UNDERSTANDING THE MECHANICS OF A QE TRANSACTION
Some people want you to believe that the Fed just injected the economy and stock market full of money that will now result in an economic boom and much higher prices in most assets. That’s simply not true. Here’s the actual mechanics behind QE.
Before we begin, it’s important that investors understand exactly what “cash” is. “Cash” is simply a very liquid liability of the U.S. government. You can call it “cash”, Federal Reserve notes, whatever. But it is a liability of the U.S. government. Just like a 13 week treasury bill. What is the major distinction between “cash” and bills? Just the duration and amount of interest the two pay. Think of one like a checking account and the other like a savings account.
This is a crucial point that I think a lot of us are having trouble wrapping our heads around. In school we are taught that “cash” is its own unique asset class. But that’s not really true. “Cash” as it sits in your bank account is really just a very very liquid government liability. What is the difference between your checking and savings account? Do you classify them both as “cash”? Do you consider your savings accounts a slightly less liquid interest bearing form of the same thing a checking account is?
What is a treasury note account? It is a savings account with the government. So now you have to ask yourself why you think cash is so much different than a treasury note? What is the difference between your ETrade cash earning 0.1% and that t note earning 0.2%? NOTHING except the interest rate and the duration. You can’t use your 13 week bill to pay your taxes tomorrow, but that doesn’t mean it isn’t a slightly less liquid form of the exact same thing that we all refer to as “cash”. They are both govt liabilities and assets of yours.
When you own a t note you really just traded your “cash” for a slightly less liquid form of the same exact thing. If the Fed buys those t notes from you they give you back your cash minus the interest rate. That’s all there is to it. No change in the money supply. No change in anything except the rate of interest you were earning. If the government removes t notes then all they’re doing is altering the term structure of their liabilities. They’re not changing the AMOUNT of liabilities.
The other day, Ben Bernanke explained that he is not adding any new cash to the system via QE:
“Now, what these reserves are is essentially deposits that commercial banks hold with the Fed, so sometimes you hear the Fed is printing money, that’s not really happening, the amount of cash in circulation is not changing. What’s happening is that banks are holding more and more reserves with the Fed.”
This is very important because millions of investors are betting on the inflationary impact of QE. But again, as Mr. Bernanke said there is no reason to believe that QE is inflationary. Why? Because they are not adding net new financial assets to the private sector. The assets already existed! They are merely swapping reserves for bonds. They are giving the banks a checking account instead of a savings account. What does this mean? If Bank A owned a 1.2% 5 year note and they sell that note to the Fed they receive reserves earnings 0.25%. Their savings account was changed to a checking account. What changed? Nothing. Just the duration and rate of the paper. The number of assets in the system is the exact same. You can see this description in the following diagram (via Alea):
As you can see the net financial assets are UNCHANGED. They are merely changing the composition of the bank balance sheet. The logical question that most people ask is: “where did the Fed get the money to buy the bonds?” They didn’t get it from anywhere. It truly is ex nihilo. But it is not new money being injected into the private sector. It is merely being swapped with something that was already spent into existence. Therefore, you’ll often hear that banks have new money to put to work. That’s not true. They had a 0.2% piece of paper that was already put to work and can be exchanged in markets for whatever they please. There is not “more firepower” in the market following QE. All that the Fed altered was the duration of the U.S. government’s liabilities. The Fed took on an asset (treasurys) and also accounted for a new liability (the reserves). But this transaction did not change the net financial assets in the system.
The point here is that from an operational perspective the Fed is not really altering the money supply. There might be some slight market change in the bonds the Fed purchases, but this is offset by the fact that the private sector is losing interest income they would have otherwise earned. For instance, in QE1 the Fed removed $1.2T in assets from the private sector. Much of this was high yield paper. We know the Fed turned over ~$50B to the U.S. treasury (its “profits”) from QE1. What did the banks get in return? They got a checking account at the Fed earning 0.25% or roughly $2.5B over the course of QE1. So the private sector LOST ~$47.5B in interest income it would have otherwise earned.
So, now you must be asking yourself why the heck they’re even doing this to begin with. Well, QE supposedly changes the term structure of the bond market. Fewer 5 year notes should lower interest rates and entice borrowing, generate lending, make other assets more attractive, etc. If you sell your bonds to the Fed and receive low interest bearing cash you might want to rebalance your portfolio. Mr. Bernanke is hoping you will reach out on the risk curve and buy equities or corporate debt. But the price you purchase those securities at will depend entirely on their fundamentals and the price that you and the seller agree upon. If you run out and bid up risk assets just because you think the Fed is “printing money” then you’re making a mistake. If you run out and buy stocks even though their fundamentals have not changed you are making a mistake.
This is probably best seen in the price of commodities presently where investors are hyperventilating over the “printed money” and buying up hard assets. For instance, coffee prices are up 70% since QE started yet Howard Schultz, the CEO of Starbucks says the fundamentals have not changed at all in the last two months. He claims the speculators are to blame (thank you for that Ben Bernanke!). Inefficient market at work in real-time? Sure looks that way and we can thank the Fed for causing the bubbly situation in commodities. They’re advocating undue speculation, causing severe market distortions, driving down the dollar and rewarding speculators for further financializing this economy.
