Sep142012

Fed buys mortgages to keep interest rates low

Forecasting interest rates is very difficult. I haven’t had much success at it. The first challenge is to figure out what the market would do if left to its own devices. With the plethora of variables in play, that’s no easy task. Further complicating the problem is the federal reserve which will often intervene to make interest rates do the exact opposite of what a natural market would do. It’s very difficult to figure out when the federal reserve will move in and mess everything up.

For example, when the housing bubble burst, a free-market would have taken mortgage interest rates sky high. Mortgage rates were too low during the bubble as risk was mispriced. You can check out Kevin A. Guttman – Reverse Mortgage Specialist to understand how the prices dropped overnight. After prices turned south, the risk became much greater, so the natural response of interest rates would have been to move higher. In that instance, the federal reserve moved to lower interest rates, and to make sure they had impact, the government took over the GSEs to make sure mortgage interest rates came down. To correctly forecast the dramatic drop in interest rates since the bubble imploded, a forecaster had to recognize both the market forces at work and the impact of policy makers who control mortgages and mortgage interest rates. No easy task.

Despite the chorus of bottom callers talking up the housing market, sales volumes and prices have only ticked up slightly. The government and federal reserve is worried that the engineered recovery will fail just as it did in 2010. As a result, they are bring out their bazooka and aiming at the real estate market.

Fed Pulls Trigger, to Buy Mortgages in Effort to Lower Rates

Published: Thursday, 13 Sep 2012 | 2:27 PM ET

By: Jeff Cox — CNBC.com Senior Writer

The Federal Reserve fulfilled expectations of more stimulus for the faltering economy, taking aim now at driving down mortgage rates until an improvement in unemployment that the central bank says will be a problem for several years.

The Fed said it will buy $40 billion of mortgage-backed securities per month in an attempt to foster a nascent recovery in the real estate market.

The purchases will be open-ended, meaning that they will continue until the Fed is satisfied that economic conditions, primarily in unemployment, improve.

How much clearer can the federal reserve be? They will continue to keep interest rates low, particularly mortgage interest rates, until house prices rise enough to bail out the member banks.

“There’s strong hints that they’ll do Treasurys next,” Joe LaVorgna, chief economist at Deutsche Bank Advisors, said in a phone interview from London. “They’re pulling out all the stops to try to get this economy to gain some traction and, most important, to get unemployment down.”

Enacting the third leg of quantitative easing, or QE3, will take the Fed’s money creation past the $3 trillion level since it began the process in 2008.

“The Committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions,” the Open Market Committee said in a statement.

How many trillions of dollars will the federal reserve print before they’re done?

As a follow-up to the statement, the Fed released its latest economic projections, which foresee slow growth including a jobless rate that stays above 7 percent into 2014. The economic projections expect growth to remain slow but to improve due to the stimulate measures announced Thursday.

In addition, the Fed said it will continue its program of selling shorter-dated government debt and buying longer-term securities, a mechanism known as Operation Twist. It also will continue its policy of reinvesting principal payments from agency debt and mortgage-backed securities back into mortgages.

Perhaps the federal reserve could buy up the toxic loans from its member bank’s balance sheets and absorb the losses?

The Fed left its funds rate unchanged at near-zero but offered one change in that regard, saying the rate would stay at “exceptionally low levels” until at least mid-2015.

“These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative,” the Fed statement said.

The vote was 11-1, with Jeffrey Lacker voting against the notion of asset purchases as well as setting a time frame for rates.

At an afternoon news conference, Fed Chairman Ben Bernanke offered a defense of the Fed’s QE activities, saying they are not adding to the government budget deficit nor causing runaway inflation.

In addition, he addressed concerns that savers are being penalized from low interest rates, saying that the policy has allowed for growth in other areas.

“While low interest rates impose some costs, Americans will ultimately benefit most from the healthy and growing economy that low interest rates promote,” he said.

