Business that Matters: Unloading the Fed’s balance sheet

How would you describe the American economy since the Great Recession?

I like to think of it as the hand soap bottle in your kitchen. When it’s almost empty, you fill the rest of the bottle with water, assuming there isn’t a difference from the original. It’s not the same thick soapy texture, but you figure it’s close enough. Still, at some point you have to fix the problem.

You have to buy more soap.

The Federal Reserve has been facing a similar problem ever since they went on a bond-buying spree in 2008, accumulating a $4 trillion bond portfolio to save the economy from bottoming out.

Top investment firms like Bear Stearns, Goldman Sachs and Lehman Brothers were making a lot of money from selling bundled mortgages. However, this strategy backfired when home buyers defaulted on their mortgage loans, making the bundled mortgages worthless.

When no one else wanted to buy the bundled mortgages from the investment banks, the Fed stepped in, purchasing nearly $2 trillion of a valueless asset.

Why should you care about this, you ask? The Fed bought these bonds when the economy was hurting — they will sell them when the economy starts showing signs of improvement.

With two interest rate hikes this year, Federal Reserve chairwoman Janet Yellen has decided the time was right for the Fed to start selling the bundled mortgages — a great sign for college students entering the job market.

In a Federal Open Market Committee meeting last week, the Fed announced that they are preparing to initially peel back their bond holdings by about $10 billion per month. Once they start selling off the bonds, there will be less supply in the market, making the bonds more valuable.

Although it will happen slowly, the borrowing costs for consumers and businesses will increase.

By reducing the Fed’s balance sheet, the safest type of investment, Treasury yields will go up. Since the Great Recession, the International Monetary Fund estimated the Fed’s quantitative easing program has reduced 10-year Treasury yields by about 0.9 percent.

Now that the Fed is slowly reducing their holdings, Treasury yields will increase. As Treasury yields become more and more attractive, investors and businesses are more likely to invest in the American economy, creating additional job opportunities nationwide.

Stock prices will go down after being artificially boosted by lower interest rates on bonds. Financial Times columnist and macroeconomic commentator Gavyn Davies said during the Great Recession, the Fed increased U.S. stock prices from 11 to 15 percent. With the Dow Jones at record-breaking highs today, it might be hard to believe the stock market will go down.

Now that the Fed is beginning to reduce its balance sheet, however, a stock market correction is imminent. While a correction won’t necessarily create additional job opportunities for college students, what it will do is give college students a better picture of what industries and businesses are generating the most value.

The great news about the Fed’s decision is that it signals to investors that the American economy, which has been slowly recovering since 2008, is strengthening even more. When Lehigh graduates enter into the job market, they will be pleased to find a positive economic future where companies invest in new production facilities and new workers for thousands of jobs. Although there are still corrections to be made, the Fed is taking the necessary steps toward a fully recovered economy.

We’re finally replacing our watered down soap with a fresh bottle.

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Andrew Schillaci, ’17, ’18G, is a columnist for The Brown and White. He can be reached at [email protected].