The sources for funding the federal deficit (about a trillion left to fund in fy 09, 1.2 trillion in fy 2010 and 2 trillion in refi’s over the next 12 months) are the US market, the foreign markets, Fed purchases (monitizing), and/or controlling the equity markets to force capital out of equities and into treasuries. If funding an average of 225 bn a month for the rest of 09 and 200 bn in 2010 (new money) is left to market forces, interest rates will increase resulting in unfavorable consequences to the housing market. If the Fed buys, then the inflation forces are unleashed.
These two consequences are against administration policies. Foreign sources are unlikely to buy to the extent they now hold our debt — many of the countries are in worse shape than we are and there is some movement out there for an alternative reserve currency (China holds only 10% of our publically held debt, Japan, 9%)
That leaves putting a squeeze on the equity markets to force capital back into treasuries. In addition to providing a ready pool of money, the keeping of rates lower than normal, will help keep the interest portion of the federal budget lower. The downside of this is that forcing the equity markets back to a March low will wipe out bank capital. This may be right up the administration’s alley. It will provide an excuse for more control which will offer the opportunity to reach into the bank balance sheets and rip out the toxic assets. The facitlity is already in place to handle this, which the institutions (PIMCO, et al) already chosen. The FOMC is meeting next week. Will be interesting to see if they begin to dis the recovery and begin to plant seeds that the equity markets are not the place to be.