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Is the Fed Losing the Fight Against Deflation?
Barron's ^ | 11/13/2012 | Randall W, Forsythe

Posted on 11/15/2012 3:06:11 AM PST by gotribe

Prior to the financial markets' obsession over the looming fiscal cliff, their single-minded focus was on monetary policy. Now, two months after the Federal Reserve announced its so-called QE3, its third round of quantitative easing, it appears the fuss was much ado about very little.

Ben Bernanke seems to be losing his battle with deflation, observes Walter J. Zimmerman, chief technical analyst for United-ICAP. So far, the Fed's scheme announced in September to buy $40 billion of mortgage-backed securities for however long it takes to lower unemployment has little to show for it. Quite to the contrary, market prices show the U.S. central bank has shown itself impotent in its fight against the undertow of deflation.

snip

Governments are the other great beneficiaries of the bond market's beneficence -- for now. There has been no penalty for the U.S. hurtling toward the fiscal cliff -- and more potential downgrades of its remaining triple-A ratings from Moody's and Fitch after last year's cut by Standard & Poor's -- while the Treasury can borrow at record-low interest rates. The so-called bond vigilantes of yore -- who in the 1980s and 1990s sharply boosted interest rates at the first sign of inflation -- are overcome by the central bank's purchases of the securities that finance the budget deficit. So, Bernanke & Co. are enablers of the dysfunction in D.C.

But, the signs are building that even the Fed is failing in its main aim of QE3, the blunting of deflationary forces. Along with equities, Zimmerman points out that even the DJ-UBS Commodity Index is down 8.4% since the mid-September announcement -- a sharp contrast to the 42% total rise after QE1, the 23% pop after QE2 and the 8.6% gain after Operations Twist.

(Excerpt) Read more at online.barrons.com ...


TOPICS: Business/Economy; Crime/Corruption; Government; News/Current Events
KEYWORDS: epicfailobama
Timberrrrrrr

(if link takes you to protected article, search headline on Google News for free version.)

1 posted on 11/15/2012 3:06:20 AM PST by gotribe
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To: gotribe
QE3 is not the same as QE1 and QE2, and shouldn't be analyzed as if it is. In fact, I'm surprised "experts" like this don't pick up on this.

When the Fed buys U.S. Treasury bills, it allows the U.S. government to print money and flood the market with it. That's why it was "inflationary" in nature (from a purely monetary standpoint, at least). But when the Fed buys mortgage securities, it is simply acquiring ownership of assets backed by money that was put out in the marketplace when the original mortgage was extended -- maybe years ago.

Again -- I'm surprised more folks out there haven't picked up on this. QE3 was never supposed to be a "stimulus" measure. It was a mechanism for taking troubled mortgage securities off the books of large institutional investors and getting them out of sight.

2 posted on 11/15/2012 3:16:17 AM PST by Alberta's Child ("I am the master of my fate ... I am the captain of my soul.")
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To: Alberta's Child
"But when the Fed buys mortgage securities, it is simply acquiring ownership of assets backed by money that was put out in the marketplace when the original mortgage was extended -- maybe years ago."

Question who do they buy "mortgage securities" from?

3 posted on 11/15/2012 3:23:08 AM PST by Mad Dawgg (If you're going to deny my 1st Amendment rights then I must proceed to the 2nd one...)
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To: Mad Dawgg

I can almost guarantee you that they purchased those mortgage securities from major U.S. brokerage houses and foreign banks that had ended up “holding the bag” when the real estate market crashed in 2008.


4 posted on 11/15/2012 3:25:34 AM PST by Alberta's Child ("I am the master of my fate ... I am the captain of my soul.")
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To: Alberta's Child
"I can almost guarantee you that they purchased those mortgage securities from major U.S. brokerage houses and foreign banks that had ended up “holding the bag” when the real estate market crashed in 2008."

I wonder if there is a way to find out where exactly this money is going? Who holds the securities they are buying up? Because it sounds like to me we are just buying up worthless pieces of paper.

5 posted on 11/15/2012 3:30:10 AM PST by Mad Dawgg (If you're going to deny my 1st Amendment rights then I must proceed to the 2nd one...)
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To: Mad Dawgg

http://research.stlouisfed.org/fred2/series/WMBSEC


6 posted on 11/15/2012 3:42:24 AM PST by gotribe
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To: Alberta's Child

It seems to me QE3 does involve inflationary money printing. A simple example. The Fed buys a $500K non performing mortgage from Well Fargo backed by a house that is today worth only $300k. Had Wells foreclosed on the mortgage instead of selling it to the Fed, Wells would have received $300K cash from the sale and booked a $200K economic loss. By selling to the Fed, Wells receives $500K in newly printed money which it can now loan to customers. There is now $500K cash available to Wells instead of the $300K from a normal foreclosure.