The Fed has caused this mass hysteria over a minor interest rate decline. In short, there is not more cash in the system following QE. There is not more “firepower” with which to purchase equities. Hopefully, the above description makes that very clear. This was most obvious in Japan where QE caused a brief 17% rally in equities as speculators leveraged up, jammed prices and then later realized that the slightly lower yields hadn’t really changed anything. What happened next? Their equity market fell 40%+ over the next two years. QE was a great big “non-event”. All it did was manipulate markets temporarily and cause a huge amount of confusion.
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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278 Comments
@ LVG
> They don’t really have a choice do they? The Fed wants to effectively retire some > of the debt. Its like getting called on a bond.
> Look at the math from TPC’s example. In QE1 the banks lost 47.5B in interest >income. They did not make money on those transactions. The government made money >which means the private sector lost money.
—- Reply
If the FED bought the treasury (bond) to retire the debt, then they would “rip up the bond”, but they are keeping it as an asset on the balance sheet, so the debt is not retired it is transferred from the bank to the FED b/s.
Banks do not lose 47.5B dollars, the private sector does not lose money they lose opportunity.
So, the point is the economy is shrinking (deflation) with private and consumer debt delevering (deflationary) so the gov’t is spending like drunk sailors to try to stimulate (inflate) and the FED is QE’ing to blow asset bubbles to artificially inflate to cover up the D words, deflation and depression.
LVG has it a bit wrong. They’re not retiring the debt as you said. The tsy pays the Fed interest and then the Fed turns over the int at the end of the year (kind of hilarious how that works actually).
And you are correct. They are simply trying to paper over a massive decline in credit which has deflationary tendencies.
Alright….
So US is creating $600bn USTs and Fed is buying these with $600bn of cash. TPC says this is not inflationary. In fact, if I understand it right TPC says this action can never be inflationary since this is a mere asset swap.
How about this scenario? US creates $10000 trillion and Fed buys these with $10000 trillion of cash. What would happen to stock market and assets. Would that result in inflation? This is also just an asset swap.
I fail to understand why it does not matter how much cash Fed creates? I hope TPC is kind enough to explain.
The tipping point isn’t the FED asset swap…its the government spending $10,000 trillion in deficit spending. Bernanke is just trying to clean up the mess made by the banks/congress. There are giant holes in the balance sheets so he is going to buy treasuries to try and ease credit and create growth. If the economy doesn’t grow then we have to do what we should have done in the first place. Recognize the rampant fraud in MBS, determine which banks are insolvent, put them in receivership, and sell their assets at below face to the surviving banks. If needed issue more charters to create banks to take the place of those put in receivership.
Yes, deficit spending is inflation. Not necessarily monetary policy. But look at the mass misconception that is occurring due to QE2. If $600B can scare people into commodities like this then I don’t even want to imagine what $10,000B would do.
There’s a very dangerous psychological impact here and that, unfortunately, is what the economists generally ignore. It’s a market of humans after all. Not just a market of numbers and products.
Where is Hyman Minsky when you need him?
Probably shaking his head somewhere.
I do feel for those that didn’t specialize in business or economics. The system is geared to take money from those without financial knowledge and give it to the sharpest traders.
Those who are getting scared into commodities are probably going to buy and “take delivery” and have difficulty exiting. The commodity bubble can make you a lot of money, but as we saw in the close today there are some really big traders that are going to have some fun pushing around these tiny markets. I’d advise people to buy on dips using options and have an exit strategy ahead of the end of QE 2. The one thing QE 2 guarantees is no rate hikes before mid 2011…and rate hikes are what can destroy speculators.
A 0% curve across all treasuries…I shudder. We already have mexican 100 year bonds selling in single digit yields and railroads issuing 100 year bonds at 6%. The folks holding these are going to be in for a rude awakening, but how can you feel sorry for someone who chooses to buy a 100 year bond on a country near civil war?
This discussion shows, that a correct money supply and a good monetary police (by the government) is NOT possilbe. Everyone beliefs something else and everybody thinks he is right.
We must assume that QE will have very severe side effects, which no one will have imagined – very last the fed and the government.
That’s why we should assume the worst case scenario will happen from QE… sorry TPC.
Don’t be sorry. I entirely agree that there are unintended consequences of QE and constant Fed intervention.
Another interesting perspective on the QE subject
Debt Bubble Chronicles: Does Bernanke REALLY Think QE Will Boost Home Prices… Or is He Simply Trying to Hide an Even Bigger Problem?
http://www.zerohedge.com/article/debt-bubble-chronicles-does-bernanke-really-think-qe-will-boost-home-prices%E2%80%A6-or-he-simply-tr
As a layperson to the economic scene I’d like to ask one question. When the Federal Reserve buys the bank’s long term bill (saving a/c) and then credit their reserve account(checking a/c), what happens to the bought treasury bills? Are they destroyed?
No, the bonds sit at the Fed as an asset. They will earn interest on this and then at the end of the year the press will tell you how much money the Fed makes and how it’s such a smart and profitable bank. I’ve talked about this before. It’s a bunch of nonsense. When the govt is making money the pvt sector is losing it.
http://pragcap.com/its-good-to-be-the-fed
TPC, I would really appreciate it if you could answer my question, because I’m struggling with it….
