Chicago School Teachers entered the second week on strike following disagreements over a medley of education issues. As a result average Chicagoans have been frantically searching for safe alternative daycare. And to make matters worse our beloved Bears fell short up in Green Bay. Chicago has been busy. Yet from the Beltway came a Fed decision that deserves closer scrutiny as it will affect nearly everyone: QE3
Quantitative Easing or QE entered its third (possibly fourth, if you count Operation twist) round this past week. Under this move by the Federal Reserve, America’s government bank, the Fed will start buying Mortgage-Backed Securities. Unlike previous QEs, this will not be a single large purchase. Rather the Fed is committing to continue buying US securities until macroeconomic conditions improve. By setting an expectation of continued buying, the Fed hopes to encourage institutional investors to get out of low-yield US Treasuries (think that Treasury Bond that your grandma used to give) and into more risky investments such as loans for small businesses and mortgages.
In such a conservative bank environment, many question whether QE3 will have any positive effects. Rates are already hovering right near zero and that constitutes a lower bound. Hence my title’s reference to the Dire Straits song. In the video, a bunch of Joe the Plumber sort of characters are describing how rock stars do not do any hard work and still get lots of money and “the chicks for free.” Warning the video does contain some NAFW language. The Fed moves are too often seen by day traders as sacrosanct, and there is usually a corresponding rise in the stock values. However in the end, the Fed’s activism is being tempered by fundamental underlying issues that are not being addressed.
First and foremost is that the financial system relies on far too few pillars of support. A recent scandal in London may not have made headlines but it greatly affected the average American. Libor is a rate of interest that many loans are pegged to (i.e. Libor + 200 points). It is voted on by a small group of private bankers. Not so shockingly it appears that some of these leading bankers used to their positions to manipulate the rate to their advantage. Our entirely economy relies on the actions of bankers in New York and London. This in part exemplifies why Congress tried in Dodd-Frank to make “Too Big To Fail” a relic of the past. However, the legislation has had a small effect so far in part because it was filled with unrelated nonsense: outlawing conflict minerals in American manufacturing is a worthy aim but in a financial services bill?! Nor has the international community greatly reduced the risk of overly heavy borrowing. Failed firm Lehman Brothers would have likely passed the Basel III conditions.
Secondly, the Euro question remains a major challenge. Many countries such as Spain and Italy have massive debts. In the past they would have diminished the value of their currency, but a united euro makes this strategy impossible. ECB bond buying will have to continue indefinitely if this method is to secure the community. The decision by the European Central Bank to buy bonds is perhaps part of the reason for the Fed’s use of QE3. Globally, this might act as a sort of united front against default and recession.
Finally, the Fed’s decision is not without an understanding of its political environment. Congress spent last week passing its final major bill before the election. By sending out this controversial signal at a time when Congressmen are preoccupied the Fed is unlikely have much oversight. In addition, most institutional investors are waiting until the elections. This action might have a least force them into the market and increased short-term liquidity.
What does it mean to you? If you are a saver, your job is going to get even harder. With bank accounts interest well below one percent you are literally losing ground against 1.7% inflation! On the other hand, those looking with stellar credit can expect to find great loan and mortgage rates for years to come. However, be aware that those with ok credit will remain in trouble. Unless QE3 ends up saving the day, non-FHA mortgages will remain out of reach of most people. Worst of all, foreign affairs such as turbulence in the Middle East or Iran could easily over power the buying.