Among the options: Having the Treasury borrow more money than it needs to fund the government and leave the proceeds on deposit at the Fed, which would issue debt under its own name rather than the Treasury's; and asking Congress for immediate authority for the Fed to pay interest on commercial-bank reserves instead of waiting until a previously enacted law permits it in 2011.
The Issue: The Fed has sold or committed a lot of its Treasury portfolio to support markets. Some worry it will soon run out of room to do more.
• The News: The Fed is considering several contingency plans for getting more lending capacity so that won't happen.
• The Bottom Line: The Fed has lots of firepower left before it has to turn to these contingencies.No moves are imminent because the Fed has plenty of maneuvering room. The internal discussions are part of a continuing effort at the Fed, similar to what is under way at foreign central banks, to determine its options if the credit crunch becomes even more severe. Fed officials believe the plans largely eliminate the risk that the Fed will exhaust its stockpile of Treasury bonds and thus lose its ability to backstop the financial system, as some on Wall Street fear.

Originally posted by jefwane

Fed Weighs Its Options in Easing Crunch

online.wsj.com

The Issue: The Fed has sold or committed a lot of its Treasury portfolio to support markets. Some worry it will soon run out of room to do more.
• The News: The Fed is considering several contingency plans for getting more lending capacity so that won't happen.
• The Bottom Line: ... the risk that the Fed will exhaust its stockpile of Treasury bonds and thus lose its ability to backstop the financial system, as some on Wall Street fear.

Fed plotting how to achieve infinite money

So the Fed is seeking ways to expand its balance sheet without causing the federal funds rate to drop.

The likeliest option, one the Fed and Treasury have discussed, is for the Treasury to issue more debt than it needs to fund government operations.

Treasury's principal constraint is the statutory limit debt. Treasury debt was $453 billion below the limit Monday. In the past, Congress always has responded to administration requests to raise the limit, sometimes only after political theatrics.

The Fed would use the cash to purchase an offsetting amount of Treasurys in the open market; for legal reasons, it generally cannot buy them directly from Treasury.

It has never done so; the legality is unclear.

Another possibility is seeking congressional approval to pay interest on banks' reserves immediately instead of waiting until a 2006 law permits that in 2011. If the Fed paid, say, 2% interest on reserves, banks would have no incentive to lend out excess reserves once the federal funds rate fell to that level.

Congress put off the effective date because paying interest on reserves reduces the Fed profits that are turned over to the Treasury each year, widening the budget deficit.

Although preliminary explorations suggest Congress would be open to accelerating the date, the Fed is leery of depending on action by Congress.

The Fed Is Terrified

The Fed is effectively in a position of not to being able to print money to buy Treasuries from banks, because of restrictions mentioned in the WSJ article and also because the banks are insolvent. Simply put, banks do not have the cash to accumulate Treasuries on their books to sell to the Fed this time around. And more writedowns ... are coming. This will require still more capital raising efforts.

The Fed has already sponsored 3 new lending facilities, yet is having still more discussions on what to do next.

Recap Of Fed Sponsored Facilities

* The TAF (Term Auction Facility) failed to restore liquidity.
* The TSLF (Term Securities Lending Facility) failed to restore liquidity....
* The PDCF (Primary Dealer Credit Facility) will be the next "facility" to fail.

The Fed's ongoing discussions shows deep concern that the above facilities will not be sufficient.

The Fed is now considering borrowing from the Treasury (US taxpayers). Were the Fed to have to do this to remain whole, i.e., have the Treasury underwrite the Fed's balance sheet, the US central bank would be de facto insolvent, having insufficient assets to carry out its mandate.

The perceived invincibility of the Fed's ability to reflate is now clearly in question. The Fed's own discussions prove it.