In essence Q.E. is an open market operation, no? So, the Fed swaps treasuries for reserve balances. But if the treasuries are acquired from the private sector (through the primary dealers), deposits will increase (and so will M1). So, although no net financial assets are added, the money supply will increase, no?
The monetary base increases. Not the net financial assets.
Yes, the monetary base increases, but that is due to increased reserves (and doesn’t matter too much if there is no demand for loans). But if treasuries are bought from the private sector (through the primary dealers) then M1 increases as well. And that is inflationary.
a “sovereign debt market as a check for spending” is more correctly called a “crude, arbitrary check on rapid changes in public spending”. That’s good in some contexts, where there’s little selective demand, but life threatening for a nation when contexts demand rapid, flexible action. That’s why public purpose demanded freedom from the cumbersome gold std – like it or not.
What we’re always left with is group RESPONSIBILITY for group coordination. A nation has to find common purpose, set common policies, support all delegated strategies, and stay the hell out of most private tactics.
As an extension of the reality that “loans create currency reserves”, you have to also accept that “public initiative creates currency supply”, REGARDLESS of the size of that currency supply. After that, we still have the responsibility to select public purpose wisely, but our public initiative can never be constrained, only directed.
The one thing that Dallas Fed Chief Fisher had right was that the Fed has little to do with currency supply, only pricing of currency movements throughout the country – and that managing our output gap is a responsibility entirely delegated to the Treasury, Congress and Administration, and hence ultimately to the electorate.
I found this blog post which explains how loans create deposits, not the other way around.
Loans Create Deposits — how banks actually work [winterspeak.com]
TPC,
I think you are missing the point of the inflationist and the gold bugs. The argument is that the Fed, in order to maintain long-term interest at record low, will have to pursue its QE program forever…consequently, treasury has no incentive to keep a balanced budget or reduce its debt but to increase it, effectively monetizing the debt through the Fed. In your argument banks buy from treasury, Fed buys from banks is a pure illusion of an independant Fed and a free market in order to transfer fees to the banks.
your argument that QE is an asset transfer is absolutely right, if the Fed announced this is a one time deal…
That’s a very risky bet in my opinion. If QE2 does not “work” then the political opposition to further Fed intervention will be intolerable in my opinion. Especially if it ends up just causing distortions in markets and has no real positive impact on the economy.
What political opposition? I haven’t heard any complaints about QE from any politicians except a few like Ron Paul. The only critics are foreign politicians.
Off course there will be no real impact on the economy and the argument in six months will be is that QE2 wasn’t big enough. Have you been reading Krugman at all recently?
Even if QE2 fails, the resulting opposition (in Congress) is unlikely to stop QE3, because the Fed is set up as an independent agency. The only means of stopping QE3 must arise internally within the Fed. I doubt the new members in Federal Reserve Board (FRB) next year have sufficient votes to stop QE3.
I suspect we will eventually have QE4, QE5 and so on up to Q33, in order to keep asset price “higher than they otherwise would be”.
When valuations diverge from fundamentals, value investors give up – Klarman is returning cash to his investors …
http://www.businessinsider.com/seth-klarman-baupost-group-to-return-capital-2010-11
There will be QE forever as long as the Congress is running record defecits. It is the only way to have record and increasing government defecits simultaneously with low interest rates.
TPC – That’s not true. QE doesn’t give them any ability to spend more money….
It feels like we are due for an ‘event’…
So if the gvt. buys $1.2 T of “paper assets” that are probably worthless, and places $1.2 T of gvt-backed money(or bills or whatever) into the vaults of the big banks, the public is out a helluva lot more than $47.5 B in interest. We have to pay for the worthless assets, too. I see a lot of money that has to be raised somehow to cover these losses. More money = ? (inflation?).
I am happy to keep your asset-swap model, but let us use it dynamically and focus on the very process of swapping, as it could have been devised to, indeed, increase the money supply.
Mx = money in circulation + PROPENSITY TO USE IT.
Initially, no new money is created. However, as the banks, businesses, and ultimately households are forced/incited/deluded/herded into restructuring their assets and reach for risk, the utopians would hope the money would find its way, through productive lending, into productive operations and increase employment along the way. The psychological trick played on the participants – well described in most of the posts above – would provide the initial kick to the process, after which economic fundamentals should take over. Well, the QE2 and similar attempt at kicking-off the economy, are doomed to failure within their own paradigm: heavily reliant on psychology, the process will never progress beyond its asset-bubbling, superficial, ephemeral stage. The players keep building up assets prices, as it – psychologically! – looks as the easier and less risky solution. Meet Charles Ponzi, the father of the paradigm!
Simple yet Complex?
Simple: The Fed is acting to push down longer duration interest rates,hoping against hope to prop up overvalued assets and a flagging economy thereby buying time while “things” resolve themselves.
The alternative is unthinkable, politically unacceptable yet possibly necessary; all those grossly overvalued assets still lurking on the Banks’ and Fed’s (or is it Treasury’s?) balance sheets would come crashing down in value driving the world into a major recession and the Bankers to the stocks (and I don’t mean equities).
