Last week, the Federal Reserve announced the next step it planned to take to intervene in the economy and attempt to aid in its recovery.  This step is called "Operation Twist."  I want to briefly discuss it here so you understand what's actually being referred to when you hear this term.

US Treasury bonds range from short term (such as 2 year notes, though there are even shorter terms than that) to long term (30 year Treasuries).  The bonds have price and yield characteristics that move opposite each other (picture a seesaw -- when a bond's price rises, its yield falls, and vice versa).  These characteristics can be plotted along what's called a "yield curve," which under normal circumstances, depicts low yield for short term bonds and high yield for longer term bonds.  The reason for this is, if you buy a short term bond, the duration of time over which you're risking your capital is brief, and therefore lower on the risk scale -- thus, you don't get much yield back for it.  On the other hand, if you risk your capital over a long period of time, say 30 years, you would normally be rewarded for it by receiving a higher yield.

That's under normal circumstances.  We are not operating under normal circumstances.

The Fed has already used various monetary policies to push down interest rates to the 0-0.25% range, which influences the rate at which banks lend to their customers (and which has resulted in historically low rates for borrowers today).  The problem is, there still isn't as much borrowing going on as the government/Fed would like.  The reasons for this are not the point of this article -- suffice it to say that borrowing remains below target.

Enter Operation Twist.  Picture that yield curve again, with the line sloping upward from the 2 year note to the 30 year bond.  If you could grab each end, like a dishrag, and twist it (like you were ringing it out), you'd flatten out that curve.  Yields on 2 year notes would rise; yields on 30 year bonds would fall.  That's the objective behind this policy move.

So how does the Fed accomplish this?  Simple.  The Fed has a certain number of 2 year notes on its balance sheet.  It sells them in the open market.  This increases the supply of 2 year notes, diluting demand and thus lowering the value/price of the notes.  As the price falls, yields rise.

With the money it receives from the sale of the 2 year notes, the Fed enters the 30 year bond market and buys those Treasuries.  As it buys them, supply drops, increasing demand and thus increasing the value/price of those bonds.  As the 30 year prices rise, their yields fall.

Ultimately, as the 30 year bond yield falls, the eventual interest rate you or I might receive on a 30 year loan (read: mortgage) should fall, as well.  At least that's the hypothesis.  Whether banks actually lower the rates any further than they already have (as opposed to just pocketing the wider margin), remains to be seen.

But in the abstract, what does all this really signify?

Desperation.

The government, using the instrument of the Fed, is desperate to juice the economy, by stimulating more borrowing and consumption on the part of the consumer.  Specifically, juicing the housing market has all kinds of (temporary) positive effects on the economy, since so many industries benefit from home construction/remodeling/etc.  Of course, I'd thought we'd already found out in 2007-09 what happens when a housing bubble bursts...but hey let's face it, we don't learn lessons too well around here.

The key point is to see past the fancy jargon and terms of reference that the government and the Fed will throw at you, which only serves to obscure the often negative reality involved, and to understand what is actually happening and how it affects you.