Diminshed Returns: QE3

On September 13th, 2012 the Fed announced a third round of asset purchases (QE3). QE3 stands for quantitative easing, round three. Some folks call QE “printing money”. It really isn’t.

In any regard, QE3 will likely have little or no positive effect on the economy. Each round of QE has had less positive effect than the previous one.

Economic conditions as they are now, QE3 will have the least impact of all.

QE3 specifics

In this round of QE the main goal is to meet the Fed’s congressional mandate of maximum employment.

Specifically, according to the FOMC statement, the Fed will make $40 billion a month in mortgage-backed security (MBS) purchases until the labor market improves. Unlike other QEs this one is amorphous and open-ended, without a specific targeted unemployment rate set.

The MBS purchases will pump “liquidity” (money) into the financial system.

Fed Chairman Ben Bernanke summarized QE3 activity by saying this at his news conference:

If we do not see substantial improvement in the outlook for the labor market, we will continue the MBS purchase program, undertake additional asset purchases, and employ our policy tools as appropriate until we do.

To assist, the Fed will reevaluate “Operation Twist” that was started late last year and scheduled to end this year. Operation Twist could be continued, changed or augmented with “additional asset purchases” next year. It has already been extended once with no measurable effect.

The Fed’s Maturity Extension Program, or “Operation Twist”, is a Treasury security purchase program where the Fed buys long-term Treasury securities financed by selling or redeeming short term Treasury securities.

Together both programs total $85 billion per month in Fed asset purchases.

Both moves are designed to keep home mortgage and business loan interest rates low and stimulate housing construction and other economic activity until the job market improves in a sustained way.

According to Bernanke the housing sector led the recovery in every recession since WWII, except this one. The Fed’s action corrects for that.

What is Quantitative Easing?

The Fed has a variety of tools it employs to meet its dual mandate to promote maximum employment and price stability. The most dramatic are asset purchases.

There are two types of purchases:

  1. Asset-backed securities
  2. U.S. Treasury securities

Quantitative Easing is the purchase of asset-backed securities. That type of asset has intrinsic value that can later be sold. QE1 and QE2 were mostly to purchase about $2 trillion in toxic mortgages in the form of mortgage-backed securities (MBS). MBS had brought down the banking system in 2008-2009.

By making those purchases the Fed freed up credit, allowing banks to loan money again. As the housing market improves those bad mortgages will increase in value and can be sold. The MBS securities will rise in value. They could even make a profit for taxpayers as housing values rise again.

The Problem with QE3

At Bernanke’s press conference many financial reporters asked about the effectiveness of QE3.

Interest rates are already about as low as they can go and businesses are already sitting on a boat load of cash. The problem is there isn’t enough demand in the economy to get businesses to spend and lenders to lend.

But the whole purpose of QE is to increase demand by increasing “liquidity” (money) in the banking system and lowering long-term interest rates. The money is already there. Interest rates are already as low as they can go.

QE3 can’t help much with that under those conditions.

Bernanke said the Fed will do it anyway until the labor market improves.

Conclusions

At his press conference Chairman Bernanke made this very distressing comment:

We don’t have tools that are strong enough to solve the unemployment problem

Given that is the whole purpose of QE3, that is very disturbing indeed!

Regarding the job market, Bernanke reported this frightening fact about the drop in the labor force participation rate:

We’re seeing less participation among younger people, fewer college students taking part-time jobs and the like

Translation: Young people who would normally enter the job market can’t find work and are dropping out before they even get started!

He went on to say:

Monetary policy, as I’ve said many times, is not a panacea. It’s not by itself able to solve these problems. We’re looking for policymakers in other areas to do their part

In other words, it all boils to Taxmaggedon 2013 and the fiscal cliff that Congress and the President refuse to face up to.

It is a lead pipe cinch that in the current economic climate of uncertainty that the job market and the economy cannot improve until the Executive and Legislative branches – Bernanke’s “policymakers” – do their part.

QE3 can’t fix the problem it is intended to fix. That part is already fixed!

The part that ain’t fixed is the uncertainty of the fiscal cliff. Only Congress and the President can fix that and they don’t seem much inclined to do so.

Advertisements

About azleader

Learning to see life more clearly... one image at a time!

Posted on Sep 25, 2012, in Business, culture, economics, Jobs, Life, news, Opinion, Politics, The Fed, Thoughts. Bookmark the permalink. 4 Comments.

  1. This round of QE is to buy mortgage backed securities. Wells Fargo must be smiling ear to ear.

  2. I agree with you that QE3 has diminished expectations. Interest rates will stay low. But I am not so sure about the housing market bouncing back yet but possibly years from now. There are so many people underwater they cannot sell or move or buy. I know people who would love to refinance but if you are underwater and do not have perfect credit scores forget about it.

    I also have this sneaking suspicion that with Baby Boomers getting older the demand for single houses might not be there at all. Around here you see new apartment buildings going up but not new houses.

    If the mortgage market and housing market do wake up and it is accompanied by rising interest rates, those MBS held by FRB might not rise in value as much as you think. And a rising interest rate story will implode what we have now as an economy. This is my anxiety.

    As for Congress and the President not doing their jobs, the Mayans were right about 2012 being the end of the world, since no one wants to compromise.

    I liked the educational aspect of your post. Not many people understand the QE concept.

    • Right on all counts about QE3.

      Global concerns about inflation and the effect of QE3 is on everyone’s mind. The rest of the world appears to be thinking that QE3 might trigger another international currency war since the U.S. dollar is the world’s reserve currency.

      Who knows what effect that might have.

      On the other hand, if you have a ginormous national debt like the United States does then inflation is the best thing that can happen to dilute it. Large investors, like China, don’t like that.

      Apparently, QE3 is having unintended international consequences.

Comments and questions are welcomed!

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: