Quantitative Easing vs Quantitative Exit: A Bond Solution?

On August 9^th two Northwestern Economists issued a paper describing the cause and effects of Large Scale Asset Purchases, aka, Quantitative Easing. The name of the paper, The Ins and Outs of LSAPs, Arvind Krishnamurthy and Annette Vissing-Jorgensen. The 44 page paper is an in-depth study that chronicles the success of all the QE’s and the positive impact it has on interest rates. The paper details the historical decrease in yields of Treasury Security Bonds and Mortgage Backed Security Bonds as a result of the QE’s. Tracking the historical yields uncovered several interesting findings. The most important finding was the singular impact of the purchase program meaning, the purchase of Treasury Securities and Mortgage Back Securities had no other immediate impact on other long term private debt assets. Stated another way, the QE’s were effective in decreasing mortgage rates and Treasury rates but had no ancillary effect on private corporate bonds or any other private debt assets. Decreasing the private bond rates would have had given investors more private borrowing power through lower rates. The hopes were that the fiscal stimulus would directly trickle into the private sectors, according to the paper that did not happen.

So if the private securities/assets were not affected by the QE’s, why did the market (private sector) react negatively when the Feds suggested ending the QE?

The paper suggests that dual “unanticipated news of an exit” coupled with the “liquidation of existing portfolios” would not only affect “market prices based on new expectations” but also “affect asset prices based on expectations” which resulted in “Policy Shock”. The announcement was too much for the market to bear.

Is there a strategy that can help keep Mortgage rates low while exiting QE?

According to the paper there is since “news that the Fed will stop purchases has a different effect than news of the sale of the existing portfolios. Sales of higher coupon, older MBS from the Fed’s portfolio will have minimal negative spillover effects.”

The bottom line, keep buying new bonds, start selling the old bonds, one doesn’t seem to affect the other. As housing starts to recover the need for continued government purchasing of Mortgages Securities, “will fully disappear as new loans are originated.”

FNMA: The Governmental Goose That Lays the Golden Egg

FNMA Nears Break Even With US

Five years ago things looked really bad. All phases of the financial markets were collapsing. The Federal government stepped in, with TARP (Trouble Asset Relief Program), and bailed out Banks, FNMA, FreddieMac, AIG, Autos and more, close to 700 billion dollars were spent to keep things propped up.

Good News!

Today, the government has recovered 670 billion of the TARP money and expects profits very soon. You heard correctly, TARP will be a Federal money marker in the near term.

FNMA Nears Break Even With US.

The GSE’s (FNMA/FreddieMac) required 187 billion dollars from TARP funds, however, today they re-paid 146 billion to the Feds. That’s 78% of the borrowed funds paid back in 5 years. Plus Fannie and Freddie are making significant profits and expect to pay an additional 25 billion payment by year end. Also, since all future profits go the government, Fannie/Freddie will be money makers for the government sometime in 2014. FNMA, the Golden Goose?

More Good News!

The housing sector is not the only thing turning a profit. Bank profits have allowed them to pay back 109% of their Tarp money, meaning that the government made 22 billion on Bank stock sales. The AIG bailout has produced a 22 billion dollar profit too. Autos have re-paid 66%, and everything else has re-paid 83%.

Was TARP a good idea?

We’ll let historians debate that question, but everyone would have to agree, recovery of 670 billion in less than 6 years is pretty amazing.

Read our multi-part Series: The Liquidity Factor

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