Plosser: Fed should sell MBS sooner instead of later

PHILADELPHIA (Reuters) - The Federal Reserve should sell its mortgage-backed securities holdings sooner rather than later as the economic recovery gathers steam in order to extricate itself from fiscal policy, a senior central bank official said on Wednesday.

The Fed put in place a raft of emergency programs at the height of the financial crisis, including one to buy $1.25 trillion worth of securities backed by mortgages held by Fannie Mae and Freddie Mac. Its balance sheet more than doubled to over $2 trillion in the process.

"As the economic recovery gains strength and monetary policy begins to normalize, I would favor our beginning to sell some of the agency mortgage-backed securities from our portfolio, rather than relying only on redemptions of these assets," Philadelphia Federal Reserve Bank President Charles Plosser said in an address to the World Affairs Council of Philadelphia.

"It will take some time for the Fed's portfolio to return to its pre-crisis composition, but we should begin taking steps in that direction sooner rather than later," Plosser said.

Plosser, known as a "hawk" on inflation, is not a voting member on the Fed's policy-setting Federal Open Market Committee this year. He will rotate into a voting seat next year.

In addition to its emergency lending during the crisis, the Fed cut benchmark interest rates to near zero in December 2008 and has pledged to keep them ultra-low for an extended period. Most analysts do not expect the Fed to raise rates before the second half of 2010.

Plosser has been vocal in his uneasiness about the Fed's extraordinary policies, saying lending to certain sectors of the economy blurred the line between fiscal and monetary policy. That, along with bailouts of individual firms, opened the central bank up to attacks on its independence, he said.

"By making these unprecedented lending decisions, and at times being less transparent than we could have been, the Fed has opened itself up to criticism from various sources and has encouraged the idea that monetary policy decisions may be influenced by political or other special interests," Plosser said.

Plosser said that he believes the Fed can exit from the extraordinary stimulus it has provided to markets and the economy "without generating a serious risk of inflation in the intermediate to long term," though that "will require some careful and difficult policy choices."

Plosser reiterated his call for an accord between the Fed and the Treasury that would place responsibility for bailouts of individual firms and sectors with the fiscal authorities.

The Fed currently has the authority to lend more broadly in a crisis under Section 13(3) of the Federal Reserve Act, which allows the U.S. central bank to lend to corporations, individuals, and partnerships under "unusual and exigent" circumstances.

Plosser said the authority for this type of lending should be eliminated or "severely curtailed," saying it could "help restore the public's confidence and trust in the institution and preserve our independence."

He also pushed back against Congressional proposals that seek to overhaul the governance of the Federal Reserve system, by making chairs or presidents of regional Fed banks political appointees.

"Some of the proposals to change the Fed's structure are misguided and even pose serious risks to the health of our economy," Plosser said.

Briefly addressing the economy, Plosser said a modest recovery had begun and there were signs labor markets were starting to improve.

(Reporting by Kristina Cooke; Editing by Leslie Adler)