Fed To Begin Quantitative Easing in January
A: Would love some reader feedback on this as I always like to educate myself on fed policies in times of distress, and this certainly qualifies. Starting next month, the fed will start large purchases of agency mortgage backed securities backed by Fannie & Freddie (now in gov't conservatorship), and by Ginnie Mae. The reason this is important is because it kicks in the definition of 'printing money'. I recall the huge drop in the US dollar index when the fed announced they will take on quantitative easing policies now that the fed funds rate has been cut to a target range of zero to 0.025%. In short, QE is the dollar negative actions that directly puts newly minted electronic money into the accounts of primary dealers and ultimately the economic system.
First off, lets see what the Fed officially announced they will buy:
What securities are eligible for purchase under the program?So, it seems only fixed rate conforming MBS backed by the GSEs are eligible here. Certainly this does not solve the toxic assets on the balance sheet of the financials problem. I still think 2009 will see some type of RTC like program to transfer these toxic holdings from the banks to the government. Time will tell if the situation is bad enough to warrant such a program.Only fixed-rate agency MBS securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae are eligible assets for the program. The program includes, but is not limited to, 30-year, 20-year and 15-year securities of these issuers. The program does not include CMOs, REMICs, Trust IOs/Trust POs and other mortgage derivatives or cash equivalents. Eligible assets may be purchased or sold in specified pools, in “to be announced” (TBA) transactions, and in the dollar roll market.
This is quantitative easing by the fed, to help free up the mortgage markets, keep rates low, and directly stimulate this area of the credit markets that need private capital to come back in! As the fed states:
Who will the investment managers trade with and who is eligible to sell agency MBS to the Federal Reserve under the program?So, where does the money come from? Ahhhhh, the biggest question of them all! Well, the fed simply 'CREATES IT' out of thin air. When you think of 'printing money' you likely think of the Bureau of Engraving & Printing, part of the US Treasury, that is in charge of printing the actual dollars that we use to buy goods and services.Initially, the investment managers will trade only with primary dealers who are eligible to transact directly with the Federal Reserve Bank of New York. Primary dealers are encouraged to submit offers for themselves and for their customers.
The 'printing' that is going on here, starts at the New York Fed's OMO trading desk. Most of the worlds transactions are electronic, seeing funds transfer in the virtual world from one account to another. Rarely do we take out say $10,000 in bills, and use that to pay for goods and services. Instead we wire money, write a check, or whatever to transfer the funds that need to be transferred. Well the quantitative easing that the fed is about to embark in works in the same manner; via an electronic credit to the primary dealer's account that sells the fed the agency mortgage backed securities.
The electronic credit was 'created' out of thin air by the fed, and BAM, you have more money injected directly into the economic system but first deposited into the banking reserve system! In this case the newly minted electronic money goes to the primary dealer's account that sells the assets to the fed. This is the 'printing money' that is associated with quantitative easing and is what hyper-inflationists worry about. The entire process is very dollar negative. Don't believe me though, the fed states it clearly:
How will purchases under the agency MBS program be financed?I have been writing about Ben's Printing, Ben's Printing Take II, and Ben's Printing Continues the past few months. The fed can buy MBS, or it can buy Treasuries from the primary dealers that have an account with the New York Fed. Either form of purchase will credit the primary dealer's account with newly created electronic money. In early December, the fed hinted that they may buy up long-dated Treasuries, kicking in the quantitative easing talk around the internet/blogosphere. Take a look at the US Dollar Index after this announcement in early December:Purchases will be financed through the creation of additional bank reserves.
The first two quarters of 2009 will see plenty of new electronic money entering the system, so lets keep an eye out for effects on:
a) the US dollar
b) lending
c) bank reserves - more hoarding?
d) dollar inverse trades - oil, precious metals, agriculture, etc.
e) the adjusted monetary base
f) bids for other classes of MBS
Interesting times indeed. Happy New Year ALL!!
Comments (4)
Noah,
I actually think there are som implications worth noting about the fed's printing exercise. The fed is going to remove assets from the system that are currently "low velocity" they are sitting around rotting. They are shrinking in value and being marked to market at best and at worst they are actually becoming delinquent and their stream of cash flows is shrinking. Even worse the rescue of these cash flows through a sale of the underlying asset at a big markdowns (FORECLOSURE) is destroying money directly and also dragging down the values of neighboring homes etc, etc. Low velocity is probably way too generous a description for this paper. It is actually corrosive on a leveraged bank balance sheet. It eats away at the banks capital ratio and its ability to lend. So the fed takes this paper out of the market and sits on it. It takes whatever hit will eventually be taken and absorbs it - it dosn't change the feds ability to function or print money....in the near-term anyway. Meanwhile the bank swaps the bad paper for good paper. It can now earn money reliably on the good paper and even lever it up and lend against it. The action of the fed soaking up unwanted paper, buoys the value of all the oustanding paper of this type (lowering rates) but may also impact the prices of other types of paper as people re-evaluate spreads between credits (we will see whether the market is dumb enough to buy this relative value ploy or not). In any event money destroying (low velocity money) is exchanged for money making, high velocity (in that it can be levered and lent again) money. The magic of the invisible hand. No doubt the even more corrosive Sub Prime, Alt A, CMBS and other paper will also be sanitized by Uncle Sam in some way in order to transmogrify money/credit destroying assets into money/credit producing assets. When all is said and done some time down the road we will see what the long-term losses are on all this paper if held to maturity in strong hands. More likely than not the economic damage done by taking so long to figure out a quaranteening strategy for these bad assets has made the ultimate salvage value even lower than it had to be.
Posted by jeff | December 31, 2008 4:10 PM
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Posted by Adam Smith | January 1, 2009 2:40 AM
Jeff - so interesting. I def expected the banks to pass on to the fed their worst producing assets that fit into that mold that is eligible. But what about all the other assets that dont? What changes in respect to that? Nothing, right? The problem is still there although by doing this I guess you are right and the banks can swindle low velocity paper and replace them with CASH that can be used either to handle writedowns of toxic assets or to lend/lever.
You have to do a piece devoted entirely to this topic! Thanks and Happy new year buddy!
Posted by Noah | January 1, 2009 9:41 AM
I still do not understand Noah, what is your prediction regarding the mortgage rates in the next few weeks? I see conflicting advice from "experts". Some are saying that once Fed starts purchasing MBS in early January the mortgage rates are likely to come down to about 4.5%. Yet, when the selection of the money managers and the program was announced on December 30, the mortgage rates barely moved. In fact, on Friday afternoon both the mortgage rates and 10yr and 30 yr treasury yields actually went up. Today, more info came out in WSJ and the media about the MBS purchase plan. A bunch of folks on CNBC and Bloomberg predicted that mortgage rates are going to come down in the next few weeks. Yet, that news did not seem to affect the mortgage rates. For example, I see that at Chase, the average mortgage rate was 5% for comfoming loans in the morning and then went up to 5.125% by lunch time. Chase bases their rate on the pricing of Fannie Mae MBS 30yr notes. I would expect that the prices on those would go up brining the rates down. Apparently, that did not happen.
Posted by Leo | January 2, 2009 2:33 PM