So you think you can do better than the Fed?
Fed chair Ben Bernanke steps down at the end of January. The Fed may not be perfect, Paul Solman explains in response to a reader, but is there another way to run a modern market-driven economy? Photo courtesy of Alex Wong/Getty Images.
Paul Solman answers questions from the NewsHour audience on business and economic news on his Making Sen$e page. Friday’s questions are about the Fed. Earlier this month, Making Sense previewed the Fed’s decision to taper its monetary stimulus program, and we revisited our simulation of how the Fed’s Open Market Committee reaches those policy decisions. As part of that week-long look at the Fed, which just celebrated its centennial, we asked new Nobel laureate Bob Shiller what he would do if he were chair of the Fed and asked former Fed economist Catherine Mann to weigh in on how the Fed’s low interest rates send dollars abroad.
But here’s what readers still want to know about the Fed and its quantitative easing policy and Paul’s responses to those queries.
Lionel Ruberg — Newtown, Pa.: How much of the QE3 monthly purchases is offset by maturities of notes and amortizations of mortgages each month?
Paul Solman: None. QE or “quantitative easing” refers to net Fed purchases, not the rolling over of old Treasury securities or mortgage-backed securities when they mature.
Eric Greenfeldt — Princeton, N.J.: Who owns the mortgage-backed securities (MBS) that the Fed is buying?
Paul Solman: Elvis and Bella Narwhal of Piscataway, New Jersey.
No, not really. The Fed says it mainly buys new MBS: loans taken out on batches of mortgages that have been bundled together. The interest on the MBS loans is supposed to be paid off by the mortgage payments coming into the bundle. Ever since the crash, most of those bundles have been created by agencies of the U.S. government: Fannie Mae (FNMA — the Federal National Mortgage Association), Ginnie Mae (GNMA — the Government National Mortgage Association) and Freddie Mac (FHLMC — the Federal Home Loan Mortgage Corporation).
So, much as when the Fed creates money to buy Treasury loans and pays it to the government, when the Fed creates money to buy MBS, it pays the government as well. The big difference is that in the case of Treasury bonds, the collateral is nothing more than the “full faith and credit” of the United Stats. With MBS, there is first the collateral of the houses against which the bundled mortgages were taken, backstopped by a government guarantee.
Don Pearson — Lakewood, Wash.: Why don’t you do an extended piece on the Fed Reserve? Its origin — not as a real federal agency — its oversight, what happens to its large billions in profits not turned over to the government, the source of the pool of nominated governors, etc.? I think most believe it is a formal part of the U.S. government and do not know of its origin or its relationship to the banking industry.
Paul Solman: Oh dear, why do I fear that this “question” is yet another attempt to delegitimize the Fed?
Look, how about you tell me a better way to run a modern, market-driven economy than to have a somewhat (barely) independent central bank? And when you do, don’t forget to provide an example of one, okay?
The Fed reminds me of Churchill’s old saying about democracy: the worst form of government except for all those others that have been tried.
Pam Bishop — Miami, Fla.: I have thought, from the beginning of “quantitative easing,” that overly-low interest rates were counter-productive to banks’ willingness to lend, especially to moderately-sized domestic businesses.
Aside from low profits, the banks, even though inveterate foes of financial deregulation, could have taken a lesson from the situation when deregulation and the abrogation of Glass-Steagall destroyed the stability of our local banks: it pulled the rug out from under the S&L’s who were caught with long-term moderate-interest mortgage loans in a time of financial swashbuckling and rising rates.
Paul Solman: Whoa, there. You’ve got your chronology wrong, Pam — in an instructive way.
The abrogation of the Glass-Steagall provisions of the U.S. Banking Act of 1933, prohibiting commercial banks from risky investment banking, didn’t happen until 1999, more than a decade after the savings and loan fiasco.
Yes, it was deregulation of the S&Ls that led to their mass demise, but that’s because they were finally allowed to offer higher interest rates on their deposits, which is just what you seem to be suggesting now. In order to offer higher interest rates — in large part to compete with newly created money market funds, which paid higher rates to would-be depositors and yet seemed equally safe — the S&Ls made riskier loans. You can guess what happened next.
You could be right about the knock-on effects of the Fed’s low interest rates: banks’ reluctance to lend. Or it could instead be the case that non-risky borrowers aren’t out there as they so abundantly were, pre-Crash. Or maybe banks are just scared and, now that they’re under scrutiny, are overdoing the caution instead of the derring-do. (Once burned, twice shy.)
Or maybe there’s another explanation entirely: so much saved wealth sloshing around the world these days in places like China and the Middle East — the so-called “capital glut” — that interest rates would be low regardless of what the Fed did. Or maybe banks would be happy to lend if the Fed didn’t pay them .25 percent to redeposit their depositors’ money back at the Fed.
My guess is that all these factors are playing a role, the Fed’s efforts to keep interest rates low among them. But hey, if you were the Fed and official unemployment was still running at 7 percent, our own “U-7” reckoning far higher, would you raise rates on the bet that bank lending would thereby revive?
Paul Adler — Ann Arbor, Mich.: What the Fed does affects people in retirement. Many people in retirement have about 50 percent of their money in bond mutual funds. As interest rates increase, the net asset value (NAV) of these bond funds goes down, resulting in a loss of principal. My question: stay the course with bond funds or do something else?
Paul Solman: A year ago, I wrote about getting out of inflation-protected bonds, which I had long promoted on this page. Unfortunately for me, I didn’t manage to act on my own advice until several weeks later, by which time bonds had begun their price descent.
Now that their yield has gone up, I have less of a sense of urgency. But with the yield on U.S. Treasuries still well below their historical average, I remain leery.
On the other hand, it means nothing, practically speaking, to fear an asset class like bonds without believing in, as you put it, “something else.” And damned if I know what that “something else” might be these days, given that stocks are also selling at well above their historical average, as measured by their earnings, as new Nobel laureate Bob Shiller explained here recently and investment adviser Andrew Smithers only a little while earlier.
As I explained in my swan song to bonds last year, I switched most of our family savings to an account with TIAA-CREF that guarantees 3 percent a year at a minimum. Unfortunately, it’s closed to new investors.
My only hard recommendations are that, no matter what kind of fund you invest in, do it at the lowest possible cost. (It’s for that reason that I’ve used Vanguard funds for years.) And if you want to get specific and a little exotic, there is at least one U.S., FDIC-insured bank account denominated in Chinese Renminbi. I had it at EverBank in St. Louis and it appreciated with the rising value of the RMB.
This entry is cross-posted on the Making Sen$e page, where correspondent Paul Solman answers your economic and business questions