Complex: From all I’ve read, no-one at all knows the likely impact of the QE2 path, not one of the so called experts or the local amateurs on this site. Hence the quantity of “fact free” postulation here on various topics such as inflationary effects is risible. For example, last time I checked the data showed inflation and forward expectations still to be subued, 18 months after the massive QE1. Why should QE2 be different?
Let’s not forget it was the Fed (AG)and naked greed that got the US into the whole rotten mess in the first place. Rightly or wrongly, it’s now adding more low interest punch to the bowl saying “come on buy more risk assets, they’re cheap, really they are” as it’s cure.
Thanks TPC, a useful summary
I was reading up on mmt and come across something confusing. In the chart below it shows that vertical money creation/destruction can be conducted by either the treasury (spend/tax) or the fed (buy/sell treasuries) which would indicate that QE isn’t a simple asset swap. Could you explain how the 2 are different?
modernmoney.files.wordpress.com/2010/06/deficits_and_money.jpg
I still don’t get it…the Fed can buy Treasuries or MBS (or any asset if Congress allows it) in any amount it wants out of thin air, for as long as it wants, and that is not inflationary???
I just don’t understand no matter how much we go through this…
The government deficit spending is inflationary. What really matters is whether congress raises the debt ceiling. That the fed is moping up some treasuries with a swap for dollars mechanically has no effect on inflation (treasuries are taken out of circulation, dollars are given to the banks but held at the FED)
If you think that QE 2 increases the chance the US debt ceiling is raised then you have your case for inflation.
http://blogs.wsj.com/marketbeat/2010/11/09/precious-metals-watch-can-you-say-margin-calls/
Daily moves exceeding margin requirements…very exciting times in commodities.
Increasing margin seems to have an effect on price…interesting.
PragCap, I have to disagree, although I know you know 100x more about this subject than I do.
I look at it from a more fundamental, basic point of view. The bottom line is that the Fed has magically created almost $2 trillion dollars worth of USD in the last 2 years. Can that really have no effect? If $2 trillion isn’t inflationary, then why not create $10 trillion? Let’s put $10 trillion into the reserves of the banks and then there won’t be anything to worry about. What is the dividing line between the QE actions and what constitutes as inflationary? Why not $100 trillion? If none of this increases money supply, then why not just keep creating these excess reserves until the banks are completely saved by them?
Why did Ben Bernanke stop at only $600 billion this time?
There must be a negative consequence to all this ex-nihilo reserve creation. What is it?
TPC – The downside here is tremendous. There is moral hazard like you wouldn’t believe. Even worse, there is misinreptetation of the operation which has now created enormous distortions, etc. The dollar has been slammed for little reason. Europe now suffers as we gain. We could go on and on. The problems that arise from this sort of a govt program are enormous and I think outweigh the benefits. But this does not create any real sort of inflation problem. That is unless they were to literally scare us all into sending oil to $200 at which point we’d likely suffer the greatest deflationary collapse known to man and then we’d all turn around and point fingers at the Fed for causing a bubble in commodities. Don’t get me wrong. There are unintended consequences here….
The downside is that it increases input costs, which compress margins as end demand remains weak.
TPC already said that “It actually might be the greatest economic destruction plan since the bank bailouts.”
http://pragcap.com/qe2-dead-arrival
Oil will go to $200 when supply constraints really bite. It is a simple matter of supply and demand.
Bernanke’s Failed CNBC Predictions
http://dailybail.com/home/a-movement-by-the-people-to-prevent-the-reappointment-of-the.html
Marvin Barth Says QE2 Won’t Fix `Underlying Problems’
http://www.youtube.com/watch?v=Q6c0Ln7D49A
Republicans
You didn’t get mad when we gave people who had more money than they could spend, the top 5%, over a trillion dollars in tax breaks.
You didn’t get mad when those tax cuts failed to create any American jobs.
You didn’t get mad when we were asleep at the wheel on 9/11, despite warning after warning.
You didn’t get mad when in 2003, Bush passed The Medicare Prescription Drug, Improvement, and Modernization Act, a 600 billion dollar shell game that lined the pockets of The Pharmaceutical companies.
You didn’t get mad when lack of oversight and regulations from the Bush Administration caused US Citizens to lose 12 trillion dollars in investments, retirement, and home values.
You didn’t get mad when we didn’t catch Bin Laden.
You didn’t get mad when Bush rang up 10 trillion dollars in combined budget and current account deficits.
You didn’t get mad when we let a major US city, New Orleans, drown.
You didn’t get mad when the Supreme Court stopped a legal recount and appointed a President.
You didn’t get mad when Cheney allowed Energy company officials to dictate Energy policy and push us to invade Iraq.
You didn’t get mad when a covert CIA operative got outed.
You didn’t get mad when the Patriot Act got passed.
You didn’t get mad when we illegally invaded a country that posed no threat to us.
You didn’t get mad when we spent over 800 billion (and counting) on said illegal war.
You didn’t get mad when all the reasons for invading Iraq were found to be lies.
You didn’t get mad when Bush borrowed more money from foreign sources than the previous 42 Presidents combined.
You didn’t get mad when over 10 billion dollars in cash just disappeared in Iraq .
You didn’t get mad when you found out we were torturing people!!!!
You didn’t get mad when you saw the horrible conditions at Walter Reed.
