The Federal Reserve’s implementation of a third round of quantitative easing, or QE III, and the associated announcement that the Fed will endeavor to keep interest rates low until at least early 2015, has led to yet another flurry of interest rates setting all time historical lows, much like the two previous rounds had. QE III differs from its predecessors, however, in two critical ways. This program specifically targets mortgage backed securities (MBS), especially those guaranteed by government backed entities such as Fannie Mae, Freddie Mac and Ginnie Mae, in an effort to boost the housing market, which in turn, it is hoped, will boost the overall economy. Additionally, the commitment of the Fed is open ended with no specific timetable set as to how long it will continue to purchase $40 billion of fixed income securities per month. By targeting MBS, the Fed is not only lowering interest rates by increasing the money supply through their open market purchases, it is also providing liquidity for the home lending market. Lenders bundle about 90% of new loans into MBS to sell to investors. By moving the loans off of their balance sheets, they lower their level of risk and acquire funds which allow them to turn around and make new loans. If all of this sounds familiar, it should; the Fed is essentially kick-starting a similar process to that which created the housing asset bubble and associated credit crisis which, in turn, led to the Great Recession and the current -and seemingly endless- economic recovery. The stated goal of QE III is to assist the housing market, both by making it cheaper to finance a new mortgage and to provide current homeowners the ability to refinance their home loans to lower, more affordable rates. The most obvious beneficiary of this new initiative, therefore, should be homeowners and home buyers, right? In the long term perhaps, in the short term perhaps not.
Critics of the program say that the various attempts at quantitative easing have primarily helped the wealthiest of Americans. Those dubious as to the initiative’s ability to increase the value of homes or create jobs in the greater economy include the libertarian think tank the Reason Foundation whose Anthony Randazzo wrote that quantitative easing “is fundamentally a regressive redistribution program that has been boosting wealth for those already engaged in the financial sector or those who already own homes, but passing little along to the rest of the economy. It is a primary driver of income inequality.” Quantitative easing lowers interest rates, which helps drive up the prices of financial assets, like equities, the bulk of which are owned by the wealthiest 5% of Americans. Those not fortunate enough to be among the ranks of the wealthy, people dependent more on the value of the equity in their homes and on income derived from gainful employment, are far more likely to continue struggling through these difficult economic times as the housing market, which has evidenced glimmerings of a recovery, and the job market, still weak despite recent gains, have not improved at the same rate as have the capital markets.
Another group benefitting from the continuance of the Federal Reserve’s loose monetary policy is the lending industry, the big banks in particular. The interest levels on 30 year fixed rate mortgages have fallen just 0.13%, while the yields on the MBS into which many loans get packaged have dropped much further, down by 0.7%. The spread between the two rates recently reached a record 1.7%, which means greater revenue for lenders. This abnormally large spread is due to a number of factors, but is primarily a result of the banks inability to keep up with consumer demand, while increased interest in MBS on the part of investors drives up bond prices, thus lowering yields. Factor in the reluctance of banks to lower rates at a quicker pace and the resultant record spread between mortgage rates and bond yields is hardly surprising. This lag on the part of banks to lower the rates they offer as quickly as rates have dropped in the market has been noted by professional money managers. “Think about it this way: If you had a restaurant with 100 people out the door waiting in line, would lowering prices be the first thing on your mind?” said Scott Simon, the mortgage head at Pacific Investment Management Co. Still, there is optimism that the benefit to borrowers will increase in time. Once lenders work through the backlog of applications they will have to lower rates in order to entice continued consumer interest. In the end borrowers will benefit more than they currently are from the latest efforts of the Federal Reserve to boost the housing market, and by proxy the economy as a whole, but for now the primary beneficiaries will be the major players in the lending industry. These institutions have the largest pool of clients to approach for refinancing and are eager to take advantage of one of the few businesses currently generating revenue. The fact that such lenders have less competition than they did prior to the housing collapse doesn’t hurt either. Many banks scaled down their home lending efforts during the crisis, while others exited the market altogether, leaving those few who remain in an enviable position.
One group that will not be helped, either in the short term or in the foreseeable long term, is savers. The current low interest environment, one that will be maintained for several more years at least, per the Federal Reserve’s stated intentions, makes it very difficult for investors to find low risk yield on securities like certificates of deposit (CDs) and Treasuries. This disincentive to save is leading many to take another look at riskier investments, such as equities, in an effort to find greater return. Some investors have found creative ways to squeeze yield out of instruments like CDs, such as taking advantage of promotional rates. The benefit from the latter is generally limited due to these introductory rates being offered only to new money coming from elsewhere and by time constraints on the rates themselves which adjust downward after the initial period. Regardless, as interest rates continue to decrease, those investors looking for returns on low risk investments, such as CDs, will find it increasingly difficult.