This afternoon Chairman of the Federal Reserve, Ben Bernanke announced the $400 billion "Operation Twist" in hopes to stimulate the economy. Unfortunately this is not going to help and I am most certain will make things worse.
Operation Twist is maneuver by the Fed to sell their inventory of short term notes (1-3yr maturities) and use the proceeds to buy longer term bonds (6-30 yrs). The “Twist” is the fed lengthening the maturity of their debt.
This is a very dangerous move by the Fed because at some point interest rates will rise and forcing the Fed to sell these bonds for a loss hence making Operation Twist a failure.
For example, let’s say today the Fed buys 30yr bonds with a coupon of 4% and when it’s time to sell the bonds interest rates are higher. People or countries have a choice: Buy a $100 bond from the Fed yielding 4% or buy a $100 bond from the US Treasury yielding 6%.
This is where the Federal Reserve’s troubles begin. The only way the Fed can sell 4% bonds is by offering them at a price below $100, known as a discount and incurring a loss. The Fed and Washington know this but there’s an election coming up and politicians are concerned with seats.
Worst of all this “Twist” is a disaster for employment. Small business is the key to putting America back to work. Operation Twist increases the risk to bank lending therefore making them less likely to lend money to the real American job creators. I hope this makes sense and please feel free to post questions or start a discussion.