You didn’t get mad when Bush embraced trade and outsourcing policies that shipped 6 million American jobs out of the country, causing a loss of 26% of our American manufacturing jobs.
You didn’t get mad when the government was illegally wiretapping Americans.
You didn’t get mad when over 200,000 US Citizens lost their lives because they had no health insurance.
No…..You finally got mad when a black man was elected President and decided that people in America deserved the right to see a doctor if they are sick!
The foreign owned and operated Fox News has you wrapped around it’s finger…Reply
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Palin, whose monetary policy credentials could not be deduced.” Really, because she doesn’t have any credentials, NONE!
She couldn’t even finish her term as governor. The more she speaks about anything, the more people realize she is an idiot.
The tide is changing against Palin as a leader by Republicans. She endorsed Christine O’Donnell and Sharon Angle who are both crackpots like Palin. Carl Rove was right when he spoke out against her not being presidential because of her reality TV show but he reversed himself to please the party before the election.
People are starting to see the real Palin, not the sharpest knive in the draw. And look who she associates with that other crackpot, Glenn Beck or Rodeo Clown and Snake Oil Salesman for over priced Gold coins and other useless products that he hocks!
Teddy
You will not get an argument from me.
They will not be happy until they get their quota of Americans in poverty.
Will 50 million , 75 million or 100 million be enough??
This country needs a very sharp turn to the left before real recovery has a chance. There are no widely rich nations without balance between labor and capital.
The end result of their endless push can only be a banana republic or police state. Neither results in a widely rich state.
Was Teddy complaining about Republican Policies when the Dow was over 14,000 and the S&P over 1500?
The great thing about economics is that it makes R’s and D’s look equally stupid. Lets ignore the political bickering and focus on the real problem. The more fact based information we help promote the closer we can all come to actually fixing the problem as opposed to bickering about whose strategies work and whose strategies don’t work. The last 15 years prove that both strategies stink. So get over it and lets start finding a solution.
True dat TPC, It’s called Human nature.. We Humans are a nasty species..
But there are a few good eggs like yourself willing to take the time to help edumicate the masses.
You are a Fiscal Saint…
I posted this earlier to respond to a partisan and I’m not going to bother writing a long rant about the DEM shortcomings…here is a summary for you.
1. Stress Test was the opportunity to clean up the banks…instead we went with “fair value” accounting and papered over the problem.
2. HAMP is a disgrace…the banks should either make deals with underwater borrowers or be forced to mark past due loans to current house prices.
3. Obama election NAFTA lie…real progress on reforming international labor and environmental standards.
4. Financial Reform…incredibly weak, the laws from the 30s should have been updated and reinstated. You can be a deposit bank, investment bank, or a hedge fund…but you got to chose one.
5. Securities/Contract Enforcement…so you really think none of the bankers committed fraud. I’d argue Mr. Mozilo belongs in a cell right next to Mr. Madoff, but instead BAC pays his fine which is less then the money he made at Countrywide. When fraud pays how do you expect have a working market?
How about we have a a new party that is for the rule of law, for putting obviously insolvent banks in receivership, and limiting speculators to risking their own money…just a thought.
…………………………………………………………
Yep, its definitely all the Democrats fault…
http://www.calaborlaw.com/wp-content/uploads/2008/03/deficits-by-president.jpg
Wake up…the republicans run even bigger deficits then the Democrats. Both parties have failed to fix the problem since the mid 60s. The reason we keep flip flopping every election is we want something different, but have to chose between dumb and dumber.
Ross Perot totally destroyed Gore in the NAFTA debate…the US trade deals have all been terrible for the bottom 80% of the US population. If you allow businesses access to cheap labor and no environmental laws its no mystery where the jobs went. Republicans and Democrats have both consistently pushed really bad trade deals. This dust up with China would have never happened if we would have had sound trade deals. You trade goods for goods…instead we traded IOUs for goods and surprise, surprise blew a serious of huge bubbles on cheap credit/deregulation. Since the majority of America works in either Finance, Service, or Govt jobs its going to real fun if we manage to break global trade trying to save a bunch of insolvent banks.
Chris, The banks are gun shy because they fear a Mortgage Modification gives the home owner and upper hand IF valuation comes back.
that sorta pisses me off because the Baksters have been made whole and they want to gank Joe Home owner and share NO culpability.
I did hear of an Idea thet may pass muster though.
let me try and describe the best I can:
Home Owner x owes 200G’s on a house worth 130G’s. The Bank writes down the principle and loan to 130G’s. If the value when sold is above 130 when sold, the bank and home owner split the diff up to 200. Anything above 2 Hondo, the home owner keeps.
make sense?
Sounds like a plan to me…the lower mortgage payments would fix a large numbers of home owners balance sheets and allow them to do something other than just pay their mortgage. Would definitely boost the consumer, eliminate some of the housing backlog, and eliminate foreclosure loses (court costs, vandalism, abandonment). All good in my view
There really is no best solution, some of the loans during the bubble years are NINJA and liar loans that no modification can fix. The key here is to clean up the chain of title, get the foreclosure through the system, and take the loss on the bank balance sheet. Prosecuting those who made huge money creating these fraudulent loans would be great for market confidence.
