Republican Fed bill would restrict bond investments

Fri Mar 2, 2012 5:39pm EST

* Reform bill restricts Fed mostly to Treasuries, repos

* Measure would end Fed's direct influence in housing sector

* Consumer Financial Protection Bureau funding targeted

By David Lawder

WASHINGTON, March 2 (Reuters) - Republican legislation to limit the Federal Reserve's mandate to fighting inflation would restrict the types of bonds the U.S. central bank could buy and potentially force sooner-than-expected sales of mortgage-backed securities.

Aides to Representative Kevin Brady said on Friday his reform bill would allow the Fed to invest only in U.S. Treasury debt and repurchase and reverse repurchase transactions used to add or drain banking system reserves except during emergencies.

Brady, a long-time Fed critic and chairman of the Joint Economic Committee of Congress, plans to formally introduce his "Sound Dollar Act" on Monday.

The Brady bill brings together a series of reforms that address congressional Republicans' complaints that the Fed emerged from the financial crisis with too much power and has strayed into fiscal policy and credit allocation while perpetuating expectations it will bail out the largest financial institutions.

Under the bill's bond purchase provision, aimed at keeping the Fed from "picking winners and losers through the allocation of credit among households, firms and sectors," the Fed would be able to buy other types of assets during a crisis, but would have to liquidate these within five years, aides said.

The Fed took increasingly aggressive, emergency measures to stimulate the economy as the financial crisis weighed, including the purchase of around $1.25 trillion in mortgage-backed securities as part of its purchase of $2.3 trillion in assets.

The Fed has been reinvesting the proceeds of maturing mortgage bonds into that market to try to ignite home purchases and refinancings.

Financial markets recently have been scrutinizing remarks by Fed Chairman Ben Bernanke for any signs that he may be looking more seriously at another major round of bond purchases, which could include mortgage-backed securities.

The Fed, which has had a long-standing dual mandate to promote maximum employment and to fight inflation, under the Brady bill would be stripped of the jobs mandate and be refocused to controlling inflation and maintaining the purchasing power of the dollar.

According to a bill summary released on Friday, the inflation-only mandate would require the Fed to monitor a broad range of asset prices, such as the dollar's value, gold prices and real estate, in order to avoid the kind of bubble that led to the 2007-2009 financial crisis.

The Fed would also have to report to Congress on the impact that its monetary policy decisions have on the dollar's value.

Other details of the bill released on Friday included a provision to subject the new Consumer Financial Protection Agency to the normal congressional appropriations process. Currently, the CFPB gets its funding from the Federal Reserve. If the change were enacted, it could make the agency, widely despised by Republican lawmakers, more vulnerable to efforts to limit its regulatory scope by de-funding it.

The bill also would liquidate any assets in the Exchange Stabilization Fund that are not made up of special drawing rights from the International Monetary Fund. The $50 billion Exchange Stabilization Fund, launched during the 1930s Great Depression, is seldom used today and Brady's aides called it a "slush fund" for the U.S. Treasury secretary.

Former Treasury Secretary Henry Paulson used it to backstop money market mutual funds in 2008, while his successor, Timothy Geithner, has tapped the fund to stay under the U.S. debt limit in recent months.

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