The Fed Keeps Twisting in Its Quest for Lower Rates

(Updates with economic projections and comments from Ben Bernanke’s press conference.)

The Federal Reserve will keep spiking the punch bowl at the economic dance party through the end of the year. The Fed said Wednesday it will continue what economists like to call Operation Twist, an attempt to bring down long-term interest rates to stimulate economic growth. The operation “should put downward pressure on longer-term interest rates and help to make broader financial conditions more accommodative,” the Federal Open Market Committee said in a written statement.

William McChesney Martin, who chaired the Fed in the 1950s and 1960s, once said that the central bank’s job was to “take away the punch bowl just as the party gets going.” But under Chairman Ben Bernanke, the Fed is more worried about the ho-hum party grinding to a complete halt. Rate-setters are trying to push mortgage rates to historic lows to revive the housing market, which is a key to overall growth.

The concept of Operation Twist is to sell some of the Fed’s short-term Treasury securities and use the money to buy long-term ones—to “twist” the maturity of the portfolio. Short-term rates are already super-low; the objective is to bring longer-term rates down as well by shifting demand. The original program, announced last September, was set to expire at the end of this month with $400 billion shifted. Now the Fed will reallocate a further $267 billion toward long-term securities through the end of 2012, leaving it with precisely zero in short-term Treasuries.

While the Fed is twisting, it isn’t quite shouting. Shouting would be taking the more extreme measure of adding to the size of its bond portfolio, which already stands at about $2.7 trillion. The current program shifts the maturity of the portfolio without making it bigger.

Will this help? Probably some, but not a lot. Low mortgage rates—the 30-year fixed rate average is currently 3.71 percent— have already made houses the most affordable they’ve been in decades. The problem for many potential buyers is not the cost, but their inability to get a loan because of damaged credit. The Fed’s initiative won’t do anything about that.

The rest of the Fed’s statement was as expected: It darkened its portrayal of the economy’s health and repeated its prediction that weak economic conditions “are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.” Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, dissented from the open market committee’s decision, opposing the continuation of Operation Twist.

The Fed is now looking for 2012 economic growth of just 1.9 percent to 2.4 percent [PDF], down sharply from the range of 2.4 percent to 2.9 percent in April. That’s the range excluding the three highest and three lowest forecasts. It includes predictions from all of the Federal Reserve governors and bank presidents, not just the ones currently voting on the Federal Open Market Committee. The new unemployment prediction is for a fourth quarter 2012 average of 8 percent to 8.2 percent, up from 7.8 percent to 8 percent.

At a press conference, Bernanke fended off questions about whether the Fed wasn’t doing enough, or was doing too much. His most intriguing answer was in response to a question about a new initiative of the Bank of England–the Fed’s counterpart in Britain–to require that banks lend more to consumers and businesses as a condition for receiving new, long-term loans from the central bank. It’s called the “Funding for Lending” program, and details remain vague.

“We’re very interested in it and we’re certainly going to follow it,” Bernanke said. American banks have been criticized in some circles for taking funds from the Fed and not boosting lending. They say the problem is a lack of demand for loans, not an unwillingness to lend. Bernanke said the Bank of England’s plan may involve a subsidy from the British Treasury. A subsidy would presumably become necessary to compensate the Bank of England if banks defaulted on their loans. BBC Economics Editor James Peston says that, based on what he has been told, “the issue of whether taxpayers will guarantee the scheme is not definitively settled.”

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Groupon, the Deal That Keeps Getting Cheaper

Is Groupon (GRPN) too good of a deal to be true?

In a development that must have rueful Groupon merchants giddy—discounting cuts both ways—the stock now trades at nearly a third of the high it set after its November IPO. In August, accounting professors Anthony Catanach of Villanova University and Edward Ketz of Pennsylvania State University blogged: “It is absolutely ludicrous to think that Groupon is anywhere close to having an effective set of internal controls over financial reporting, having done 17 acquisitions in a little over a year. … When a company expands to 45 countries, grows merchants from 212 to 78,466, and expands its employee base from 37 to 9,625 in only two years, there is little doubt that internal controls are not working somewhere.”

The Securities and Exchange Commission is looking into the daily-coupon site’s accounting, which Groupon itself admitted had “material weaknesses” when it announced earnings a month ago. On Monday, word got out that Starbucks (SBUX) founder Howard Schultz was leaving Groupon’s board; the stock sank 11 percent.

Even with all this uncertainty, Groupon still sports a $7 billion market valuation—making it bigger than Safeway (SWY) and Rite Aid (RAD) combined. Who’s long this peculiar risk-reward proposition?

Start with co-founders Andrew Mason and Eric Lefkofsky. According to Bloomberg data, they own a combined 27 percent of the shares outstanding. Management on Tuesday moved to stanch its reputational bleeding by naming Daniel Henry, the finance chief of American Express (AXP), and Robert Bass, a vice chairman of Deloitte, as board members. (“With their deep financial, accounting and operational experience, Dan and Bob will provide invaluable expertise to the Board going forward,” Lefkofsky said in a prepared statement.) When you back out insiders, T. Rowe Price (TROW), Fidelity, and Morgan Stanley Investment Management round out the top 10 of institutional investors, holding a combined 11 percent of Groupon shares outstanding. Take note: Much of the company’s existing float is in “lockup,” where insiders who got a piece of its IPO are not allowed to sell until at least June 1. Shares have fallen from a high of $31 to $11.

“From the start, we weren’t particularly enamored of a story that despite billions of sales and a supposedly efficient online model was not profitable,” says Chuck Cerankosky of Cleveland-based Northcoast Research. “Now you have people realizing the financial controls issue.” He says Groupon’s impending lockup expiration adds a whole other anxiety to the situation. “A lot of people who own Groupon saw much higher paper profits,” he says. “Will they want to stick around? What if most opt to sell?”

There is, of course, a psychological floor under Groupon’s valuation: Google (GOOG), you might recall, tried to snap up the coupon peddler for about $6 billion, before it opted to go it alone with an IPO. Could a jilted suitor ever forgive, forget, and love again? Albeit with perhaps a cheaper rock?

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