Looking at the Fed, it printed $500K and bought an asset worth $300K. If it liquidates the asset it receives $300K and writes off $200K. The $200K represents printed money the Fed put in circulation by buying the mortgage from Wells at a premium.

The only way there is no stimulus effect from QE3 mortgage buying is if all mortgages purchased by the Fed are performing and are eventually fully paid off or if the mortgages are resold by the Fed for the Fed book value of the mortgage at time of sale.


7 posted on 11/15/2012 3:49:04 AM PST by Soul of the South
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To: gotribe

What is the link supposed to tell me?


8 posted on 11/15/2012 3:51:08 AM PST by Mad Dawgg (If you're going to deny my 1st Amendment rights then I must proceed to the 2nd one...)
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To: Mad Dawgg
Exactly. The money isn't "going anywhere" -- which is why (as the author points out) there hasn't been any effect from QE3.

Think of this chain of events ...

1. Someone buys a home in 2007 with a $300,000 mortgage. This money is basically created "out of thin air" when the bank borrows money from the U.S. central bank and lends it to the homeowner.

2. The person who sold the home gets the $300,000. Maybe they use it to buy another home, or maybe they just put it aside for their retirement. In either case, the $300,000 is new money in circulation.

3. The bank sells the loan to a brokerage house that packages it with other loans and sells it to institutional investors as a mortgage-backed security (MBS).

4. The homeowner loses his job in 2009 and stops paying the mortgage. It takes a long time to figure this out, but eventually it is determined that the holder of the MBS actually "owns" the home now. But since nobody wants to foreclose on the home, it just sits there in a state of limbo for a couple of years while the homeowner continues to live there without paying the mortgage. Nobody presses him to pay it, either. The holder of the MBS is basically holding a worthless piece of paper that isn't generating any income ... but it still has a "face value" of $300,000 (or whatever the outstanding balance on the mortgage was when the homeowner defaulted).

This is where things stood in 2011-12. So the Fed decides to come to the rescue -- of the MBS holder, first and foremost ...

5. The Fed announces a QE3 program under which billions of dollars of mortgage-backed securities will be "purchased."

6. The holder of our worthless MBS sells it to the Fed, along with the $300,000 mortgage that hasn't been generating any income in several years.

7. No money gets "put back into circulation" at all. The institutional investor thanks its lucky stars, and considers itself fortunate that it had been bribing lobbying members of Congress and presidential candidates for years. They take the proceeds of the MBS sale and they do with it whatever they would have done if they had never bought it in the first place back in 2008. Maybe they buy U.S. Treasury bills, maybe they buy foreign securities, or maybe they buy municipal bonds.

8. The Fed now has to deal with the delinquent mortgage.

This is where things stand right now in 2012. There's no net impact on the U.S. economy because the $300,000 mortgage originally extended to the homeowner was used to purchase a home that wasn't really worth $300,000 in the first place.

9 posted on 11/15/2012 3:52:21 AM PST by Alberta's Child ("I am the master of my fate ... I am the captain of my soul.")
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To: Soul of the South
That's a good post. See my last post for a detailed explanation.

In the scenario you describe, there is no "inflation" because the $500,000 has already been in circulation for years. Your post makes it more clear what is actually going on here ... the Fed is paying $500,000 to Wells Fargo to avoid having Wells Fargo book a $200,000 loss because booking a $200,000 loss would have deflationary consequences.

That's why the bank never foreclosed on the property in the first place, and why the Fed will never liquidate the asset and take the $200,000 loss themselves. The Fed will do whatever it takes to maintain the illusion that the mortgage is worth $500,000 -- even if it means pressing U.S. politicians to flood the country with new immigrants to help inflate demand for housing in the U.S.

Now is all the recent talk about the DREAM Act, amnesty, etc. starting to make sense?

10 posted on 11/15/2012 4:01:38 AM PST by Alberta's Child ("I am the master of my fate ... I am the captain of my soul.")
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To: sauropod

read again


11 posted on 11/15/2012 4:07:21 AM PST by sauropod (For Barack so loved the poor, he created millions more of them.)
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To: Alberta's Child

Just one question about your chain of events;

Exactly WHERE does the $700,000,000,000+ TARP money that was laundered through AIG to the banks fit in?


12 posted on 11/15/2012 4:12:33 AM PST by Roccus
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To: Roccus
My understanding is that the TARP money simply props up their balance sheets by enabling them to offset losses on mortgages with purchases of U.S. Treasury bills.

That's why U.S. Treasuries are being sold at record-low interest rates even while the U.S. credit rating is declining.

