So long story short, the Fed balance sheet will not be shrinking. Translation, each month more assets will be purchased and parked on the Fed's balance sheet, whereas 60 days ago we were talking 'exit strategies'. How quickly things change.
The Fed says they will be buying long term Treasuries which is effectively full scale monetization of debt. i.e. a license for the government to spend as much as it wants, because we now run a Banana Republic where the left pocket buys from the right pocket and we all clap like seals, talking about the best economy on Earth. What is cool is no one is outraged by this stuff anymore; we have become immune to these policies that if whispered about 3 years ago would have people shocked. Now it is simply business as usual, and if it can manipulate assets upward, we're content.
There is some hand wringing about buying Treasuries rather than MBS but frankly if the Fed bought mortgage backed securities OR US debt outright it does not matter to me. They are both now US debt in my mind as almost the entire housing market is now a government run program, with Fannie and Freddie wards of the state. (and FHA being run like a subprime lender circa 2005) Their debt is the obligation of the taxpayer, with open ended expenses as made clear in the still of the night Christmas Eve as Tim Geithner pulled a fast one on the US taxpayer. [Jan 5, 2010: WSJ - The Treasury Department's Christmas Eve Masscare of the US Taxpayer] So it's all just an accounting trick; the mortgage debt is guaranteed by the full faith of the government as are its housing debts. So what does it matter if the Fed buys MBS or UST?
The market rallied strongly as the Fed gave in to the demands of the whiny children. This is just a first step; I expect full fledged QE (QE III: Return of the Jedi) post election and into first quarter 2011. Buy anything you wish, Ben Bernanke has your back. You remember March 2009 to April 2010 don't you?? Please don't ask any questions about why a rip roaring economic recovery requires the Fed to backstop every orifice known to man - just smile and tell your European friends how awesome and flexible our economy is, and how theirs sucks. Make sure to call them socialists why you are at it, while beating your fist on your chest and screaming We're #1!.
p.s. as long as we are on the subject of Fannie, Freddie debt I am now reading stories about Fannie giving nothing down mortgages again. That worked out wonderfully in the past. A few years ago I'd scream and be outraged....now I'm too busy laughing at the absurdity of it all. But who cares if we lose money on these awesome deals - the Fed will make it whole and take all our pain away. Free market capitalism baby; go team go.