The Fed just announced QE3. However unlike the first two iterations, this one has no expiration date or amount. Call it QE infinity. The action was taken at the last Open Market Committee - although Bernanke had hinted at it in his Jackson Hole speech earlier. The vote for the FOMC was 11-1. On the committee sit all 7 governors of the Fed, the president of the New York Fed and four of the other reserve bank presidents. I presume the one "no" vote was from the president of the Richmond Fed who has consistently opposed quantitative easing. On the other side of the spectrum is the president of the Chicago fed who wants even more easing than was agreed upon. The amount the fed will buy is $40 billion per month in mortgage-backed securities. This is an important departure from the other QEs in that the Fed is not buying Treasurys. Thank goodness for small favors. The purchasing of Treasurys is called monetizing the national debt and essentially has the Fed supporting increased government spending by purchasing Treasurys directly from the US Treasury. I have long advocated that this be made illegal except in a declared national emergency. When the Fed buys mortgage-backs it is purchasing bonds that are collateralized by mortgages. It is not clear if it is only buying the bonds from Fannie Mae and Freddie Mac or from the private sector or both. The issuer of the bonds buys the mortgages from originators, pools the mortgages and issues bonds against the pools. The purchaser of the bond (now the Fed) does not own the mortgages - they remain on the balance sheet of the issuer of the bond (say Fannie Mae). The issuer typically guarantees the timely payment of the principal and interest of the mortgages to the bond holder. In the case of default of a mortgage, the holder of the mortgage - not the bond - bears the risk. Generally, the mortgage pools are diversified so that unless there is a general mortgage meltdown, the risk that the bond will default are minimal. Historically, the purchaser of the mortgages has policed risk by evaluating defaults among the originators. Thus, if an originator is making too many "bad" mortgages, the purchaser will either buy subsequent mortgages at a haircut or not at all. As a consequence, the risk to the bond holder should also be minimal. Of course, when times are not usual, like in the mortgage market meltdown, then the bonds themselves default because the bond issuer defaults by not being able to cover the defaults of the homeowners. By announcing that it is only purchasing mortgage-backs, the Fed has announced that it is no longer supported the deficit spending of the congress and the White House. Rather, it has announced that it is supporting the mortgage market instead. This is because when the bond issuer sells the bonds, it then uses the funds to purchase more mortgages. So if I had my druthers, I prefer this QE to the others.
Harold A. Black is professor emeritus in the Department of Finance, University of Tennessee, Knoxville having retired after 24 years of service. He has served on the faculties of American University, Howard University, the University of North Carolina - Chapel Hill and the University of Florida. His government service includes the Office of the Comptroller of the Currency and as a Board Member of the National Credit Union Administration. He also has served on the boards of directors Home Savings of America and its parent company, H. F. Ahmanson & Co., Irwindale, California prior to its merger with Washington Mutual Savings Bank, on the board of New Century Financial Corporation, Irvine, California, then the nation’s largest real estate investment trust and as director and later chairman of the Nashville Branch of the Federal Reserve Bank of Atlanta. He writes an occasional article for the Knoxville News-Sentinel at http://www.knoxnews.com/staff/dr-harold-black/. His web page is haroldablackphd.com