Here we are, almost
six years from the financial crisis of 2008 and yet the Federal Reserve is
still printing money--Quantitative Easing (QE).
At the beginning, it was explained that these policies were necessary to
stop us from going into another “great depression” (after entering the “great
recession”). That was with QE-1 starting
in late 2008, and QE-2 starting in November 2010 until June 2011. With the
start of QE-3, the Fed did not use any time limit which started the description
“QE-3 to Infinity”. The latest “QE-3 to Infinity”
starting in September of 2012 was also driven by much larger purchases of
bonds. Under this QE the Fed purchased $45
bn. /month of Treasury securities, $40 bn. /month of mortgage-backed securities,
while keeping the Fed Funds at a range of zero % to .25%. This strategy was used by the Fed to create a
“wealth effect” so consumers felt wealthier as asset prices rose. They expected this “wealth effect” to help
stimulate the economy. Presently, the
Fed has decided they want to stop QE-3 since their balance sheet skyrocketed from
$800 billion (bn.) to $4.3 trillion (tn.) as the S&P 500 rose close to 300%.
Here’s the problem.
The hope of the Fed has been that the economy would improve to such a
point that stimulation would no longer be necessary. But, although there has been some
improvement, many important sectors such as capital expenditures, strong growth
in well-paying jobs, housing, and retail sales, have all been disappointing,
which accounted for a negative GDP in the 1st quarter, and probably
will stay with a 2 handle for the year.
The Fed has tried to stop QE strategies before but were
unsuccessful. During the first two QE programs,
they set a date when the programs would end.
Once those dates were announced, the markets began to unravel which resulted
in the Fed starting another QE. They
essentially had to start a new QE in order to keep the “wealth effect” alive. Apparently, they noticed that stopping their
programs at a specific date was not working, so they came up with the idea of
getting out gradually (“tapering”) as if no one will notice and everything will
go back to normal.
Our hope is that the “tapering” actually works and the Fed
will no longer meddle in the markets, but realistically, how can it end
differently this time? After all, the
Fed has never had to taper bond purchases or raise interest rates with a
balance sheet of over $4.3 tn. As the
Fed continues to taper the bond purchases, it will eventually strike a nerve in
the capital markets just like the earlier programs. And if not, it will definitely
strike a nerve when they decide to raise interest rates. They may decide to try
other techniques before they raise interest rates, like pay interest on bank
reserves, issue Certificates of Deposits for excess reserves, or “repo” bank
securities by giving the banks securities while they pay the Fed cash.
However, we believe the market will correct significantly
before the Fed ends the tapering of the bond purchases and this will result in
a delay of further tapering and maybe even reverse the tapering and actually
increase the amount of bond purchases made each month. What will be interesting is how the markets
handle it. Will investors continue to
believe the Fed will bail the markets out again by buying more bonds? And will investors go back to the buying of risky
assets on the news of more QE purchases or will they start losing confidence in
these policies? Eventually, we believe
it will be the latter.
The Manager of QE-1
Agrees that the Fed has Lost Perspective
Andrew Huszar is a senior fellow at Rutgers Business School
and was the former manager of the Fed’s $1.25 tn. Agency mortgage-backed
security purchase program (QE-1). In an
interview recently Andrew questioned the enormous build- up of the Fed’s
balance sheet. He stated, “You can’t
spend $4 tn. in the financial markets and not see benefits. First of all, I should say that while I feel
the Fed has lost perspective, I believe the people working there are smart,
well intentioned people. I just don’t
believe it flies, and whatever benefit you get from this program is being
outweighed dramatically by the negative distortions that QE is creating. There’s the question of how the Fed unwinds
its unprecedented operational expansion.
This is an unwinding that will have to be invented on the fly, and it
could have huge downside risks for the U.S. economy. Note that even the Fed’s suggestion of a minor
taper this summer led to the beginning of a substantial stock market selloff.
What if the Fed ever has to sell off bonds? You can imagine far greater risk and volatility
in the markets. The longer the Fed
waits, the greater the risk gets.”