Quote of the Day: Fed’s allocation of credit is an Inappropriate Use of Central Bank’s Asset Portfolio

A balance sheet has two sides, though, and it is the asset side that can be problematic. When the Fed buys Treasury securities, any interest-rate effects will flow evenly to all private borrowers, since all credit markets are ultimately linked to the risk-free yields on Treasurys. But when the central bank buys private assets, it can tilt the playing field toward some borrowers at the expense of others, affecting the allocation of credit.

If the Fed’s MBS holdings are of any direct consequence, they favor home-mortgage borrowers by putting downward pressure on mortgage rates. This increases the interest rates faced by other borrowers, compared with holding an equivalent amount of Treasurys. It is as if the Fed has provided off-budget funding for home-mortgage borrowers, financed by selling U.S. Treasury debt to the public.

Such interference in the allocation of credit is an inappropriate use of the central bank’s asset portfolio. It is not necessary for conducting monetary policy, and it involves distributional choices that should be made through the democratic process and carried out by fiscal authorities, not at the discretion of an independent central bank.

Some will say that central bank credit-market interventions reflect an age-old role as “lender of last resort.” But this expression historically referred to policies aimed at increasing the supply of paper notes when the demand for notes surged during episodes of financial turmoil. Today, fluctuations in the demand for central bank money can easily be accommodated through open-market purchases of Treasury securities. Expansive lending powers raise credit-allocation concerns similar to those raised by the purchase of private assets.

Moreover, Federal Reserve actions in the recent crisis bore little resemblance to the historical concept of a lender of last resort. While these actions were intended to preserve the stability of the financial system, they may have actually promoted greater fragility. Ambiguous boundaries around Fed credit-market intervention create expectations of intervention in future crises, dampening incentives for the private sector to monitor risk-taking and seek out stable funding arrangements.

This is from Federal Reserve Bank of Richmond President Jeffrey M. Lacker and his Director of Research John A Weinberg at the Wall Street Journal

The point is that the de facto easing policies embraced by central banks as the FED has been to invisibly redistribute resources in favor of certain parties which leads not only to the accumulation of imbalances but also to ethical controversies such as moral hazard, inequality et.al.

And along the same redistributive basis, Germany’s Bundesbank chief Jens Weidmann last week warned against the ECB’s proposed QE via Asset Backed Securities

From Reuters: (bold mine)

ABS are created by banks pooling mortgages and corporate, auto or credit card loans and selling them to insurers, pension funds or now the ECB.

Then the credit risks taken by private banks would be transferred to the central bank and therefore taxpayers without them getting anything in return," said Weidmann, who is also an ECB policymaker.

"But that goes against the basic principle of liability that is fundamental to a market economy: Those who derive benefit from something should bear the loss if there are negative developments," he was quoted as saying.

Bottom line: There are natural limits to the central bank’s embrace of Keynesian zero bound quasi boom policies. Those limits are becoming increasingly apparent even to central bankers.