Hello Ray, the first Operation Twist (OT2) in the Kennedy era was indeed about yield curve flattening. Many people would scratch their heads nowadays and wonder why the Fed would do the opposite of its “normal” easing operations. At the time, however, there was still gold convertibility and the goal was to take down long term rates a notch without lowering the short end, which would keep the US Dollar strong. The goal was to stem gold outflows (due to weakening Dollar) and stimulate the economy.

Today, of course, the Fed doesn’t have that “problem” (re: gold). While the stated goal might be to encourage what Bernanke calls the “substitution” effect (swapping lower yielding investments for higher yielding, riskier ones), I think it’s a tie-in to the coming massive mortgage refinance program to be pushed on the fiscal side, which the POTUS alluded to in his speech last week. Currently, it looks like the Soros option is the front-runner:

http://absalonproject.com/wp-content/uploads/2011/09/BHM-V11-final.pdf

In order to get people to swap a 5% 30 year fixed for an adjustable that begins at 4%, but fluctuates with prevailing mortgage rates over time (crazy, right?), the Fed needs to convey that it will hold the long end down for an extended period of time.

As to selling the short end to buy the long, the Fed really doesn’t have to sell anything because over the next year it has over $600 billion in maturing or prepaying assets on its balance sheet that it has authority (under QE Lite) to replace with any Treasury security of its choosing.

As to “malinvestments”, don’t use that term around Bernanke because he has no clue what it means.

Hi EB

Thanks for dropping in and commenting