Fed officials divided over when to sell mortgage securities; concerns raised about Europe

Fed officials divided over timing of asset sales

WASHINGTON — Federal Reserve officials were divided over when the Fed should start shedding its vast portfolio of mortgage securities. The tricky endeavor would move the central bank closer to tightening credit for millions of Americans.

Minutes of the Fed’s closed-door meeting April 27-28 released Wednesday show Fed officials expressed wide-ranging views about when and how the Fed should go about selling some of the $1.25 trillion of mortgage securities bought during the financial and economic crises. The assets were purchased to drive down mortgage rates and aid the housing market.

The minutes also reveal that some officials had new concerns that the European debt crisis could slow the U.S. recovery. At the same time, Fed officials offered a more upbeat outlook for the U.S. economy with stronger growth, slightly lower unemployment and tame inflation.

On the mortgage securities matter, the challenge is to sell those assets in a way that doesn’t weaken home prices and jack up mortgage rates.

Most Fed officials expressed a preference for strategies that would “eventually” lead to the sale of mortgage securities in an effort to shrink the Fed’s $2.3 trillion balance sheet back to a more normal size. And, they thought that any move to sell the assets should be communicated in advance. But they differed on the timing and the details of how to do this.

Most favored “deferring asset sales for some time.” A majority preferred beginning sales some time after the Fed’s first increase in its key short-term bank lending rate. Such an approach would postpone any asset sales until the economic recovery was firmly entrenched.

Others favored an approach in which the Fed would “soon” announce a general schedule for selling assets in the future. The start date wouldn’t necessarily be linked to the timing of the Fed’s first rate increase.

A few wanted to start selling the mortgage securities “relatively soon.”

And, Fed officials differed over the pace of sales. Most said they liked a gradual pace that would complete sales over the course of five years. Others preferred a faster approach of selling the mortgage securities over three years.

Michael Feroli, economist at J.P Morgan Chase Bank, said the minutes provided important insights into the Fed’s thinking on this topic. “The exit path is illuminated,” he said. Economists thought the Fed would eventually settle on the gradual selling approach over five years. And it would be timed to after the first rate increase, which is still months away.

On Wall Street, the release of the minutes didn’t have much impact on stocks, which were already sagging. The Dow Jones industrial average closed down nearly 67 points.

Despite the robust discussion over the mortgage sales that dominated April’s meeting, the Fed, in the end, didn’t adopt a plan. The statement issued at the end of the April meeting was silent on the thorny matter. It also didn’t mention the percolating debt crisis in Greece.

However, the minutes reveal that some Fed officials worried the European debt crisis could shake Wall Street and possibly slow the U.S. recovery.

Short of that, many believed a spreading crisis in Europe would slow economic growth on the continent and weaken the global economy.

Conditions in Europe worsened after the Fed’s April meeting. Earlier this month, fears of contagion may have caused Wall Street to swoon — dropping nearly 1,000 points at one point before trimming losses. Investors have been on edge since.

Still, before the European crisis intensified, the Fed had upgraded its outlook for the U.S. economy.

In new projections, Fed officials now think the economy can grow between 3.2 percent and 3.7 percent this year. That’s stronger than a growth rate of between 2.8 percent to 3.5 percent made in a January forecast.

The unemployment rate, now at 9.9 percent, will drop to between 9.1 percent and 9.5 percent by year’s end. In the January forecast, the Fed didn’t think unemployment would dip below 9.5 percent this year.

The officials predict inflation — excluding volatile food and energy costs — will rise just 0.9 percent to 1.2 percent this year. That’s better than the January estimate of an increase in prices of between 1.1 percent to 1.7 percent.

The new outlook represents the middle range of forecasts of officials on the Federal Open Market Committee. That’s the group of Fed board members and central bank presidents who meet eight times a year to set interest rates.

To strengthen the recovery, the Fed at the April meeting agreed to keep its key lending rate at a record low near zero. It also repeated a pledge to hold rates at those levels for an “extended” period.

Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, for the third straight meeting was the sole member to dissent from the Fed’s decision to retain the pledge. He thought the rate should be increased toward 1 percent this summer, the minutes reveal.

Hoenig has said he fears keeping rate too low for too long could lead to excessive risk-taking by investors, feeding new speculative bubbles in the prices of stocks, bonds and commodities. He’s also expressed concern that low rates could eventually unleash inflation.