13 posted on 11/15/2012 4:20:35 AM PST by Alberta's Child ("I am the master of my fate ... I am the captain of my soul.")
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To: Alberta's Child

My understanding was that since the MBS couldn’t be unwound, it was easier to pay off (through AIG) the insurance that had been bought against those MBS failings at 100 cents on the dollar. Since many of the banks and brokerages you mention in your #3 are one and the same, TBTF, these entities are being paid off TWICE for the same loss....and THAT is why so many houses are resting in limbo (#4). Not only are they carrying an “asset” that has ALREADY been paid off, but whenever it is converted in the future, it will be pure profit.


14 posted on 11/15/2012 4:37:01 AM PST by Roccus
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To: Mad Dawgg
In 1938 FDR established Fannie Mae to buy mortgages and expand the amount of housing money available by creating a secondary market. Constitutional, right?

Wall Street just followed our government's lead decades later gets all of the blame.


15 posted on 11/15/2012 4:41:51 AM PST by Jacquerie (Obama voters don't know what they lost, because they never learned what they had.)
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To: Alberta's Child

Maybe they buy U.S. Treasury bills, maybe they buy foreign securities, or maybe they buy municipal bonds.


Thanks for your post! It really helped clarify my thinking on QE3, which had been a bit of a head scratcher.

This last bullet is the kicker and there is no maybe about it—the purchase is mandatory. QE3 was a grand bargain between the Fed, the Banks, and the Government. In exchange for taking these worthless properties off the Banks’s hands, the Banks now must use this $$ to buy US Treatures. So....this avoids the appearance of the Fed directly buying USTs, but the net effect is the same.

Since the Fed is doing QE3 incrementally, Banks not holding up their end of the bargain will not get their mortgage securities purchased in the future.

Of course, the big question is: will USTs eventually be even more worthless than MB securities?


16 posted on 11/15/2012 4:42:17 AM PST by rbg81
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To: Alberta's Child

PS - About the time QE3 was announced (maybe a little before), the bonds of banks that had been selling well below discount (like Bank of America) suddenly started doing very well. They gained maybe 20% in a matter of weeks.


17 posted on 11/15/2012 4:44:48 AM PST by rbg81
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To: Soul of the South
Depends on where that house worth $300 k is located. For instance, let's take California ~ they buy the paper on that $300 k home and put it on the market, and finally it sells for $60 k to a speculator who is building a series of slum properties which are rented out to several dozen families who drift around looking for limited work opportunities.

A few years of that the properties are worth the value of the land and its utility connections.

So, how did the bank really do? What happened to the local markets. Why did the speculator let the properties deteriorate?

18 posted on 11/15/2012 4:48:04 AM PST by muawiyah
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To: Alberta's Child
It was a mechanism for taking troubled mortgage securities off the books of large institutional investors and getting them out of sight.

The "troubled mortgage securities" are "purchased" from the institutional investors. This means the Fed gets the securities and the institutional investors get cash.

This cash will then be reinvested by the institutional investors.

Given the asset class they sold was government-backed securities, it will undoubtedly be invested in a similar or the same asset class. Some would undoubtedly be invested in Treasuries, where one can have "theoretically zero risk" and still get a small return. It would probably stay in some sort of government paper, in any case.

The Fed continues to enable the government to push more Treasuries and any other type of government paper or government-backed paper into the private sector. It's a case of the government wanting to get cash one way or the other, either through taxes or borrowing it. If the private sector appetite wanes, the Fed needs to buy the paper the private sector holds so the private sector will buy new paper. Keeping our eye on the ball amounts to simply watching the $16 trillion figure grow.

Keep in mind that every dollar invested in government debt is a dollar not invested in a business that produces things (the producing business would increase the supply of goods and services thereby also add to downward pressure on prices) and, out of the profits it earns while doing this, pays taxes, which provides cash to the government that does not have to be paid back.
19 posted on 11/15/2012 4:48:10 AM PST by PieterCasparzen (We have to fix things ourselves.)
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To: Roccus; Alberta's Child

BTW, something that received little attention at the time, especially here at FR, was that the $700 Billion number was just some SWAG at Treasury.

http://www.google.com/search?q=need+a+really+big+number+treasury&rls=com.microsoft:en-us:IE-SearchBox&ie=UTF-8&oe=UTF-8&sourceid=ie7&rlz=1I7ACEW_enUS385US385


20 posted on 11/15/2012 4:49:45 AM PST by Roccus
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To: Alberta's Child

“There’s no net impact on the U.S. economy.”

Yes, there’s a net inflationary effect that’s staving off deflationary pressure on the US economy.

Essentially - what the Fed is doing is trying to keep housing prices up and fighting off the market forces telling people that housing prices need to drop.

