January 6, 2013

A Pretty Dangerous Thing

Readers suggested a topic on the latest Federal Reserve minutes. “Which asset class would get hammered the worst if QE-to-infinity-and-beyond were suddenly ended? My guess is that the current discussion is a jawboning exercise designed to start the adjustment process to the absence of QE before it actually begins in 2015 (or whenever). Once the expectation for an early exit by the Fed is priced in, the stock market can enjoy a future rally on the announcement that QE will end ‘later than expected.’”

A reply. “I don’t see QE ending anytime soon, as having to pay real interest rates would wipe out the Fed Gov. And as long as big inflation does not rear its ugly head, why would they even think of stopping?”

One said. “The Fed is becoming the sole buyer of bonds printed up by the Treasury. What does that tell you? The marketplace won’t buy at the current rate. So, yes, the Fed is controlling interest rates by not allowing free market bidding for Treasuries. Additionally, the collusion of Central Banks world-wide, working with Goldman-Sachs and the other big banks has created international instability.”

From Reuters. “In a surprise to Wall Street, minutes from the Fed’s December policy meeting, published on Thursday, showed a growing reticence about further increases in the central bank’s $2.9 trillion balance sheet, which it expanded sharply in response to the financial crisis and recession of 2007-2009. ‘Several (officials) thought that it would probably be appropriate to slow or to stop purchases well before the end of 2013, citing concerns about financial stability or the size of the balance sheet,’ the minutes said, referring to the narrower group of voting Fed members.”

From Quartz. “Most interesting is not what the committee said but why. Numerous statements within the minutes suggest that the Fed is truly growing concerned about the unintended consequences of ultra-loose monetary policy on a long-term basis. With regard to the possible costs and risks of purchases, a number of participants expressed the concern that additional purchases could complicate the Committee’s efforts to eventually withdraw monetary policy accommodation. Depending on the path for the balance sheet and interest rates, the Federal Reserve’s net income and its remittances to the Treasury could be significantly affected during the period of policy normalization. Participants noted that the Committee would need to continue to assess whether large purchases were having adverse effects on market functioning and financial stability.”

“This hawkish stance extends to long-term interest rates, which could eventually hurt savers and push investors into unnecessarily risky assets.”

“A few participants, observing that low interest rates had increased the demand for riskier financial products, pointed to the possibility that holding interest rates low for a prolonged period could lead to financial imbalances and imprudent risk-taking. One participant suggested that there were several historical episodes in the United States and other countries that might be used to build a better understanding of the financial strains that could develop from a long period of very low long-term interest rates.”

“In other, shorter words, committee members are worried that prolonged easy money might get the economy addicted; that it will put a strain on the Fed’s own finances; and that it will encourage moral hazard. (That mystical reference to ‘historical episodes’ might be a warning about Japan’s ‘lost decade’ in the 1990s, or US stagflation in the 1970s.)”

The Business Insider. “Regular readers know that “bond king” Bill Gross, who runs the world’s biggest fixed income fund at PIMCO, is not the biggest fan of the Federal Reserve’s quantitative easing programs. In his January letter, entitled ‘Money for Nothing, Checks for Free,’ Gross tells investors to avoid long-term U.S. government debt, writing that ‘ultimately government financing schemes such as today’s QEs or England’s early 1700s South Sea Bubble end badly.’”

“Gross takes aim at a speech given by now-Fed Chairman Ben Bernanke back in 2002, in which Bernanke says the Fed can increase the monetary base ‘at essentially no cost.’ Gross writes: ‘When the Fed buys $1 trillion worth of Treasuries and mortgages annually, as it is now doing, it effectively is financing 80% of the deficit for free…Bernanke’s dreams of economic revival, which would then lead to the day that investors can earn higher returns, may be an unattainable theoretical hope, in contrast to a future reality. Japan we are not, nor is Euroland or the U.K. – just yet. But ‘costless’ check writing does indeed have a cost and checks cannot perpetually be written for free.’”

From CNBC. “According to Sam Chandan, president and chief economist with Chandan Economics, the Fed is trying to signal two things. The first is that the Fed believes that the U.S. economy is developing ‘its own momentum’ and a continuation of the easy monetary policy is not warranted. The second is that financial markets need to get used to the idea that this is the beginning of the end of easing.”

“‘They are signaling to the market that extraordinarily accommodative monetary policy is not something that will last forever,’ Chandan told CNBC Asia’s ‘Squawk Box’ on Friday. ‘They have done this in several ways - putting time frames around it, and with discussions around where rates might begin to rise. But the market hasn’t internalized a lot of that.’”

“‘If the market believes that this (easing) is going to go on forever, that’s a pretty dangerous thing,’ Chandan said.”

The Marin Independent Journal. “The jumbo loan is making a comeback, a welcome trend for Bay Area homebuyers and one more sign the housing market is reviving. After a sharp drop last year, loans greater than $625,500 have bounced back in Alameda, Contra Costa, San Mateo and Santa Clara counties in the past 12 months, according to DataQuick, rising from about 8 percent to 13 percent of Bay Area home loans. San Francisco has seen an even bigger increase in jumbos, from 18 percent to almost 33 percent of all loans.”

“‘The high-end homes market is reviving because buyers feel the combination of good prices and low interest rates make today a good time to buy,’ said Wells Fargo spokesman James Hines. ‘The availability of low-rate jumbo loans, therefore, is enabling these consumers to buy homes and finance them.’”

“The interest rates for jumbos are also now close to those of conforming loans. For example, Star One Credit Union in Sunnyvale last week offered a 30-year fixed-rate jumbo at 3.875 percent with no points; what it calls a conforming ‘high balance’ loan of $417,000 to $625,500 at 3.625 percent; and one below $417,000 at 3.5 percent. That’s a difference of only a quarter of a percent between the high balance and the jumbo loan. At the worst of the credit crunch, the spread at some lenders was 1 percent or more, according to Zillow.”

A Letter to the Editor, Vancouver Sun. “Re: Buyers waiting for housing bubble to burst could be in for a long wait, Dec. 29. I’m not a real estate expert, but Cameron Muir’s arguments against a real estate correction are so flawed even a novice like me noticed. He is correct that the 2008 financial crisis did not result in a real estate correction locally. However, at the time, the Bank of Canada was able to lower interest rates from 4.75 per cent to 0.5 per cent to help the economy. It is currently at one per cent. There isn’t a lot of room to lower rates should another crisis occur.”

“He is correct that a 10 per cent mortgage rate increase was required in 1982 to cause a sharp real estate drop. However, mortgage rates were generally higher then. The 10 per cent increase only doubled it. Today’s mortgage rates are much lower. A three per cent increase would double rates.”

“His statement ‘But are you willing to sell your house at 60 cents on the dollar? … You don’t have to sell and people have to have somewhere to live,’ is the most ridiculous of all. Under that logic, house prices will never go down. People in the U.S. needed somewhere to live in 2008, the house prices there still crashed. I think they discovered something new called renting.”

Bits Bucket for January 6, 2013

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