September 14, 2012


September 14, 2012


On Thursday Fed Chairman Bernanke announced QE3. This will be open ended buying by the Fed of $40 billion worth of MBS (FNMA and FHLMC home loans) per month. The Fed will also use any payoffs of home loans in its existing portfolio to be pumped back into MBS. This resulted in a 1-day drop in home loan rates. The bigger picture is a good bit more blurry.

It serves to look at what happened with the last round of QE. The following paragraph was written by Jim Grauer:

It is interesting to note that the Wall Street punditry has ascribed this dramatic selloff and attendant yield escalation to the notion that the Federal Reserve will not invoke QE III in the shorter time frame heretofore expected. That logic would presume that QE’s automatically translate into lower yields all along the curve. Unfortunately, the facts do not bear out that assumption and it would be well to recount the 8 month experience of QE II. At the commencement of that demarche on November 1, 2010, the 10 year Note was yielding 2.66%. By February 8, 2011, its yield had spiked up to 3.75%. Finally, at the conclusion of the policy ease on June 30, 2011 and about $600 billion in Fed reserve additions later, the Note yielded 3.18%. So much for that theory and why we should give pause to the sustainability of this selloff, particularly in light of the inevitable tape bombs sure to be coming out of Europe in the near future and the consequent flight to quality back into Treasury debt.

However with the Fed dedicating this round of QE to MBS what we saw immediately was a change in the relationship between the 30-year bond, the 10-year note and MBS. Money ran from the 30-year toward the 10-year and MBS. Will this continue? No one knows but probably so.

The Fed also announced that it will keep the Fed funds rate low until mid-2015. In essence the Fed is spinning things as positively as possible which is not such a bad idea. It will take weeks before we see how markets react to this. The knee jerk runup in equities was, as always, predictable. The fact is that what we need is jobs and GDP growth.

The Fed is trying to stimulate the housing market. I get that and I appreciate it. But home loan qualifying standards are so high that there are many who could purchase and afford the payment but cannot qualify under the present standards.

Also, if housing is the key to GDP growth and the Fed acted to keep home loan rates low there is something perverse about the fact that they did this the same week that FHFA raised the guarantee fees on conforming sending rate up 0.125% permanently. The right hand was apparently not in communication with the left hand.

Moreover there is an overriding fallacy about money supply. 85% on the money supply is private money. This is the money which you and I have deposited in banks etc. This is to be precise M4 (Broad Money) – M0 (Base Money.) The other 15% is public money (M0.)

Recent regulations (Dodd-Frank and Basel III) have restrained private money lending by banks and shadow banks. These regulations discourage the deployment of private money. Overregulation renders useless QE3 . Throwing more public money into banks and making regulations to discourage lending activity is just plain dumb.