Why QE3 is Likely to Fail for Most Americans

This article published with permission from InvestmentU.com.

When you start talking about quantitative easing (QE) in the investor or political world, you evoke emotions. In fact, if your last name is Krugman or Paul, the whole existence of the Federal Reserve could start something of the likes of the Hatfield-McCoy feud.

So now, in an election year, Mr. Bernanke has decided to introduce a third round of QE.

Rick Perry is trolling around the District looking for the Fed Chief, and Republicans on the Hill have come up with more conspiracy theories than Oliver Stone. All the Keynesians out there are thanking the Federal Reserve for preserving the economy that the big bad Congress is holding hostage.

So much drama.

I’ve written more “academic” pieces explaining quantitative easing and what it does. But let’s just go over the basics and then talk about what was done and what the Fed was attempting to accomplish with last week’s announcement.

QE in laymen’s terms

The Fed buys up some U.S. Treasury bonds and or mortgage-backed securities. You take the supply out of the market, which shoots prices up and knocks down their rates. With fewer bonds, you expect the investment world to go out into the market for better returns.

Now, according to the Fed, if you float all this excess cash in the markets, the increase in the market gets people feeling better and investing more.

How does this work? (Here’s a little foreshadowing of what we’ll cover later.) Let’s say the Fed buys mortgage-backed securities and keeps mortgage rates low — or gets them to go lower. If that happens, maybe more people will buy homes. If more people buy homes then more homebuilders are building more homes. Homebuilders will hire more construction workers. There are more jobs. All of a sudden, there’s a housing recovery and you have job creation.

And back at Jackson Hole a few weeks ago, Ben Bernanke spoke of his belief of what the first two rounds of QE did for the economy. He let it be known that QE and QE2 produced more than two million new jobs and added three percentage points to GDP.

That, coupled with the fact that he stated the current “economic situation is obviously far from satisfactory” and that the unemployment rate is way too high, was a precursor to what we heard from the Federal Open Market Committee (FOMC) last week.

Targeting the housing market

The FOMC last Thursday announced that QE3 had indeed arrived and it would target the housing market. It will buy $40 billion in mortgage-backed securities a month without a time restraint.

The release from the meeting stated:

“The Committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions… strains in global financial markets continue to pose significant downside risks to the economic outlook.”

In addition to QE3, what should not be forgotten is that the Fed is extending Operation Twist through the rest of 2012, and will probably keep it in place till around sometime in 2015. That’s an extra year than previously expected.

The Fed also hinted that it could bring out some bigger monetary bombs — employ other policy tools — if markets don’t get better.

Here’s the statement:

“If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.”

Monetary policy actions may be far from over.

Spurring job creation?

I went over the theory of this earlier. But here’s the key correlation that needs to be made in order for this to make any sense. You have to believe that lower mortgage rates — or the continuation of lower mortgage rates — will be the catalyst for home buying. If that’s the case, then you have a snowball effect at the bottom of the hill that leads to job creation.

The market should be ripe for home ownership by consumers.

As I mentioned a few months back in an article regarding Warren Buffett’s bet on the housing market, Trulia’s latest “Rent vs. Buy” report states that buying is now cheaper than renting in all of the 100 largest U.S. markets.

With all that being said, ask yourself: how long have mortgage rates been low? Now ask yourself, has the job creation gotten better because of these rates?

The answer is no.

According to Trulia.com Chief Economist Jed Kolko, “This makes home ownership cheaper, but that’s only one factor going into owning a home… The biggest obstacle is actually saving for a down payment.”

According to Ryan Sweet, Senior Economist at Moody’s Analytics, “I think this will have a bigger impact on refinancing than on home sales because the mortgage rate hasn’t held home sales back, jobs have.”

Rates aren’t the issue. I think everyone likes the cost of a 30-year mortgage right now.

The problem is getting a big chunk of change to put down as deposit to buy a home. Rates mean nothing if lending standards are too stringent. So, we’ll probably wallow in this quagmire a little more unless we see some fiscal policy come about soon.

Who are the real winners?

Mortgage-backed securities soared in their best day in nearly four years because of the announcement. QE3’s plan to buy the additional $40 billion a month in bonds went beyond expectations. Traders and investors had been stock piling these securities for a while, expecting some sort of Fed bond buying.

The purchasing of mortgage-backed bonds allows the Central Bank to lower the rate at which banks can sell their loans through government-sponsored entities like Fannie and Ginnie Mae and Freddie Mac and their securitization programs. They fund about 90% of America’s home loans.

Don’t expect the drop in mortgage-bond yields to help out the everyday Joe American through lower rates, but banks and REITS should expect a big payday.

Seems like this is how most stories end lately.

Jason Jenkins is a part of the research team at InvestmentU.com. See more articles by Jason here.