Is this printing money? It isn’t any different than normal bank credit creation if you simply view the Fed as another bank. The only difference is the Fed isn’t subject to reserve ratios or capital leverage requirements (e.g. it’s extremely levered), so it can, not necessarily will, create credit much too imprudently.

The Fed can acquire bad assets no matter what asset it takes. US debt may be one such bad asset but is it really worse than the rest of the stuff? By definition, the Fed is buying all of them at rates above what they are worth when marked to market. But the idea is this is for longer term benefit and hence not imprudent.

I think the outcry about the Fed buying government bonds rather than other assets is the Fed’s special relationship with the Treasury and the potential for abuse. The Fed has a chummy depositor who will never participate in a run on it, and that is the Treasury. And such a depositor will get any amount of money it needs to deposit with the Fed by issuing debt that even if nobody wants, the Fed will happily buy. The metaphorical printing press is in two pieces, mediated by the accounting trick that is permanent debt issuance. So if the two collude, they can put the printing press together and make it work. Whether such collusion is or is not happening is debatable, as there is no sharp line to cross. Everybody is still happy to leave their deposits with the Fed and presumably still believes the Fed (or the government) that the Treasury means to retire these debts eventually, to unwind these positions.

But if this economy doesn’t turn better soon, these assumptions will become untenable.

The Treasury Department issued $40 billion in 35-day cash management bills Wednesday at a rate of 0.30%. Proceeds from the sale will immediately be transferred to the Federal Reserve to fund its operations to improve liquidity in money markets. The sale was needed to help the Fed expand its balance sheets, which has been shrinking as it lent out cash to banks and primary dealers to keep the financial system working.

Not nearly as bad as this scenario, where

… the accounting trick is simply for the Federal Reserve to “agree” to “buy” worthless assets like new government bonds that nobody else wants and for the government to turn right around to “fund” the Federal Reserve with the new money it got.

In fact, quite the opposite. I’m glad that people still want Treasury bills, even to the tune of zero (and perhaps soon to be negative) yield. I guess there is really no alternative. Where else is money to be kept … I would keep it where people/companies are most willing and able to produce valuable goods, but these are hard to identify clearly these days, so a proxy is as good as anything.

Fed Easing Liquidity in Funding Markets

By Jeannine Aversa, AP Economics Writer

The Fed announced the creation of a new tool, called the Term Securities Lending Facility (TSLF), geared to provide primary dealers — big Wall Street investment firms and banks that trade directly with the Fed — with 28-day loans of Treasury securities, rather than overnight loans. They would pledge other securities — including federal agency residential-mortgage-backed securities, such as those of mortgage giants Fannie Mae and Freddie Mac — as collateral for the loans of Treasury securities. Fed officials said that’s the first time they’ll be accepting mortgage-backed securities through this type of lending program.

Unfortunately, that does tend to make the Fed less credit-worthy, say if the banks were unable to repay their 28-day debts. And since the Fed is where the government keeps its money:

U.S. Treasuries Riskier Than German Debt, Default Swaps Show

By Abigail Moses

March 11 (Bloomberg) — The risk of losses on U.S. Treasury notes exceeded German bunds for the first time ever amid investor concern the subprime mortgage crisis is sapping government reserves, credit-default swaps prices show.