Huge FED Actions
The big news today was the FED action to spend $1.1TRILLION dollars to “save the economy.” I want to break down the FED statement and intended actions and explain the consequences of this action.
The FED intend to make two big moves:
- Use $300B to buy long term Treasury Bonds
- Use $750B to buy mortgage backed securities for Fannie and Freddie.
Naturally buying long term bonds drives interest rates down, and the value of bonds up. Coincidentally, isn’t this just what the Chinese asked our government to do last week? So, interest rates on the 10 Year Treasury fell almost 0.5% today – an amazing move downward. Lots of other interest rates will follow, and the most important one, as far as the government is concerned, is the 30 year fixed mortgage rate.
But, what about the unintended consequences? The FED is playing with fire in this arena. Why am I stating this as all the news is good? Well, the FED is manipulating long term interest rates – something they have NEVER done before. Will this mean that all other bonds – those not attracting the FED money – are much more risky, and so will drop in value in the very near future??? Manipulating markets is something that has never worked in free markets, and this one won’t work either. It will work in the shorter term, but when it fails, watch out.
What about the second announcement – the purchase of mortgage backed securities for Freddie and Fannie. The idea is to get these markets moving again as they are totally frozen today, and writing mortgages has substantially slowed (except for FHA loans). But think about the dilemma that all the big banks are in who hold these toxic securities from the past. Naturally, these NEW mortgage securities will start with today’s housing values, rather than the values of the past few years. But, what is going to stop the value of houses from dropping???? I’ll leave that to the reader to answer. If housing prices fall, these NEW mortgage securities will ALSO fall in value, and this time it is the FED holding the bag.
So, I plea for you to think before you open that bottle of champagne.
Yes, opening the mortgage securities market will help slow the fall in housing prices. But will it be enough by itself? What will be the rules for writing a NEW mortgage? What about all those houses that are going to be foreclosed anyway in 2009 – and drive the market down further?
Lastly, what about all this money that the FED is placing in circulation? Won’t it cause inflation? Let’s watch that spot very closely now, because if and when TOO MUCH money is placed in circulation, the killer forces of inflation will strike, and the FED will not be able to stop its spread. Too early to tell today if we are at that point yet. However, we can firmly state that we are over $1TRILLION closer to that point.
The markets today…..
Stocks rallied on the news from the FED, but it was really irrational – unless the housing price crisis is really solved once and for all.
Bonds rallied like they have NEVER rallied before. This was a HISTORIC day for bonds.
The Dollar got killed as the fear of inflation swept the currency market.
Gold got caught in the downdraft, but it should rally with the inflation scare too.
Here are the last numbers for today:
Dow Jones 30 Industrial – 7487 (up 91 points)
10 Year Treasury Bond – 2.53% (down 0.47%)
Euro – $1.3428
Gold – $889 (down $28)
Oil – $48.14 (down $1.02)
Gasoline – $1.37 (down $0.06)
We can be assured there is be significant unintended consequences from the Fed’s quantitative easing (inventing money to buy assets).
We are still in a deflationary environment so I personally don’t see inflation rocketing upwards soon. However, at some point if the base money isn’t removed from the system AND we releverage the system, then the money supply (money & credit) will explode causing inflation.