Operation Twist

With Operation Twist, the Federal Reserve is taking a page out of Hollywood’s book by rebooting an old idea and hoping for positive results. Operation Twist, in reality, is nothing new. It is based on a policy that was used in the early 1960. This time around, the operation is being used to shift $400 billion from short-term Treasury securities to long-term ones.The move officially started on Monday, October 3, and will end June 2012 according to a schedule on the Fed’s website. 

The intent behind Operation Twist is to boost the U.S. economic recovery. If it works, the operation “should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative,” according to the Federal Reserve. Obviously, spending boosts the economy. And although people are spending again, they’re not spending enough. The idea, by lowering long-term interest rates such as those on mortgages and loans, is to encourage lending, get businesses expanding, and persuade consumers to spend a little more.

It appears that having lower long-term rates would primarily benefit homeowners as rates on mortgages and other fixed-rate loans are lowered. In fact, the Fed is specifically targeting mortgage rates “by reinvesting proceeds from maturing investments in mortgage-backed securities."

At the same time, by selling short-term securities, prices will fall and yields will rise. This move is intended to attract foreign capital and enable investors to enjoy higher rates on short-term investments like T-bills and money market accounts. If everything turns out as the Fed intends, Operation Twist will lower expenses and increase income for investors.

Like every plan, there are potential drawbacks to the execution of Operation Twist. The main problem is that, even if it works, it won’t make a substantial difference for home and car buyers, savers, or credit card users. At the end of the day, credit card rates could actually go up, savers would suffer a loss, and even insurance prices could be affected.

Is Operation Twist the same thing as QE3? Actually, it’s not. Although the ideas are similar, there is one important aspect that differentiates them. Quantitative Easing (QE) involves printing money – something that won’t be happening with Operation Twist. As previously mentioned, in order to buy long-term Treasury securities, the Fed is using the money it makes from the sale of short-term ones. No additional money is being printed for the operation to take place.

The announcement of Operation Twist didn’t exactly go over well. However, at this stage in the game, it is doubtful that any plan is going to get people shouting for joy. When the plan was unveiled, stocks fell as investors fled to so-called “safe-haven” investments and critics were quick to voice their disapproval.

On the bright side, the plan was not declared a failure by everyone. Jerry Webman, chief economist at OppenheimerFunds Inc. in New York, pointed out that “it would be helpful if someone would lay out exactly the economic mechanism that gets us from yet lower interest rates to actual economic activity.”

If this had been done, perhaps panic would not have ensued. And although it seems Operation Twist won’t be the solution to all of our economic woes, if it works, at least it’s one step in the right direction.

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