In the meantime, the federal reserve will continue to steal the bread from the mouths of seniors.

Bernanke also issued his latest challenge to Washington to get serious about fiscal policy.

“We can’t solve this problem by ourselves,” he said.

With a summertime rally pinned on hopes for aggressive central bank intervention — both in the U.S. and Europe — the Fed essentially split the difference, offering a quantitative easing program the aggressiveness of which will depend on the strength of the recovery.

The stock market, which had been slightly positive prior to the decision, shortly after 12:30 p.m., surged while bond yields, particularly farther out on the curve, jumped higher. Gold and other metals gained at least 1 percent across the board while the dollar slid against most global currencies.

“The language of its policy stimulus leaves us in little doubt that the central bank is trying hard to allay fears over the prospects for inflation, which it continues to see as a low likelihood, as well as its exit strategy,” said Andrew Wilkinson, chief economic strategist at Miller Tabak in New York. “The Fed is going all out to say that easy money is here for a very long time. Will markets warm to its latest actions? We think so.”

Or perhaps market participants will become more cautious because the federal reserve is openly admitting the economy sucks and needs stimulus. There is one simple fact the federal reserve always ignores: providing stimulus never improves confidence. It may cause market participants to front-run the federal reserve for easy money, but the federal reserves actions call attention to how weak the underlying fundamentals really are. We will know when the economy is really healthy when the federal reserve winds down its stimulus programs and raises interest rates. Until then, attempts to bolster confidence will fail because market participants will rightly interpret the federal reserve’s actions as one of desperation. I’m not the only one who has noticed:

The economists note that the Fed plans to keep interest rates low for an extended period only because it believes the economy will be weak until then. This approach not only may make consumers and businesses fear a long period of economic malaise, but also suggests that the Fed will start to raise rates if the economy shows signs of recovery.

“You are changing expectations in a way that makes people even more reluctant about how they’re going to spend,” said Michael Woodford of Columbia University, who recently wrote a major paper on the subject. “That’s a large part of the problem with the economy — a lot of people are saying, ‘We should wait and see.’ ”

Back to the main article.

Doug Roberts, chief investment strategist at Channel Capital Research, said small-cap stocks, technology shares and precious metals probably will be the chief beneficiaries of QE3.

“What QE3 does is inject liquidity,” he said. “Right now what you do is follow the Fed.”

Actually, what you do is front-run the fed, buy assets before they do, then sell them to the fed at inflated prices. Bond traders will do well.

Though the Fed is ostensibly politically independent, the decision comes at a ticklish time with the presidential election less than two months away.

Washington conservatives have been critical of the central bank’s money creation, which has caused its balance sheet to swell to $2.8 trillion. They worry that the growing money supply will lead to inflation, which has reared its head in food and energy prices but has remained tame through the broader economy.

Bill Gross, who runs bond giant Pimco, said the new round of easing would take the Fed’s balance sheet up to nearly $3.5 trillion if the purchases continue for a year.

“That potentially is reflationary,” he told CNBC. “We’re just to have to see if it works.”

Interesting that he chose the word “reflationary” rather than “inflationary.” The injection of free money will serve to reflate the housing bubble and bond prices — from which Bill Gross will profit.

Faced with an unemployment rate stubbornly above 8 percent and other indicators showing only halting signs of recovery, the Fed was pressed into action by a market worried that the nascent recovery was on wobbly ground and needed more stimulus.

That’s encouraging, isn’t it?

Two previous rounds of QE had uneven effects on economic growth though they did manage to levitate stock prices by more than 100 percent from their March 2009 lows.

Quantitative easing reflates asset values, nothing more. The injections of liquidity do little to stimulate consumer demand, which is what the economy really needs to recover. The best way to stimulate consumer demand would be to increase employment and wages and reduce consumer debts. Since lenders are unwilling to write off the debts of the Ponzis they enabled during the housing bubble, consumer demand is weak and likely to stay that way no matter how much money the federal reserve prints.

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