The Edmond Sun

Business

September 24, 2012

Blazing bazookas from the Fed

EDMOND — I was wrong. OK, I said it. I thought for sure helicopter Ben wouldn’t actually do it. That is Quantitative Easing 3, commonly called QE3. But he did and I’m appalled! When will the madness stop?  Perhaps only when he drives the economy off the cliff. We were driving toward it already. Now it’s “pedal to the metal.”

No Central Bank has ever done anything like this in modern times and we are clearly in uncharted territory with this giant experiment. I hope he’s right because he and European Central Bank Chairman Mario Draghi just bet the ranch on it.

You might recall that in mid-summer 2007, then Treasury Secretary Hank Paulson asked Congress for the authority to buy up some troubled sub-prime assets if necessary. He said he didn’t think he would need it but “if everyone knows you have a bazooka in your pocket, you won’t have to use it.” Of course, it wasn’t but a month or so later he fired the bazooka.

This time it’s Fed Chairman Ben Bernanke firing the bazooka. Actually it looks more like a cannon and it’s starting to look like the shoot-out at OK Corral. What the Fed did was actually more than QE3. Call it QE3 plus — a gift that will now keep on giving. No maximum. No time limit. I think Bernanke just cleaned out his ammunition shed.

I recall a funny sign someone had in their office years ago that said, “The beatings will continue until morale improves.” That’s what this round of QE feels like. Instead of doing a certain amount of QE, or for a certain time period, this time it is open-ended. They will keep doing it until things get better. What does that mean? More importantly, what if it doesn’t? Do we keep going until the “mother of all bubbles” finally explodes? This is pretty scary stuff.  It seems that all major central banks of the world have basically said they will never face the music and allow economies to seek their natural levels.

QE adds money to the system. It also lowers the value of money and drives asset prices up, especially commodities, oil, food, gold and the stock market. They wish it would drive up real estate prices but that is not working so well. It does nothing to improve the economy. It hopes that higher asset prices and the so-called wealth effect will make people feel better, spend more money and cause business profits to expand and thus create the need for hiring people to produce all the things they are buying. It hasn’t worked so far.

What is not addressed here is that liquidity is not the problem. Lack of demand is the problem and that is not changing anytime soon until the demographic headwind we are all facing, and the deleveraging of excess debt, runs its course. This only postpones the problem. Banks have plenty of money to loan. But most of the people the banks would like to loan to don’t want or need a loan. And many of the ones who want a loan don’t qualify under today’s tougher lending standards.

Much of the idea of the Fed buying mortgage-backed securities is to help the housing market with cheaper loans, but average mortgage rates are currently 3.7 percent and that has not created significant additional home buying. If 3.7 percent can’t get more people to buy homes, will 3.2 percent? Maybe some, but not much.

It probably will create another round of refinancing, but it doesn’t help the housing market.  It does nothing for the person who can’t qualify for a home loan, or is underwater on their home mortgage and would love to refinance but can’t. Until that problem is solved, the housing market is stuck. The harsh reality for the housing market is the backlog of homes with negative equity, and the demographic headwind of downsizing baby boomers is so ferocious that the Fed is unable to push against it.

One thing significantly different this time is the Fed’s policy is very explicitly tied to the labor market. “If the outlook for the labor market does not improve substantially, the committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability,” the Fed said in its official statement. In other words they will keep doing this until the job market improves substantially. That could be a long time. As I said, we are now in uncharted waters here. Did I mention that I’m really ticked off about this?

However, this is a game changer for investors and the “risk on” trade is back with a vengeance. All of the money is going to go somewhere and the stock market is one of those places. This is not about fundamentals. This is about money looking for a place to go. All bets are off and the direction of the stock market is definitely up for the time being. Oh, for sure 2013 still looks very precarious and nothing about the U.S. or global economy has really changed or is likely to change anytime soon. But in the meantime, if you’re an equity investor and can stand the volatility, buckle up and go for the ride.

When Ben Bernanke became chairman of the Federal Reserve in 2006 he promised a significant change. He has certainly kept his promise. Please stop the madness, Ben. And please stop playing with that bazooka. You’re making me nervous. Thanks for reading.

NICK MASSEY is a financial adviser and president of Householder Group Financial Advisors in Edmond. Massey can be reached at www.nickmassey.com. Securities offered through Securities Service Network Inc., member FINRA/SIPC.

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