Zero Interest Rate Policy (ZIRP) and Quantitative Easing (QEx) have been blamed for everything from the coming dollar apocalypse to imminent hyperinflation to troubles in the Middle East.

I’ve spilled too many words on why Fed intervention is yet another backdoor bailout for banks’ ravaged balance sheets; propping up residential real estate merely delays the inevitable denouement; it prevents the proper allocation of assets; and last, it acts as a stop against a needed de-financialization of the US economy.

Today, as an intellectual exercise, I want to argue for QE.

Why? Call it the lessons of Moot Court. It is one of the more interesting things you can do in law school. You are given a case, with a set of facts and specific laws to apply. As you prepare your case, you may not know even which side you will be arguing for or against. Hence, you have to truly understand the strengths and weaknesses of both sides of the case. You can argue pro or con with far more effectiveness if you truly know what the strengths and weaknesses of the opposing party are. Thus, you avoid the typical confirmation biases that affects most advocates — and investors.

So this morning, I want to take the other side of the trade, and consider what the positives of QE are. I have come up with three simple economic improvements that QE helped create:

1) Housing Improvement
2) Corporate Balance Sheets
3) Manageable Federal Debt

Let’s review them in order.

1) Housing: As you may have noticed, while the rest of the economy has been pretty weak, Housing has held its own. In a note to our asset management clients at the end of Q3, we observed that while Employment, Durable Goods, Income, and Retail Spending were all soft, Housing is actually one of the few bright spots in the US economy.

The reason for that is simple: The Fed’s QE.

Today, you can get a 30 year fixed mortgages at 3.5% (assuming you have pristine credit and a good job history). That is a ridiculously low rate; it has increased a prospective home owner’s buying power by 15%. While home sales and prices still remain wildly below their 2005 record highs, they have stabilized and moved off the bottom. None of this could have happened without the Fed’s action.

2) Corporate Balance Sheets: The WSJ reported today what most of us have known for awhile: US companies are feasting on the cheapest money in living memory. 30 year investment grade corporate bonds are averaging a mere 2.77%. And, investment-grade companies have sold more 30-year bonds in the U.S. so far in 2012 than in any full year since 1995.

The WSJ:

“Companies are taking advantage of investors’ appetite for yield—and fear of riskier bets—by issuing more long-term bonds, aiming to reduce their refinancing needs in coming years, when interest rates are likely to be higher.

Investment-grade companies have sold more 30-year bonds in the U.S. so far in 2012 than in any full year since 1995, according to data provider Dealogic.

The $91.9 billion of 30-year bonds sold in 166 offerings this year, is about 26% more than the $73.2 billion sold in 145 deals during all of 2011.”

This corporate debt finds its way back to the economy in myriad ways: Dividends, CapEx spending, share buybacks and (yes) hiring.

 

3) Federal Debt: The trillion dollar annual US deficit spending has created an outstanding debt of over $15 trillion dollars. The only way this is even remotely manageable is by keeping rates so low that the servicing costs are bearable.

