Chris Whalen has a particularly tough-minded post at Reuters in which he explains why QE does little for the real economy (similar to the conclusions reached by the Bank of Japan regarding its own QE) and why its benefits for banks fade over time. Key sections:
When interest rates are low, savers move their preference for liquidity to infinity, especially after the past several years of market breakdown. Retirees spend less because the interest earned on bonds and savings has plummeted….
When the Fed buys securities through QE, it is removing duration from the markets, pushing down yields and volatility. For a while this boosts the net interest margin (NIM) of leveraged investors such as banks, who are able to borrow at lower rates to fund current assets. As assets re-price to the low rates maintained by the Fed, however, NIM begins to disappear. Over the medium to longer term, think of duration and NIM as being linked, so obviously a sustained period of QE is bad for NIM. This is why NIM in the U.S. banking sector is starting to fall.
Just as the earnings of leveraged investors like banks are starting to suffer due to zero rate policy, so too the spending by all manner of savers, from retirees to companies and not-for-profits to municipalities, is falling too. Fed Chairman Bernanke and the other members of the FOMC are killing the real economy to save the banks — but none of the benefit flowing to the banks is reaching U.S. households. In fact, the Obama Administration has been providing political cover for the Fed to conduct a massive, reverse Robin Hood scheme, moving trillions of dollars in resources from savers and consumers to the big banks and their share and bond holders.
Yves here. A big error the Fed made during the crisis was overly sharp rate cuts when markets swooned. The cliche was “75 [basis points] is the new 25.” A lot of commentators got nervous when the Fed cut its Fed funds rate below 2% because that put it on the path to ZIRP. But there were so many other distractions that concerns about the level of policy interest rates got lost in other crisis issues.
Whalen further argues that increased concentration in the banking industry has allowed the big banks to strangle credit:
“In every Fed easing event during my career in finance (1986, 1992, 1998, 2002), it was the wave of refinancing of debt after the Fed eased interest rates that put permanent disposable income into the hands of households,” notes a former Fed official who worked in the banking industry for decades. “In this last easing, however, FNM, FRE and the TBTF banks have conspired to break the transmission mechanism for monetary policy and are now strangling the U.S. economy to save themselves from past errors.”….
First, the Obama Administration should use the power provided in the Dodd-Frank legislation to force an accelerated cleanup of bad assets and to mandate refinancing and principal reductions for performing loans with viable borrowers….
Second, President Obama also needs to focus on the growing competitive problem in the U.S. mortgage sector…
The top three banks control 55% of all mortgage originations. The top 10 banks control 95%. The top five run the only surviving channels to sell loans to Fannie Mae (FNM) and Freddie Mac (FRE), and force their pricing upon the entire banking industry. Small banks give up half the economics of a typical loan to sell a loan to FNM or FRE indirectly, through WFC or JPM. Why is there no antitrust investigation of the top banks by the Department of Justice?
The Obama Administration should move to restructure FNM and FRE now, not in 2011. The Treasury should use its existing authority under the conservatorship to force FNM and FRE to make rules changes to allow for the refinancing of all existing residential mortgages, if only to reduce the current cost of the debt and increase disposable income for households…
President Obama should make some political hay over the fact that loan origination margins for the top four banks have gone from ½ point to over 4 points in the last two years. This is the subsidy for Wall Street above and beyond the zero interest rate policy of the Fed.
My quibble about the Fannie/Freddie refi idea is that this more deeply entrenches the role of the GSEs when Whalen argues against their powerful role, and it also creates large amounts of low yield paper which if we escape our near deflation conditions, will mean big time losses to the chump holders (and until we get over causing pain to bondholders, having Bill Gross hold a lot of securitized low yield mortgages means Bill Gross will be lobbying for more ZIRP and QE). Plus this move (by design) is a subsidy to homeowners and not renters. I’d prefer more straightforward ways of getting cash to ordinary consumers. But putting more heat on the banks is very much in order. And if they don’t like official criticism, they have only themselves to blame.