Basically, they are setting fire to their money. This increases the dollars in circulation.


21 posted on 11/15/2012 5:09:31 AM PST by JCBreckenridge (They may take our lives... but they'll never take our FREEDOM!)
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To: gotribe

QE3 ineffective


22 posted on 11/15/2012 5:11:06 AM PST by quintr
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To: gotribe

Outside the short term gas prices, what exactly has gone down in price. Hell, my homeowners insurance premiums just went up 19%, my property tax up 10% Some deflation!!!!!!!


23 posted on 11/15/2012 5:12:13 AM PST by catfish1957 (My dream for hope and change is to see the punk POTUS in prison for treason)
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To: gotribe

You can’t fix the monetary problem until you fix the fiscal problem.


24 posted on 11/15/2012 5:57:02 AM PST by ari-freedom (It's the bennies, stupid.)
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To: catfish1957

You have to look at commodities. Taxes go up because of politicians.


25 posted on 11/15/2012 5:59:49 AM PST by ari-freedom (It's the bennies, stupid.)
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To: catfish1957

“Outside the short term gas prices, what exactly has gone down in price. Hell, my homeowners insurance premiums just went up 19%, my property tax up 10% Some deflation!!!!!!!”

Here in NC Duke Energy just received approval from the utilities commission for a 7% rate increase. It is needed because they are closing down coal plants as fast as they can due to the Obama Administration environmental regulations. My homeowner’s and auto insurance premiums also jumped. The cost of a doctor visit is up over 10% this year. Every time I go to the grocery store food prices are up and the container size is reduced. I see stock prices declining today but not much else.


26 posted on 11/15/2012 9:03:36 AM PST by Soul of the South
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To: Mad Dawgg

I just got a notification from Fannie Mea that my mortgage (from Chase)had just been transferred to Fannie Mea, and “not publicly recorded”???

So I suspect they’re laundering money into the banking system that way.

If Fannie Mea paid Chase for my loan, and I’m paying Chase for my loan ??????????????


27 posted on 11/15/2012 9:16:55 AM PST by JMJJR ( Newspeak is the official language of Oceania)
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To: PieterCasparzen
The "troubled mortgage securities" are "purchased" from the institutional investors. This means the Fed gets the securities and the institutional investors get cash. This cash will then be reinvested by the institutional investors.

Well, OK -- but after having been nearly burned once, I can assure you that smart institutional investors aren't going to be too enthusiastic about investing in mortgage-backed securities -- or ANY dollar-denominated assets, for that matter.

28 posted on 11/15/2012 3:32:22 PM PST by Alberta's Child ("I am the master of my fate ... I am the captain of my soul.")
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To: Alberta's Child

And voila, you have it exactly...

eventually (e.g. Europe) people will not - and can not - continue to buy securities issued by goverments that need to borrow more (”roll over” the debt) just to pay the interest on the bonds they sell to people.

An annual SURPLUS is necessary, mathematically, in order to “pay down” the debt. That means, to “retire” debt without having to borrow to do it.

If on Jan 1 gubmint has $16 trillion outstanding,

then, during the year, the gubmint

a) issues $1 trillion in new bonds, and
b) redeems $2 trillion in old bonds

at year end, December 31, the outstanding debt would be $15 trillion.

This reduction in debt is limited to the size of annual surplus. Of course nowadays we have no surpluses in sight - just annual deficits.

Since investors know the annual deficit/surplus picture for the next ... forever years looks so dismal, and the debt is about 8 times as large as every dollar that comes in for 1 typical year, investors are indeed getting to the point of having no stomach for buying more government bonds.


29 posted on 11/15/2012 4:58:28 PM PST by PieterCasparzen (We have to fix things ourselves.)
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To: JCBreckenridge
Good post, but keep a couple of things in mind:

1. The money supply is only one factor in inflationary pressure. The velocity of that money supply -- i.e., the rate at which it changes hands -- is a very important factor, and is one that has declined considerably in the last couple of years.

2. Don't focus on home prices when assessing inflationary pressure. Hardly anyone pays cash for a home, so the prices are heavily influenced by credit terms, availability of credit, interest rates, etc. Very few people have actually bought homes in the last couple of decades. As we've seen since the housing market collapsed, most of them bought mortgages.

30 posted on 11/15/2012 6:47:39 PM PST by Alberta's Child ("I am the master of my fate ... I am the captain of my soul.")
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To: Alberta's Child

In any case, Bernanke will be able to arrest the deflationary collapse, he won’t be able to stop it.


31 posted on 11/15/2012 7:45:17 PM PST by JCBreckenridge (They may take our lives... but they'll never take our FREEDOM!)
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