If the US had normalized yields, the cost to US taxpayers would be astronomical. Radical spending cuts and tax increases would follow, likely leading to another significant recession.

~~~

That is my pro-QE exercise. (Regular readers know that my heart isn’t in it). And note that I refuse to attempt a Wealth Effect argument, knowing as I do that it is nonsense.

However, if you do not understand what is driving the Fed, it is harder to see when they might actually end the program, with consequences across the economy. To paraphrase an old quip, watch what they do, not what they say.  Understanding the positive quantitative metrics they can observe that encourage their ongoing  MBS purchases and other quantitative easing can help us anticipate when it will be over. I suspect when we see the preliminary signs that is about to occur, substantial changes to one’s portfolio will be of urgent necessity.

Until then its best to wargame various outcomes, and consider all sides of the argument . . .

Category: Bailouts, Federal Reserve

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

30 Responses to “Arguing for QEx . . .”

  1. But What Do I Know says:

    Lower interest rates are great for borrowers but bad for investors/creditors. One man’s payment is another man’s income. What the Fed doesn’t understand (or chooses to ignore) is that in our current demographic the loss of income by the retiree investor has perpetuated the slowdown. Why? Because when households hold many more interest-bearing assets than debt (as they do in the aggregate), cutting interest rates results in a net loss of income.

    I know this sounds counter-intuitive, but in our present demographic situation low interest rates slow inflation rather than spur it.

  2. Jim67545 says:

    Much has been said here about everything from TARP to the Fed’s actions being a bank bailout. Driving down interest rates makes borrowing for consumers (as with businesses) more affordable thereby reducing delinquencies and makes it feasible, without requiring measures such as principal reductions, to refinance borrowers who might otherwise default. So, I think the 4th objective was to support the shakey banking sector. How long the compression in the net interest margin can continue before this turns negative for banks remains to be seen.

    Had 3 corporate bonds redeemed last week. Lost 6.5-7% yield. Ouch.

  3. rd says:

    QE buys time.

    In 2008 nearly everybody was unprepared for 2008. In 2012, many more people and entities are prepared for 2008. The primary parties that are still not prepared for it are the TBTF firms because the final step is going to be the destruction of many of their supposed assets (derivatives, HELOCs, CDSs, etc.) that they have been encouraged to pretend have much more value than they actually do.

    However, the overall economy may not be as badly impacted as the financial sector. Companies are sitting on mountains of cash that they won’t invest because there is no demand. However, they learned their lesson that they are their own lenders of last resort and so have been separating somewhat from the financial sector for loans etc. They have refinanced their debt into long-term low interest rate bonds while building their cash buffers. Many companies should be well positioned to invest in their businesses when the demand re-emerges.

    People who have been able to refinance their homes have. Those who can’t refinance have either been foreclosed on or are living their homes virtually for free awaiting foreclosure. At some point, the foreclosures will need to move through at which point the HELOC defaults will come home to roost on the TBTF balance sheets. That final cleansing of the housing market will allow for housing to normalize at reasonable levels across the country. Housing may then be cheap enough that families will be able to live on one income again and employment levels can revert back to 50s-60s percentage of the population.

    At some point, the laws will need to be changed to allow for student debt default in bankruptcy. At that point, the next generation will be able to step up to the plate to buy houses etc. Many of them can’t right now between unemployment and large debt loads. QE is keeping rates relatively low so that the debt service isn’t too punitive yet.

    The financial pundits have been decrying the move of the small investor to reduce their equity holdings. However, this means that they will be relatively sheltered from the coming drop in asset values that Bernanke has been so focused on preventing. The TBTF firms will probably be left holding the bag on many inflated assets when they begin to deflate unless they have been able to pound the drum hard enough to get small investors to step in and buy those assets at the wrong time. However, the third time will probably not be the charm on this as the baby boom generation have watched their portfolio go through two major roller coaster rides in the past 15 years as well as watching their houses go through the the same ride. The financial sector has lost its credibility with the man on the street and will not regain it for a generation.

  4. [...] BLOG: Gap strategy with intraday data • BIG PICTURE: Arguing for QEx … • PRAG CAP: 4 Bullish supports for stocks • ZERO HEDGE: Why the big overnight move in EURUSD? [...]

  5. danm says:

    What most of the 55+ plus need to undetstand is that they have to keep on working and forget about retirement.

    The concentration of wealth has never been so high, yet they still cling to the rentier mentality.

  6. danm says:

    There is a dearth of people willing to roll up their sleeves and do the dirty work and a glut of people looking for easy money.

    That’s what the last 30-40 years have given us.

  7. The mark of a good investor is to think of alternative scenarios or to prove himself wrong, to be flexible and to entertain all options (those coming from technical analysis included). This has been a valid intellectual exercise which may translate into good investment performance.

    regards,

  8. Greg0658 says:

    since i’m in now
    ‘Investment-grade companies have sold more 30-year bonds in the U.S. so far in 2012 than in any full year since 1995′ .. to wargame that –
    under current $LawOpSys those super-corps will eventually offer those for sale when interest rates rise to the point bidders wish the already printed money to be pulled off the shelf and offered at a perceived profit for themselves / when the cash printing has been abolished by outcry
