It’s difficult to puzzle out what Bernanke thinks he is accomplishing with QE3. The level of bond buying, as various commentators have pointed out, is much lower than in the earlier QE programs. And pulling out bigger guns in the past was not terribly productive. As we wrote in April 2011 in a post titled “Mirabile Dictu! Economists Agree All the Fed Has Done is Goose Financial Markets!“:
You heard it first in the blogopshere. From the New York Times:
The Federal Reserve’s experimental effort to spur a recovery by purchasing vast quantities of federal debt has pumped up the stock market, reduced the cost of American exports and allowed companies to borrow money at lower interest rates.
But most Americans are not feeling the difference, in part because those benefits have been surprisingly small. The latest estimates from economists, in fact, suggest that the pace of recovery from the global financial crisis has flagged since November, when the Fed started buying $600 billion in Treasury securities to push private dollars into investments that create jobs….
A study published in February found that interest rates decreased, but only for companies with top credit ratings. “Rates that are highly relevant for households and many corporations — mortgage rates and rates on lower-grade corporate bonds — were largely unaffected by the policy,” wrote Arvind Krishnamurthy and Annette Vissing-Jorgensen, both finance professors at Northwestern University
We’ve argued repeatedly, as have others, that well targeted fiscal stimulus and more private sector debt restructuring were the right medicine. But Obama and his bankster friendly advisors had no stomach for much of either remedy.
For what it’s worth, QE and QE2 have gotten a barrage of criticism. Jim Hamilton looked at the much bigger first round of QE and concluded that it lowered long bond yield by only 17 basis points. Paul Volcker thought making a fuss over the program was silly, since the Fed used to buy bonds as a matter of course. And as Marshall Auerback has pointed out, the idea of a fixed dollar amount of purchases was bizarre. There was no way of knowing what if anything it would accomplish. It would have made more sense for the central bank to set a rate target (say for whatever longer-dated maturity it chose to target) and buy whatever it took to keep that level.
You could argue that the big impact of the QEs was psychological, that it was tangible proof that the Bernanke put was the Greenspan put on steroids.
Back to the current post. Given that previous QEs amped up the stock market, weakened the dollar, lifted commodity prices, and made central bankers in emerging markets mighty unhappy (risk on trades boosted their currencies and sent hot money into their economies, developments they did not like), all on a temporary basis, it’s quite a stretch for Bernanke to depict it as a way to boost employment in the US, unless he has a very bad case of “if the only tool you have is a hammer, every problem looks like a nail” syndrome.
One interpretation is that Bernanke, despite his protests otherwise, is giving the stock market a short term sugar high to assure an Obama reelection. The Republicans have threatened to take hot pokers to the Fed, so Bernanke could rationalize his actions as preserving his institution rather than mere electioneering.
Another is that the central bank is quite cognizant of what it is doing and is deliberately boosting bank profits, perhaps also hoping that the banks will eventually feel robust enough to do more lending. The wee problem is that financial speculation is so much more profitable and much easier to dial up and down quickly.
Even though mortgage backed securities prices rose (as in interest rates fell) sharply after QE3 was announced, mortgage rates remained unchanged:
The average rate on a 30- year fixed mortgage held at 3.55 percent in the week ended Sept. 13, near a record-low of 3.49 reported July 26 in data dating to 1971, according to McLean, Virginia-based Freddie Mac.
The New York Times’ Dealbook on Friday evening took note of the failure of banks to lower borrower interest rates in light of more favorable funding costs:
The federal funds effective rate, one short-term rate that banks use to lend to each other, is at 0.14 percent. That compares with a rate of 3.62 percent in September 2005.
The 10-year Treasury note has a yield of 1.87 percent, down from 4.2 percent in 2005. These are huge declines.
Yet the cost of credit card loans has hardly budged. The Fed’s own data shows that average credit card interest rate was 12.06 percent earlier this year; in 2005, it was 12.45 percent…
But even when fear of default is removed from the equation certain interest rates seem to be stuck too high.
Take mortgages. The federal government agrees to shoulder the cost of defaults in nearly all of the mortgages made today. Banks make mortgages to borrowers, and then take those loans and attach the government guarantee of repayment to them.
After that, they package the loans into bonds, which they then sell to investors. The Fed’s purchases of these bonds have helped their yields fall to 2.2 percent. But the cost of mortgages to borrowers hasn’t fallen anywhere near as much.
The banks are choosing not to reduce mortgage rates further. One reason: By keeping the rates elevated, they are able to earn much larger profits when they sell the mortgages into the bond market. If the level of profits on those sales stayed at recent average levels, borrowers might, for instance, pay $30,000 less in interest payments on a $300,000 mortgage, according to a recent New York Times analysis.
Today, the Financial Times took note of the issue, but added a bit of bank PR: they really, truly want to lend more, but golly gee, they haven’t staffed up:
The Federal Reserve’s attempt to push aid into the heart of the US economy is being blunted by banks struggling to process mortgage applications fast enough, keeping rates on home loans elevated, according to the largest lenders.
“In the very near term [QE3] has virtually no transfer mechanism whatsoever to the customer,” said one executive at a leading lender, who requested anonymity. “Originators are massively backlogged in terms of origination volumes.”
Steven Abrahams, MBS analyst at Deutsche Bank, noted that the yield on mortgage-backed securities fell more than 30 basis points after the Fed announcement.
“Very little of that is likely to make it through immediately to consumers,” he said. “There’s nothing that will force mortgage originators themselves to lower the rates that they’re offering to consumers. Right now they have their hands pretty full in terms of the pipeline and managing paperwork and making loans. These folks are busy. There’s not a bunch of people on long cigarette breaks.”
MBS Guy confirmed our skeptical view:
No one on the planet can be surprised that mortgage rates are very low and refinancing is attractive (few bank executives should be surprised by QE3, plus they’ve all been banging on the table for it for the last few months).
Yet, for some reason, banks don’t have the staffing to originate loans faster, as if they were somehow unprepared for this environment. It’s preposterous.
The only explanation: lenders don’t want to originate any faster.
They want to capture more spread and, perhaps, they want fewer people to lock in at lower rates?
Nonetheless, QU3 will be a huge opportunity for bankers to make a lot more trading revenue and come up with new strategies to leverage and arb the new regulatory environment. The Fed basically confirmed low rates and continuous MBS purchases through 2015 – that provides a lot of opportunity to make money. Lending, however, is an afterthought.
Note that there has not been a peep out of the Fed on the failure of the banks to lower borrower rates to reflect their cheaper funding costs. The central bank has a powerful bully pulpit, and if it were to make noise, you’d see Congresscritters and the media piling on. One wonders if the Fed has even broached the topic privately. I can imagine Jamie Dimon grousing about the loss of profits on float and the flatter yield curve justifying them taking margin wherever they find it, and the Fed unwilling to point out that the banks created the new normal and they need to adjust to it too.
So the Fed looks to be completely on board with this sort of rent-seeking. Perhaps the central bank believes its charges need more in the way of earnings to strengthen their balance sheets, even though history shows they prioritize executive bonuses over building their equity levels. Or maybe Bernanke was being completely truthful when he said QE3 was targeting employment. After all, fatter bank margins will preserve their staffing levels.