So would it be correct to say that BB w/ his use of QE is enabling the Gov’t. to create inflation themselves through deficit spending via treasury issuance at very low rates?
TPC – no
MJM, I don’t think so because the Gubment raises the debt ceiling and just spends.
QE has nothing to do with the debt ceiling, that is a congressional action and congress can do that as well as appropriate and spend virtually unlimited … the FED has to ensure that there is a monetary base that supports the money demand, GDP growth and turnover of real dollars, using interest rates to achieve money supply expansion and contraction — using monetary policy to influence/control the interest rates and/or corollary amount of monetary base to impact supply/demand of real dollars vs deposited dollars.
What is occurring is an end around of the “The FED can not monetize the deficit” statute of the FRA to monetize the deficit as well as cover up the crimes and mass transfer of wealth from the middle and lower class (essentially any class that is not part of the elite bankster club) by expanding the monetary base in an attempt to inflate the deflating economy and deleveraging that is underway.
Questions still unanswered
1. If QE is just an asset swap NON-EVENT than why do it … perhaps to fill the banks reserve accounts in preparation for buying the toxic MBS back in the forced put back — something is scaring Ben B.
TPC – Part prep for downturn in banks B/S. Part interest rate reduction.
2. Why would the commercial banks agree to swap interest bearing treasuries for reserve cash or accounting entry.
TPC – As primary dealers they do the Fed’s bidding.
3. Why discourage saving in favor of inducing speculative (high risk) investing
TPC – Because the Fed is concerned that a deflationary debacle will turn into a depression. So they’re trying to induce more credit creation.
4. Why force fixed income investors for retirees and/or close to retirement asset diversification towards high risk speculative investments.
TPC – Good question. The Japanese have been asking this for 10 years.
The FED is out of bullets and is trying a hail mary hoping that the economy will turn so the empty chamber is not discovered … because the next move will be more nuclear instead of conventional in the analogy of using bullets.
TPC – They are out of bullets in terms of stimulating the economy. Not out of bullets in saving the banks.
So Saving the banks is the objective — that’s what everyone is afraid of, another bank bailout…
Let them fail, use the new powers of FinReg to wind them down, have the federal reserve system handle money markets, liquidity needs and utility banking while the new era (distributed banking) takes hold.
See here:
http://pragcap.com/qe2-bank-bailout
and here …
Emac’s Bottom Line
Is the Fed’s Debt-Buying Unconstitutional?
http://www.foxbusiness.com/markets/2010/11/09/fed-breaking-law/?test=latestnews
TPC – This article is misleading. The Fed ops are not helping tsy to fund anything.
@TPC – See here:
http://pragcap.com/qe2-bank-bailout
100% agree with your assessment here — now to just get a majority of the 99% in the land of obliviousness to understand, then perhaps a few letters, calls, emails to their senators and reps instead of tweeting and facebooking would send a message of outrage into the politicos
Great work TPC, loved the short and sweet summary.
Minor observation.
If one of the goals of QE2 is to drive down interest rates (including mortgage rates, I am assuming ), why has there not been a decrease in mortgage rates?
Perhaps it was already baked in…, but there has not been a significant move downward in rates since the actual plan was announced.
Is it because the asset swaps have not occurred yet?
I’m watching sadly as commodities trades I bailed on earlier have soared higher (silver and gold mining, mostly). Hoping it’s the right choice, I suppose it’s better to have a little profit than a big loss.
TPC – This is one of my biggest problems with QE and why I think it is not necessarily intended to help Main Street. The purchases are focused on the short end of the curve and not the long end where most loans occur. For instance, 30 year mortgages have barely budged in the last few months. I am more baffled by the Fed’s actions every day.
Hi Roger,
Where can a lay person get a good chart of mortgage rates?
TPC: SS – Try BB: http://www.bloomberg.com/apps/quote?ticker=NMCMFUS:IND
That’s a decent and handy chart…missing the average costs. Freddie charts do a better job of that, but only comes out weekly.
http://www.freddiemac.com/pmms/pmms30.htm
You can poke around that site and mine interesting data.
The short look: rates are ridiculously cheap. Might go lower, but many will be knocked out of qualifying, or pay higher rates by lower home values to come.
Fewer borrowers qualify. Loads are stuck in crap loans that HARP/HAMP won’t/can’t help. It was a big mistake not to open the HARP program to non-Fannie Freddie loans. MANY would have qualified, got in more stable fixed loans, and went right on paying, EVEN if the asset was overvalued.
While I’m opining, I wanted to defend appraisers, who were maligned here by a respected commentator (Chris, maybe?) on another thread.
You won’t hear me argue there were no crooked appraisers, it’s just that I never encountered any, and never had the need or desire to ask an appraiser to be crooked. I never had the impression they would have complied, had I asked.
Rapidly increasing home prices did not require that crooked appraisers supply “inflated” values. Appraisers use comparable sales. If something sells higher down the block, then the appraised values rise. It can happen incrementally.
Rapidly inflated values came about because of looser guidelines, and exotic products, both offered by banks. The banks took the risks, because they could profit handsomely, and most of the folks that benefitted the most, made off with most of the money, even if many banks failed, and thus never paid full price for the risks they took.
