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Saturday, May 30, 2009

How Bernanke Uses Quantitative Easing to Control the World

A couple days back, I wrote this provocative piece about a term called quantitative easing. Quantitative easing is the process by which any central bank, like the Federal Reserve, buys major financial instruments in an attempt to keep interest rates low and to pump money into the economy. I predicted that the Federal Reserve would have to engage in some serious quantitative easing because the Treasury Bonds were tanking and this would shoot up all interest rates. While most of the piece was well done, I failed miserably in one portion. That is this.

So, it appears that the Federal Reserve is boxed in. If bond rates continue upward, it appears that Bernanke will have no choice but to announce a major investment in U.S. Treasuries soon because that's the only way to bring interest rates back down to a level that would allow a recovery. Of course, the end of the link should tell everyone the potential disaster this could lead to. Still, it appears that in the next couple weeks Bernanke will have no choice but to engage in serious "quantitative easing" and buy back somewhere in the neighborhood of a trillion dollars worth of U.S. Treasuries.

First, I should have mentioned that the Federal Reserve announced about six weeks ago that they would buy back somewhere in the neighborhood of a trillion and a half dollars worth of bonds, both U.S. Treasuries and bonds backed by mortgages. In fact, the Fed has long been engaged in quantitative easing. According to the Wall Street Journal, the Federal Reserve still maintains about $100 billion still unpledged in Treasuries and $800 billion in mortgage bonds.

As such, for the most part, the Fed will continue the process of quantitative easing. In fact, it's almost certain they have just recently. After running up from 3.15% to 3.75% in the span of a week, the 10 year U.S. Treasuries suddenly did an about face on both Thursday and Friday. They closed yesterday at 3.47% after two monster rallies. There wasn't necessarily any outside news to stimulate this recovery. There was however a bond offering on Thursday that went well by all accounts. On Thursday, the U.S. Treasury auctioned off $26 billion worth of 7 year U.S. Treasuries. Prior to that auction, the U.S. Treasuries had seen massive short term selling and a lot of market observers were waiting anxiously for this offering to see if anyone would buy them. Suddenly, and with no logical explanation, the bonds had no trouble selling. Presto, and with it, we saw the rates on treasuries go down. With them, the rates on mortgage bonds, and mortgages themselves, also went down. (though mortgage rates are still way up from when they started tanking at the end of the week previous)

This is all not merely for wonks. While the U.S. Treasuries were going up so too were mortgage bonds. As a result, in less than a week, the average 30 year Fannie/Freddie mortgage went from 4.888 to 5.44%. Given the Fed's aggressive quantitative easing stance, this had all sorts of ripple effects in the mortgage market as a result.

So what's a half a percentage point or even three quarters of a point, when mortgage interest rates are still historically low? Well, apparently a lot.

I'm told that a lot of loan applications, and refis in particular, that are currently in the pipeline were submitted without a rate lock. Mark Hanson, of the Field Check Group says, "millions of refi applications presently in the pipeline, on which lenders already spent a considerable amount of time and money processing, will never fund."


Why were these loans not locked? One reason is this.

rates have been consistently on the 'lower' side for months. The sense (moral hazard) is that the Fed had their back, so why not float the loan and wait for the lowest rates possible to come around.

By "having their backs" mortgage brokers assumed that the Fed would step in and buy aggressively to counter act any upward move on the part of the mortgage bond market. In other words, mortgage brokers assumed the Fed would engage in aggressive quantitative easing to make sure that rates didn't pop from their historically low levels.

When a loan is started, the rate is either floated or locked. If it is locked then for the next set of days, 12, 15, 30, 60, etc, the borrower gets that rate no matter what happens to interest rates in the interim. If it is floated, then the borrower is at the mercy of the market until they are locked. The longer the lock the worse the rate. Mortgage brokers had grown so accustomed to low rates over the last couple months that they just assumed they would stay low because they were aware that the Fed had announced its qunatitative easing stance. Because for four days, the Fed didn't continue in quantitative easing, hundreds of billions worth of potential mortgages are lost because rates are no longer available.

So, this is how Fed Chairman Ben Bernanke will continue to pupeteer the economy as we move forward. Make no mistake, it is Bernanke and not anyone else, Obama included, right now pulling the strings. Obama may in fact take credit for it if it works. He will continue to take credit for any signs that it is working, but his contributions to the economy are essentially non existent. The stimulus is barely spent. The loan modification program has resulted in so few actual modifications that they aren't even worth mentioning. The public private partnership set up to buy so called toxic assets has had little mention since being announced and ultimately will be as big a failure as the modification program that was supposed to save many millions of homeowners from foreclosure.

It is Fed Chairman Ben Bernanke and his trillion dollar plus quantitative easing program that is not only controlling our economy but ultimately the world. With a billion dollar investment here and a ten billion dollar investment there, he quietly manipulates rates to keep borrowing costs low. With it, he even more quietly pumps billions into the economy not all at once, as I foolishly predicted, but little by little. Ben Bernanke controls the country's money supply and by extension the world. (since other central banks follow the lead of the U.S.) Right now, every single day, he decides just how much more money the world will have.

2 comments:

Simon said...

Benanke is being widely praised for his efforts thus far.

Krugman says the main risk is deflation, not massive inflation. He says inflation [especially hyperinflation] is very unlikely and cites examples.

http://www.nytimes.com/2009/05/29/opinion/29krugman.html?ref=opinion

"But it’s hard to escape the sense that the current inflation fear-mongering is partly political, coming largely from economists who had no problem with deficits caused by tax cuts but suddenly became fiscal scolds when the government started spending money to rescue the economy. And their goal seems to be to bully the Obama administration into abandoning those rescue efforts."

What say you to the Nobel Prize winning economist Mike?

mike volpe said...

There is so much peculiar in your comment. First, I don't who these people are that are widely praising Bernanke but I think they're the same people that praised Greenspan in 2002-2003. Don't necessarily listen to conventional wisdom.

That said, I never even criticized Bernanke in this post. I certainly said nothing about inflation. So, why are you countering two points I never made here at least.

That said, if Krugman really thinks that massive government borrowing doesn't carry with it eventual inflation then he can go back to basic economics and learn it again. I am neither impressed with Krugman or his Nobel Prize.

He is the very political ideologue he accuses his opponents of. He is a true believer in Keynesian economics which by the way is not anything like quantitative easing. Both eventually cause inflation. His whole statement is purely political. he wants to impugn the credibility of his opponents because they don't, like him, believe in Keynesian economics.