Fed to Begin Laying Plans for Withdrawal

WASHINGTON, DC-Federal Reserve Bank Chairman Ben Bernanke wasscheduled to testify before Congress House Financial Servicescommittee Wednesday on the Federal Reserve Bank’s exit strategy forits ultra low-interest rate policy as well as the other measures ithas put into place over the past 18 months. That hearing was canceleddue to weather with no immediate date set for a rescheduling.

However, advance notice of his testimony has been reported. That,along with earlier speeches by other Fed officials, give the industry aclue as to how the banking authority is going to proceed–which isslowly and cautiously, when it does begin to scale back; likely not for several months.

For starters, the Federal Reserve may not make rate hikes until 2012,according to comments made by James Bullard, president of the St.Louis Federal Reserve, to Fox Business News. “You could take back someof the quantitative easing, not in a really rapid way, but in a slowway as the economy improves–that might be a helpful way to proceedwhile you are waiting for the day to raise interest rates,” he said.

The real question will be how the Fed will begin to suck back themassive amounts of liquidity it has poured into the credit markets. Ithas said, despite a few hints to the contrary, that will end itspurchases of mortgage-backed securities and the TALF program thisMarch.

The immense amount of liquidity, though, will require more than justtraditional measures. The Wall Street Journal reports that the Fed istaking a series of innovative steps before it begins raising interest rates.

One is to encourage banks to tie up money at the Fed for a setperiod—preventing them from lending it—in what are called “termdeposits.” Another is to lock up funds, and thus constrain the supplyof credit in short-term lending markets, by borrowing against theFed’s large portfolio of securities holdings, in trades known as”reverse repos.” When the Fed borrows from the markets, it effectivelytakes money out of circulation and replaces it with securities fromits holdings.