Roger,
You’re probably a good person to ask about this. Do you know the average duration of a home loan in the USA? I can’t seem to find a good answer on this.
Thanks,
Cullen
This is what I’ve used to answer the question in the past. It’s probably missing some element (like excluding those that never refi), and possibly overstating the churn, but it has been measured in a consistent way over a number of years.
http://www.freddiemac.com/news/archives/rates/2010/3qupb10.html
Not very darn long.
And here’s decent reference for rates
http://www.freddiemac.com/pmms/pmms30.htm
Glad to be of some use.
Am I missing something or is that showing the average age of the loan? I was curious if you have any idea what the average American mtg duration is? I would guess its 20 years or so, but that’s a guess….Thanks and sorry if I missed something. If you can’t find it then no big deal. I’ve looked all over….
I understand the chart to show the average length a mortgage is held before it is refinanced.
If you are looking for what the average product mix is at origination….hmmm… probably around somewhere. I’ll bet it’s somewhere between 20 and 25, since the 30 yr fixed is so popular. With all of the cash in refis, and low rates, the 15 and even 10 yr have made a bit of a comeback recently.
What would be more difficult to come up with is “what is the average remaining duration of all the residential mortgages in America?”. My direct experience and impression would be biased, since most of the people I talk to self select as “freqent traders”.
I can tell you this.
Only one time, in over 7 yrs of doing this, and talking to many thousands of borrowers, have I encountered anyone in the last 12 months of their loan. That borrower had remained at 9% the whole time.
It is indeed rare to talk with anyone that is in their current loan more than 7 yrs. Typical is probably 3 to 4 yrs.
Tell me specifically what you are looking for, and I may be able to poke around for an answer.
That basically answers the question. I am curious which product is the most widely used and what is the average mix. I think you’re probably right that it’s 20-25 with the 30 being the most popular at origination.
It’s interesting for this debate because 74% of household debt is mtg debt so you’d think that Bernanke would target the longer end of the curve if he was trying to make housing and refis more attractive. Who knows what the hell they’re doing. I’d like to think they’re not prepping for another bank bailout, but that’s the only logical answer I can keep coming back to.
Thanks a lot Roger.
To make refis more attractive, they need to do a better job of selectively loosening guidelines, to allow more credit worthy borrowers to refinance.
Low interest rates are not enough.
The people that are benefitting most from these low rates are people who already have good terms and low rates. I’m generally refinancing people from low 5′s to low 4′s.
Not purchasers, as they are not appearing in droves. Not enough new qualifiers, too much economic uncertainty (employment, income and future prices).
Not the people in risky loans, as they were specifically excluded from HARP (loans for creditworthy borrowers who are now underwater).
And not the people who own free and clear (about 1/3 of housing is debt free).
Kind of far off topic, but I think if there is to be a recovery, housing is going to have to lead it, barring some deux ex machina, in technological invention. I cannot see that QE2 is propping up housing, or solving it, for that matter.
I think FED is essentailly buying time for the banks. Banks need steep curve, otherwise they are not in position to make money. This is why FED will not buy long end. But long end will not collapse, as Baby boomers are retiring and they need income. With rates as low as now you need twice as much savings to generate income or more. Actually the whole world needs income, because people got burned in stocks and real estate and are not willing to commit to that stuff again. They simply haven’t saved enough…The world becomes Japan.
Banks can not aggressively lend because regulators are telling them to get their capital ratios in order. So whatever politicians tell them to do is for general public ears. Also, banks can not ramp up assets, as there are not enough willing or qualifying borrowers.
Business cycle becomes short (as it used to be), as there is no more credit smoothing mechanism. So markets will remain very volatile, with large 40-50% swings.
$ debasement – doesn’t make sense. US world dominance to significant extent is built on it’s currency and financial infrastructure. More so, US firms are the largest investors in EM accross the globe. Other countries, in particular EM, are not in position to build such infrastructure in the immidiate future. I doubt that people who run USA are prepared to kill the goose which brings golden eggs. Are they playing it on the edge? May be…Essentially US authorities are trying to create growth, as hard as they can. But it will probaly fail and impact all markets, because in the absence of new ideas, industries, technologies and new growth drivers, markets try to evolve around same old story.
Another thought, world press is becoming hysterical about $ printing, but DXY seem to be bottoming at higher low (75-77 level), relative to 2008 low of 71.4 and 2009 low of 74.25. Chances are high that market is setting up itself for large unwind which will make $ rally either late this year or some time after usual January exuberance next year.
TPC – thank you for great site!
The Fed and the Treasury are two different arms of the government. They are not the same.
A bond is an obligation of the Treasury used to fund government spending. Cash is a note from the Fed not backed by any hard asset except the Fed’s good faith to replace one piece of cash with another piece of paper.
There is nothing which says that the Fed is buying bonds from banks only. What they are doing is taking the bonds out of circulation and replacing it with cash. They might be going through the dealers but the bonds might be coming from anywhere.
QE will reduce the number of bonds in the market, and hence increase their price and reduce the interest rate. This will allow the Treasury to fund deficit spending without the risk of failed auctions. The Fed is indeed printing cash to monetize the bonds.
