Ben Bernanke Does the Right Thing

On September 13, the Federal Reserve announced a third round of quantitative easing (QE3) by committing to purchase mortgage bonds at the rate of $40 B per month and to continue doing so indefinitely.

Effectively, QE3 does several things at once, all of which LANDCO has called for in the past few years, particularly in our Q3‑11 Situation Analysis (“Foreclosure Resolution”) and in our Q2‑11 Situation Analysis (“Time and Money”).

 

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Voraciously buying mortgages will drive down interest rates. More buyers will come into the market. Greater demand will buoy home prices, even as foreclosures persist.
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mortgage origination, particularly refinancing. By lowering rates and signaling home price-support, QE3 will not only continue to spur refi’s, but it will add significantly

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Inflation is the solution,
not the problem
QE3 essentially declares that inflation is not a

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problem right now, nor in the foreseeable future. The far greater risk is deflation, such as further declines in home prices or household income.

Employment Of all financial assets, mortgage bonds are the best employment lever. Construction, home goods, home sales and financing — all these are major employers that respond immediately to changes in demand.
Optimism With a floor under home prices, consumer confidence will improve. Home equity will again be seen as a nest egg. Household spending will rise, hiring will follow, good news will breed further confidence — a positive feedback loop.

 

As we’ve said before, when political opposition to federal spending is so entrenched, so partisan, and so wrong-headed, the Fed can initiate its own policies to move us in the right

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With QE3, they have done so. Congress could have made this work better, faster and more efficiently, but its members are unwilling to do so.

So, thanks for finally stepping in, Mr. Bernanke.

4 Responses

  1. This piece highlights the issue confronting our country at this time-congress’s inability or unwillingness to come together. Now the country faces reversion to pre-Bush tax status. Many feel it is worth allowing the Bush tax cuts to expire in favor of some other less palatable proposal. As we recently witnessed in the national election, the party most in favor of a revised tax code favoring the middle class prevailed. No one knows exactly how this will play out but the idea of a “fiscal cliff” if it is not by January seems a bit overstated to me. A revenue shortage will be resolved, as it always is, with more borrowing until the cost becomes unbearable. Apparently the world still views the United States as a safe or the safest bet for warehousing their money. Just look at the rates on treasury bills. It really doesn’t seem to matter what the rating is as long as we remain the better option. That said, as in anything, there is a limitation. At some point, our fiscal house needs to be restored or there will be grave consequences. This kind of leverage will have dramatic effects when the cost of borrowing increases.

  2. Interesting article Mark. When it comes to jobs in the next year or two, which do you will have a larger impact, monetary expansion that we are seeing worldwide, or the imminent fiscal contractionary policies that are pretty much a certainty at this point? How do they compare in size? Isn’t stagflation a legitimate concern?

  3. My view:

    Monetary expansion (big):

    The Fed’s monetary expansionism, insofar as it is explicitly intended to acquire assets beyond U.S. Treasuries, is tantamount to fiscal expansion. Or call it a defense against fiscal contraction, if you will. Either way, the point of it is to drive private capital back into use, starting with housing. With Congress thus far resistant to putting federal money into the economy, the Fed is simply doing the next best thing.

    The danger of inflation from this form of monetary expansion is minimal to non-existent. All the “inflation” occurs on the Fed balance sheet, where Federal Reserve Notes grow the liabilities and mortgage bonds grow the assets. As private capital is drawn back into the bond market (why not, since the Fed’s supporting it), investors will buy the Fed’s assets by tendering back the Fed’s liabilities. All the “inflation” thus goes back into the private capital market where it is absorbed in normalized home prices (where so much deflation occurred to start with).

    Fiscal contraction (not big):

    My assumption is that we will not be stuck at the bottom of the “fiscal cliff” for months on end — in which case we would have a large contraction. But the political cost of pursuing such a policy is prohibitive, so I don’t see it happening. Rather, I see most of the fiscal policy currently under consideration (tax increases on high earners and large estates, end of the payroll tax holiday, long term retrenchment of Social Security outlays, military cuts) as not immediately or severely contractive.

    1. Higher taxes on the wealthy won’t even show up as an economic blip. The idea that such taxes are job-killing is side-splitting.

    2. Ending the payroll tax reduction will show up in household spending and to that extent will be a drag on hiring.

    3. The entitlement cuts that are on the table are back-loaded, so their effects on employment will be minimal. If these actually are enacted, they won’t become effective before the economy has added back any job-losses that might have resulted.

    4. Military spending is perhaps the least effective means of economic stimulus, so judicious cuts there will not be generally disruptive. Yes, there are some payroll implications, and the local politics become outsized, but in the big picture, the military invests in extremely expensive technology with non-competitive margins. In other words, employment effects are quite low in proportion to outlays. Not only that, but at the end of the day, military production gets blown to smithereens one way or another and has no multiplier effect on employment. No one gets to use that bomb a second time, or hop an F-18 to Cincinnati.

    And don’t forget, the Obama proposal, which will largely win out at the end of the day, contains a fair amount of stimulative spending (unemployment benefits and the like, plus about $50 B at last count in infrastructure and other expenditures). The fiscal contraction being negotiated today is timed to be as little disruptive to job creation as it possibly can be.

    Stagflation (legitimate, but second order, concern):

    Right now, deflation is a bigger concern than inflation, stag- or otherwise. The Open Markets Committee would never have gotten behind QE3 unless they were very worried about two things: deflation and Congressional irresponsibility.

    So, what would bring about stagflation? As your post suggests and I agree, it could be caused by a moribund job market — i.e., a moribund job market in combination with rising commodity prices. One of those commodities, of course, could be money. If our national credit comes into question (as for example when the debt ceiling was held hostage, or if we can’t grow GDP fast enough to shrink our debt leverage), that would tend to raise the cost of funds.

    In such event, without sufficient demand in the economy, without enough employment and adequate wages, we would be at risk of stagflation. That’s the argument for a fiscal policy focused on stimulus — increase the denominator in the debt-to-GDP ratio, even if the numerator goes up in the near term. The argument for austerity is to cut the numerator.

    Right now, the U.S. enjoys a substantially negative cost of borrowing. We can use other peoples’ money at THEIR expense! Cutting the numerator is therefore financially counter-productive right now, and of course, it would turn out to be politically toxic, as it is elsewhere in the world.

    If we can stay more or less with the President’s program — long-term deficit reduction, near-term stimulus and monetary expansion — we should be able to improve employment markedly in the next couple of years and grow GDP enough to keep an advantageous cost of funds.

    We’re in a deep hole, and nothing that anyone can propose will get us out in short order. But there are things on the table that can improve employment, and it appears that these will be implemented.

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