we're seeing is that the Fed IS buying on the secondary market and the banks are aware of this. That reduces the supply of Treasury bonds (absent the Fed's intervention) which, everything else equal, drives the price up and the interest rate down.

Furthermore since the banks KNOW that the Fed will buy the bonds off of them, potentially at a small profit they don't have any problems going to the auction and buying the bonds to flip to the Fed. If the Fed dried up as a buyer of Treasurys it's entirely likely that the banks would stop buying, the auctions would be less successful and the interest rate on the bonds would go up as the price of the bonds goes down.

So what I'm arguing is that I would agree with you but only if the Fed either 1) didn't buy Treasurys on the secondary market or 2) the Fed couldn't create money to buy Treasurys from the banks who are buying them at auction. Since neither of those conditions is met, I would disagree. I would argue that they're monetizing the debt but indirectly. Just because it's indirect doesn't somehow make it not happen. It just makes it harder to follow.

[preempalver]

Ok lets agree to disagree :). Just FYI, 10 Yr Aug UST low yield (best price for bank to buy) was 258bps. Highest rate for Aug was 278bps (highest point at which the fed could have bought). By doing the flip the bank could make a yield of 20bps. It has to front cash for capturing this yield. If it just kept the cash at the fed it would earn a risk-less 25 bps (IOER). The fed is sterilizing the purchase by IOER so it isn't monetizing the debt! This is the fundamental misunderstanding with QE, its just a tool to target the rate. If we were truly monetizing the debt, inflation would be soaring through the roof! I would strongly recommend reading this -> http://pragcap.com/understanding-quantitative-easing

[yuliyp]

How is there any sort of difference? The effect of reducing the supply of treasury bonds in the market and increasing the supply of money in the economy is the same, regardless of whether the bond is removed from the open market at auction or from the secondary market.

[preempalver]

Reducing the supply of UST !=Increasing the money supply. All QE is doing is increasing bank reserves. Unless bank lend the reserves out money supply is not affected. With IOERR and general aggregate demand being jacked, banks are not really lending money out to actually increase the money supply. If just taking UST's out would have increased money supply we would have seen a lot more inflation!

*edit: IOER = Interest on excess reserves. See http://synthenomics.blogspot.com/2012/08/interest-on-excess-... for a good explanation