    hense a sell before maturity for corp profit now ..
    but alas to the beginning of this roundabout
    the now future outcry’ers spare change is at the super-corps disposal

    hense my dismay at the allowance of so many sovereign/corp money printings aka dual super-novas

  9. danm says:

    In 2008 nearly everybody was unprepared for 2008. In 2012, many more people and entities are prepared for 2008. The primary parties that are still not prepared for it are the TBTF firms because the final step is going to be the destruction of many of their supposed assets (derivatives, HELOCs, CDSs, etc.) that they have been encouraged to pretend have much more value than they actually do.
    ———
    I’ve been doing a lot of reading on economies that have suffered government intervention and one constant is the whack-a-mole effect. No matter how hard we try to forecast, once the genie is out of the bottle, things can go either way.

    And it’s always mind boggling to see how long these cycles last. The Weimar republic hyperinflation was probably cast with WW1. Despite gross inefficicneis the USSR lasted 67 years.

    I don’t believe many people are more prepared than in 2008.

  10. Greg0658 says:

    YES danm at 8:56a -
    that is what money tabs were invented for (besides the trade vehicle)
    brawn & brains

    the point I wish to make is the population expansion via this OpSys – we allow over production of not so useful labor that needs feeding by brawn & precious commodities –
    second point brawn likes the brains stuff / but not to an excess –
    it is the ways of nature – and nature’s can not be fooled (multiple times) … (unless the memories are erased)

  11. CSF says:

    In sum, QEx has helped debtors – homeowners, corporations, and the U.S. Treasury. The important question is this: who are the creditors who will be left holding the bag when yields finally begin to rise?

  12. wally says:

    Those are three pretty compelling reasons.

  13. DarthBeta says:

    Creditors have the ability to be quite profitable now. Banks for example are paying nothing on demand deposits and in turn can invest where they like. Now the safe play is keep your WAM inside 90 days, but if have the ability to go out years you make a pretty nice spread.

    The Federal Govt does not have debt and cant ever have an interest rate burden problem. That doesn’t mean you as a user of the USD won’t have a currency depreciation or inflation problem. Paradoxically, low interest rates rarely lead to inflation, when compared to higher rates. Higher rates entice creditors to make more reckless loans, and that credit creation in turn leads to inflation.

    Housing itself isn’t a reason, price stability is and the Fed will continue to stimulate until prices (housing being the largest for most people) are more stable.

    The other mandate the Fed has is to maintain full labor markets. The Fed will continue to stimulate until labor markets reach potential.

    What continues to go un-discussed is that the Fed is prescribed to do all this by Congress! And that Congresses complete lack of action (and in some ways destructive action) has forced the Fed’s reactive hand further.

  14. techy says:

    When 5% of the population accumulates all the wealth and makes most of the income and 95% are in debt. the only way out is reflation/inflation, value of the money has to be reduced such that 95% can climb out of the hole. Other way to do this than ZIRP is by massive stimulus spending driving unemployment down to 5%, but I am a bit of a green guy and I dont buy into the perpetual increase in consumption, hence I do not mind ZIRP. Personally I am hurting since most of my savings happened in the last ten years, and dont see the power of compounding helping me at all.

  15. hue says:

    danm, welcome back

    we’re all dogs on top of the car with QE infinity, and no matter who wins this election http://bit.ly/RtprEn

  16. jb.mcmunn says:

    Although I’m in the anti-QE/anti-bailout camp myself, every once in a while I recall how everyone howled when Volcker cranked up interest rates. They predicted doom and destruction. It was a political firestorm. Thanks to Volcker my first mortgage rate was 13% so I wasn’t exactly thrilled with the guy either.

    Now he’s considered a role model for courageously making unpopular decisions. If things turn out well Bernanke will be hailed as a genius. If not, he’ll be the goat.

  17. dead hobo says:

    I have no problem whatsoever with QE. It provides liquidity. Removing liquidity causes asset price collapse. The lack of QE does not add ‘purity’ to pricing. It only creates an artificial demand for cash which causes the price of all assets to fall. Bank runs are a good example. the 2008 equity markets are another. Those weren’t pure markets. They were disasters that added liquidity would have prevented.

    The only QE oriented details I have problems with are secrecy regarding QE and plans for QE, start and stop QE, a favored few getting QE information for front-running, and QE information that is not publicly disseminated. QE secrecy is counterproductive and makes everything look rigged. Fortunately, that appears to be a thing of the past. I hated the secrecy. It made the Fed look stupid and like a lacky of the big banks.

    QE liquidity allows markets to be markets and remain as active markets. Without any QE, we would be seeing the Greatest Depression, which would dwarf the original Great Depression.

  18. b_thunder says:

    BR says: “… if you do not understand what is driving the Fed, it is harder to see when they might actually end the program, with consequences across the economy. To paraphrase an old quip, watch what they do, not what they say.”

    Exactly.

    And what are they doing? They’re using the bottomless money pit to buy unlimited quantities of MBS! And looking at the changes in the cost of funding for the mortgage lenders vs the drop in mortgages since QE3 announcement, at least 95% of the benefit goes to the BANKS, and 5% at best to the public. Indeed, watch what they do!

    The Fed is doing what it was designed to do, and what it has been doing for 99 years: it transfers wealth from the American Public to the Banking industry, and backstopping the over-leveraged banking cartel when there’s a risk of losses. And I believe the Fed is very worried that the slowdown is coming, and banks may come under pressure once again. So the Fed is making a preemptive attempt to pump more $$ into the banking cartel.

