After much anticipation and speculation, the Federal Reserve's "Operation Twist" was announced Wednesday. This rehash of 60's Fed policies were exactly what the markets were expecting, yet the market closed down 284 points on the news.

It would appear that the market had been clinging to an unspoken hope that the Federal Reserve would outright print more money even though pretty much everyone was predicting the Federal Reserve would do exactly what the Federal Reserve did. So when those fleeting hopes were dashed, the market tanked.

While the sell-off was an interesting study in market psychology and wishful thinking, the bigger question is: Why is the Federal Reserve doing this?

According to the Federal Reserve itself:

This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.

To help support conditions in mortgage markets, the Committee will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities.

As has been the case in past statements, the reason given by the Federal Reserve is dubious at best.

The reality is that the housing market is not suffering due to high interest rates. Mortgage rates are already at historic lows and even that isn't enough to attract buyers to the housing market.

Nor will the Fed's actions help employment. If printing trillions of dollars and maintaining low interest rates for over three years hasn't done the trick, the latest "twist" isn't going to either. Just as potential home buyers aren't staying away from houses due to high interest rates, businesses aren't refraining from borrowing and expanding for that reason either. Everyone's waiting for some certainty to come to the economy and for the current correction to run its course.

So if the Fed's actions aren't going to improve the housing market, prod businesses into borrowing to expand, and won't reduce unemployment, what's the point?

As has been the case since the beginning, the Fed's actions are about bailing out the U.S. Government.

Our increasingly dangerous problem is not the national debt, per se, but our deficit combined with our refinancing costs. When the government borrows money, it often does so for shorter periods of time which means the money we borrow today will most likely need to be refinanced within a few years at whatever the prevailing interest rate is at that time. In any given year, perhaps $2 trillion of our national debt will come due. When that happens, we need to borrow $2 trillion to pay back the amount that came due, plus borrow the additional amount we need to cover our new debt.

The Fed's action today, I think, is primarily attributable to two primary considerations:

1. Due to so much short-term debt being generated by the U.S. Treasury, the amount of money we need to borrow each year to pay back what comes due is becoming larger and larger. By converting short-term debt to long-term debt, the Federal Reserve will spread our debt payments over a longer period of time to reduce the amount of money the Treasury needs to re-borrow each year. Think of this as being overwhelmed by the payments on a 5-year car loan, so you refinance the car loan over 30 years. It alleviates an immediate cash-flow problem by kicking the can 30 years down the road.
   
2. The Fed may foresee increasing interest rates. When interest rates rise, the government will have to refinance its existing short-term debt at much higher interest rates. This will cause the annual expenditure on interest payments to become very large--perhaps too large for the country to afford. By converting to longer-term debt, the Federal Reserve is reducing the Treasury's exposure to increases in interest rates.

This would seem to be further confirmed by other reporting:

More perplexing to analysts was the Fed's decision to allocate 29% of its portfolio to buying Treasuries with 20 to 30-year maturities. The Fed issues significantly fewer new 30-year Treasuries each month, so it's essentially planning to buy almost all new issuances before June 30, 2012.

Translation for the perplexed analysts: The Federal Reserve will be virtually the only entity buying long-term (20 and 30-year) debt from the U.S. Government through mid-2012. This is most likely because even though the government would like to extend its debt for two or three decades, not many investors are willing to trust the government with their money for three decades.

First we ran out of money so the Federal Reserve printed some more. That had no significant impact on sparking economic activity so there's little benefit in doing it again (for now), but the government still needs to borrow unhealthy amounts of money. Continuing to engage in short-term borrowing that will have to be refinanced in a few years is increasingly dangerous so the logical solution is to refinance the maturing debt for longer periods of time. That allows the government to lock-in today's low interest rates for three decades while simultaneously reducing the amount of money it's going to need to borrow a few years from now since the new debt won't mature for 30 years. But since few investors are foolish enough to loan the government money for 30 years, the Federal Reserve will do so.

It really seems that we're reaching desperation. The Federal Reserve has all but given up on trying to use monetary policy to stimulate economic activity (good!). Now it appears that it will engage in activities that only make sense in the context of easing a nearing financial crunch for the Obama Administration.

And with Europe apparently at serious risk, the world and U.S. economies heading towards a double-dip recession, U.S. unemployment holding at above 9%, no reasonable hope that we solve our spending problem in Washington, and with Europe's problems being just about the only thing preventing U.S. debt from coming under serious scrutiny, it's still likely that the Federal Reserve will soon be driven to engage in the QE3 that the markets were apparently hoping for today.

And when that happens, things are bound to get ugly pretty quickly.