You say, and I quote, “If Bank A owned a 1.2% 5 year note and they sell that note to the Fed they receive reserves earnings 0.25%. Their savings account was changed to a checking account”. If what you say is true, what’s the incentive to participate in such a transaction? Why sell an investment earning 1.2% for one only paying 0.25%? There is no incentive unless you are altruistic, which banks are not. It makes no sense, and on the basis you describe, no one will sell to the Fed, and QE2 will be as big a failure as the Public/Private effort sponsored by the US Treasury was to buy MBS and CMBS from the banks was!
Your arguments are very interesting but I am missing something. I am looking to the Atlanta Fed graphs (http://www.frbatlanta.org/documents/research/highlights/finhighlights/fh_110310.pdf) of Federal Reserve Assets and Liabities. Assets increased because of QE1 (Agency Debt & MBS). On the liabilities side, Banks Reserve Balances increased and currency in circulation didn’t change. When you say “there is no new money creation”, are you referring to the fact that currency in circulation didn’t increase?Does this depend to the money multiplier “not creating more commercial bank money supply” because of the velocity of money is so low?You spoke about Fed and commercial banks…what about if horse starts drinking water again?What is your opinion about currency debasement?Is this another misunderstanding of QE?In a fiat money monetary system I think credibility of central banks is all you have…and actually, I think Fed is al least losing it.
Thanks.
If the Fed is increasing bank reserves, it is increasing the ability of banks to lend. New bank lending creates new check book money. There is no increase of government liabilities, but the balalnce sheets of the bank grow.
TPC – This is not really correct. Banks don’t lend their reserves. This is not a supply side issue.
Guys, adding to the monetary base is not inherently inflationary.
“The nonbank public – nonfnancial
corporations, state and local governments and
households – cannot use deposits at the Federal
Reserve Bank to effectuate transactions. Moreover,
currency is not suffciently broad to be considered a
temporary abode of purchasing power. For Friedman,
high-powered money can be properly regarded as
assets of some individuals and liabilities of none.
So, let us be clear on this subject. In 2008, when the
fed purchased all manner of securities, to the tune of
about $1.2 trillion, the fed was not “printing money”.
Bank deposits at the fed exploded to the upside, the
monetary base rose from $800 billion to $2.1 trillion,
yet no money was “printed”. Deposits did not rise,
loans were not made, income was not lifted, and
output did not surge. The fed could further “quantative
ease” and purchase another $1 trillion in securities
and lift the monetary base by a similar amount yet
money would still not be “printed”. It is obvious the
fed authorities would like to see money, income, and
output rise, but they cannot control private sector borrowing. If banks were forced to recognize bad
loans and get the depreciated assets into stronger
more liquid hands, it could be debated on how much
reserves should be in the banking system. Until that
cleansing process is completed it will be a slow grind
to cure the one factor which makes the fed “impotent”
and unable to “print money”….overindebtedness.”
http://www.hoisingtonmgt.com/pdf/HIM2010Q2NP.pdf
Adding to MB is not necessarily inflationary, adding to M1 is. And if the Fed purchases treasuries from the private sector (through the primary dealers), it adds to M1 due to increased deposits.
The biggest part of Q.E.1 was used to get MBS from the bank’s balances, so then it primarily adds to the monetary base. But Q.E.2 might very well alter the balance sheet of the private sector (because primary dealers buy treasuries in the open market and then sell them to the Fed). And in that case Q.E. leads to an increase in M1, because it causes primary dealers to buy treasuries from the private sector.
TPC – You’re missing the point of the article. The “deposits” were already in the system. They had already been “put to work”. They were sitting in a savings account and were then transferred to a checking account in the form of bank reserves. That’s all. There’s NOTHING inflationary about QE. NOTHING.
“TPC – You’re missing the point of the article. The “deposits” were already in the system. They had already been “put to work”. They were sitting in a savings account and were then transferred to a checking account in the form of bank reserves. That’s all. There’s NOTHING inflationary about QE. NOTHING”
I am really trying to understand it, so am I correct in saying the following:
You basically say that treasuries are a form of money (only with a different duration and interest than for instance cash). So swapping treasuries for cash only alters the duration of the money supply; no net assets are created.
But I still have to wrap my head around the concept of this form of money and whether it is inflationary. As I see it (and please point out where I go wrong): If the private sector buys treasuries from the government (or central bank) it decreases cash/checking accounts/deposits, which can chase goods. Selling those treasuries to other private sector participants doesn’t change the total amount of money (that can chase goods) in circulation. Only if a treasury matures, or is bought by the Fed, can the total amount of money that can chase goods increase again. So, swapping a treasury for cash by the Fed, does alter the money THAT CAN CHASE GOODS, and therefore is inflationary. Damn, I still don’t understand it because my logic brings me to the same point
I would really appreciate it if you could explain how treasuries can be used to DIRECTLY buy goods, because as I see it, only then would there be no difference in inflationary impact.
TPC – You’re making the false cash on the sidelines argument. That cash is already in the system. The firepower to purchase other goods is there. If I own a tsy bill and I want to buy stocks I have that liquidity. I have to sell my bill and then buy stocks (someone gets my t bill and then I exchange my cash for equities and someone else gets my cash). Adding more cash doesn’t add more fuel to the marketplace. It just alter the duration of the paper.