    If the Fed wanted to stabilize the housing market they’d give $3 trillion (Fed balance sheet expansion from $0.8T to $4T in 2009-2013) to the people to buy/refi/pay down mortgages. The money would still go to the same banks, but with one significant difference that 95% of the benefit would go to the public.

  19. techy says:

    QE’s only objective is to make capital as cheap as possible since demand in non-existant. When Romney wins the election QE will not be needed because spending will take care of demand. No matter how hard you scream, the only solution to the current 95% being in debt is to reduce the value of money, sorry be prepared to work till 75 unless you have more than 3-5 million or get lucky in risky assets, there is no more 5% yield on safe assets.

  20. whskyjack says:

    Deciding if cheap money is good for the country is way beyond my paygrade. But it is damn good for me right now. All the money I can borrow and under 5%, I am looking for deals and locking in my rates. As long as I invest in long term productive assets I’m fine.
    As we all know interest rates will raise but not right now. It will take a while.
    When they do it will be time for me to sell and lock in some high rate bonds for the retirement years.

    But unlike BR my voice doesn’t count for much all I can do is keep my seat in the saddle and ride this bronc
    c);-)
    Jack

  21. danm says:

    Hue,

    LOL!

    Me thinks the economy is too small for the size of the capital markets…

    You have a good memory. I read this blog everyday, just don’t post as much… Too much time sink.

  22. 10x25mm says:

    Hasn’t the single biggest positive of QE been the supression of the U.S. Dollar, particularly against the Euro? This was the basis of the U.S. export surge.

  23. wally says:

    ” When Romney wins the election QE will not be needed because spending will take care of demand. ”

    Say what?

  24. whskyjack says:

    Wally
    Check out this weeks polls. Tied race.

    It has come down to who wants to lose this race more Obambi or the Mittster

  25. sellstop says:

    QE is a way to debase/revalue the US dollar. We need to get out of our debt committments that are impoverishing the middle class of US citizens. We will devalue the dollar by keeping interest rates below the rate of inflation, encourage asset inflation in this country as it continues to be a problem in China. They must drop the peg to the dollar, QE will push them against the wall. The currency manipulation by Asia over the last decades will be countered by US currency manipulation, even as the US citizen rails against it. China must let it’s currency appreciate, reduce exports, increase consumption and eat US Tbonds…..

    It is economic war. Not as much outright bloodshed this way…..

    gh

  26. hue says:

    danm, should have said welcome back to the comments ;) yeah Barry has the Hotel California right here, you can check out but you can never leave. great blog, readership is the silent majority.

    Mitt Headroom http://bit.ly/T29RPf

  27. Widgetmaker says:

    I have no problem w/ QE. It is just basic monetary policy. We are stuck at the Zero Lower Bound, unemployment is high and the economy is still weak. Short term interest rates cannot be lowered further, so the Fed must initiate unconventional policy by purchasing long bonds, reducing the outstanding supply, which will further reduce long term rates. I don’t have a problem with that.

    So you say it punishes those living off the income from their savings. Yes, that is the other side of the coin and mitigates its effectiveness. So then you say we should increase rates so these people have more to spend, increasing demand. This means that borrowing will become more expensive, which will harm businesses and consumers who borrow to buy homes and durable goods, suppressing economic activity, increasing unemployment.

    Which is the greater good? How should we tailor policy? I believe the unemployment situation is our greatest concern and keeping interest rates as low as possible for the near future will spur economic growth/employment more than it suppresses spending by savers. Remember, the rate of inflation was 4% back when it was Morning in America. I seem to recall those were pretty good days for our economy.

  28. techy says:

    Sellstop: you nailed it.

    If 20 trillion is owed by US govt and 95% US Citizens, you will get your USD back as soon as we can print enough. Sorry savers only Soc Sec can help you so pray that safety net for retirees will also be extended with the help of the printed $$, unless they introduce a govt subsidized scheme for the saving of retirees.

  29. Lord says:

    While the Fed buying MBS has lowered mortgage rates, its buying of treasuries actually raised rates which fell after they ceased, such is the ambiguity of investors about what the Fed knows and expects, what they know and expect, and what they are communicating to each other. While interest rates are low in both nominal and real terms from presumed inflation, it does not mean they shouldn’t be even lower. With the devastation another depression wrecks on the economy and the imperative to deleverage, while lower rates are constrained for collateral and capacity reasons, they still assist in that deleveraging. It could use more effective tools, but to avoid them because they aren’t what they could be, would be an error.

  30. [...] –Arguments for QE: Barry Ritholtz, who has been skeptical of the effectiveness of Fed action, notes three areas where QE has been helpful. “1) Housing: As you may have noticed, while the rest of the economy has been pretty weak, Housing has held its own. In a note to our asset management clients at the end of Q3, we observed that while Employment, Durable Goods, Income, and Retail Spending were all soft, Housing is actually one of the few bright spots in the US economy. The reason for that is simple: The Fed’s QE… 2) Corporate Balance Sheets: The WSJ reported today what most of us have known for awhile: US companies are feasting on the cheapest money in living memory. 30 year investment grade corporate bonds are averaging a mere 2.77%. And, investment-grade companies have sold more 30-year bonds in the U.S. so far in 2012 than in any full year since 1995… 3) Federal Debt: The trillion dollar annual US deficit spending has created an outstanding debt of over $15 trillion dollars. The only way this is even remotely manageable is by keeping rates so low that the servicing costs are bearable.” [...]