Wednesday, September 21, 2011

Twist & Shout!

@CNNMoney September 21, 2011: 2:35 PM ET

NEW YORK (CNNMoney) -- The Federal Reserve announced 'Operation Twist' Wednesday, a widely expected stimulus move reviving a policy from the 1960's.

The policy involves selling $400 billion in short-term Treasuries in exchange for the same amount of longer-term bonds.

While the move does not mean the Fed will pump additional money into the economy, it is designed to lower yields on long-term bonds, while keeping short-term rates little changed.

The intent is to thereby push down interest rates on everything from mortgages to business loans, giving consumers and companies an additional incentive to borrow and spend money.

"This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accomodative" the Fed said in its official statement.

It's controversial to say the least, especially following a high-profile letter from Republicans Monday, urging the central bank not to intervene in the economy more than it already has.

And even within the Fed, three regional bank presidents, Richard Fisher of Dallas, Narayana Kocherlakota of Minneapolis and Charles Plosser of Philadelphia, dissented against the decision.

Interest rates have already been at record lows since 2008, and that has yet to entice consumers to take out loans.

"This is not a situation where people are saying, 'gee, I really want to buy that house but interest rates are too high'," said Frank Sorrentino, CEO of North Jersey Community Bank. "Rates are already at historic lows and over the last six to nine months, we have not seen loan demand go up."

While the launch of Operation Twist was widely expected by both markets and economists, experts still question its effectiveness.

"I don't think it really solves the fundamental problems facing the economy, which are the bad shape of the housing market and that people still have very high debt levels," said Dean Croushore, chair of the economics department at the University of Richmond and former vice-president of the Philadelphia Fed.

Named after the popular 1960's dance, the Twist, the policy was first undertaken as a combined effort by the Federal Reserve and the Treasury Department under the Kennedy administration in 1961.

But economists today largely view the policy as a failure, arguing that it may have been too small to have a significant impact.

Totaling $8.8 billion, the original Operation Twist was roughly equal to 1.7% of the total U.S. economy in the early 1960's.

"It changed rates maybe 0.1% to 0.2% at the time, but that wasn't enough to get much happening in the economy," Croushore said. "That's the only time we've tried it before, and we lack a good amount of empirical data to figure out how much difference a bigger amount might make."

The second rendition, at $400 billion, is equivalent to roughly 2.7% of today's gross domestic product.

The launch of Operation Twist follows the Fed's sixth policymaking meeting of the year, which due to weakness in the economy, was rescheduled to last two days instead of the original one.

Speaking in August, Fed Chairman Ben Bernanke said the meeting had to be extended "to allow a fuller discussion" of what the Fed should do to respond to "disappointing" growth.

At the Fed's last official meeting in August, the policymaking committee decided to keep interest rates low until 2013 -- a move that was widely interpreted as a sign that the central bank is not expecting the economy to improve much for at least another two years.

On Wednesday, the Fed reiterated its gloomy outlook, saying "economic growth remains slow."

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