Thursday, January 16, 2014

The Fed Quantitative Easing and Interest rates

A while back, someone pointed out that if homes were selling like hotcakes when interest rates were 6%, there shouldn’t be any inventory left at 4%. As it is, housing is not as robust as it was in the boom days. Bernanke said that the Federal Reserve would curb their buyback plan of 80 billion a month of Treasury’s and mortgage backed bonds.

Let’s use the back of an envelope and do some computations on the Feds involvement in Real Estate. Figure that they dropped about 40 billion per month buying real estate mortgages. If we calculate the number of homes that could be bought, figure the low end price of 200k and a high end of half a million. So the range of home loans purchased by the Fed is from 200,000 cheap ones to 80,000 expensive ones. The November real estate report calculated that 4.9 million homes were sold in the span of a year nationwide. The wild thing that I haven’t verified is that they claim 7 out of 10 buyers paid cash. If that is true, 1.47 million homes needed financing. Extrapolating the Federal consumption of Real Estate paper, on a yearly basis, we get a range of 1.4 million to a little over a half million homes financed. Take out for a down payment, and it kind of looks like the Fed is the market maker for Real estate loans.

The banks do not want to hold low interest bearing real estate loans and I don’t blame them. It puts them in the position of borrowing from their depositor’s short time and loaning it out long time. The Fed on the other hand, in theory, has no problem holding a low interest rate loan for 30 years. The printed dollars come back to them in monthly payments and in the end; it is a zero sum game.

This whole QE problem which some refer to as QEternity, has robbed the silver foxes of their retirement interest. While at the same time our youth are scratching their heads over the big deal that everyone use to make about compound interest being the 8th wonder of the world. Put money in the bank and save it? Why bother? My credit card pays me 2% interest for spending money and that’s more than the bank pays for saving it. We are living with the “I want it now” generation.

The young are not going to put money in the bank long term, but there is still one game in town going strong –the stock market. People with 401K’s can save on income taxes by putting money away for retirement. Where are these money mangers putting the funds? The stock market.

What needs to be realized is the fact that there has to be a correction of sorts. There is no incentive to save for a “rainy day.” If quantitative easing were to end, where does the money come from to finance the next real estate purchases? I’m not about to give anyone my savings for 30 years at 2% interest.

Many things revolve around interest rates; bonds, real estate prices, pension funds, national debt, bank rates, commodity futures, credit card debt and stock market margin to name a few. What we do know is that interest rates should rise if the Federal Reserve stops its quantitative easing. Risk would reenter the market and interest rates would reflect the perceived risk. The net result, the investor would reallocate their financial resources to take advantage of the markets. Change the rules and the game changes. The real estate recovery would probably hit the skids. A doubling of interest rates would trash the bond market and the interest on the national debt would approach one trillion a year. Commodity futures would cost more with higher interest rates, and the stock market would not be the only game in town anymore. Retirement funds heavily invested in long term bonds and real estate would be toast. Banks would be willing to pay more interest on savings which would be a boon to retirees, and credit card debt could become a lot more expensive. This could lead to a drastic drop in consumer consumption.

There is only one market that the Federal Reserve has not insured—the stock market. So if QEternity continues, we can see Google stock hitting $15,000 a share. Of course you say it could never happen, well, Ben Bernanke’s financial shenanigans remind be of John Law and the Mississippi bubble of 1720 in France (which wasn’t really a bubble); read up on it if you think $15,000 a share is excessive.

What we can realistically state about our present financial government solution to our present dilemma, is that it is not self-sustaining. A long term Federal Reserve bailout is only manipulating the financial structure in ways that affect those about ready to retire or are already retired. Basically Congress has no idea on how all of this Federal Reserve money fits in with their budgets, but it appears to work splendidly.

Presently gas pumps will accept $20 bills but not $50 bills. It takes $62 dollars to fill my tank. Do you get the feeling that the $100 bill is the new “$20” that you use to use? Of course it’s not inflation, let’s blame the Arabs,---and we are not even buying their oil, go figure!

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