With all the talk about quantitative easing and its subsequent variations called “asset purchases” and “expanding the balance sheet” at the Federal Reserve, one would think the average investor and Joe Sixpack would be familiar with these terms and what they mean.
In my many discussions with investors and people on the street, nothing could be further from the truth. Few people understand what all these terms mean, yet most believe whatever the Federal Reserve is doing is certainly meant to help.
Many economists and analysts support such quantitative easing programs, while many others (this analyst included) do not.
Regardless of which side you find yourself on or even if you have no opinion at all, it’s important that we as citizens know exactly what these programs are and how they work.
After all, if they are meant to steer us into some improved economic situation and may or may not actually accomplish that end, the fact remains any improvement and/or damage they do can be significant because the dollar amounts being tossed about are stunning in their magnitude (we are talking trillions here).
The Federal Reserve’s balance sheet sounds like a good thing, and indeed in a typical business, one would regard assets on a balance sheet as a positive.
In reality, however, when the Federal Reserve talks about asset purchases (which increase the Fed’s balance sheet), it actually represents the exact opposite of what most people envision.
The assets that the Federal Reserve is purchasing are usually two types — mortgage-backed securities (sometimes called agency debt) and U.S. Treasuries.
Mortgage-backed securities are simply all those toxic mortgages that the banks and the now-federally backed mortgage agencies (Fannie Mae and Freddie Mac) hold on their books and cannot sell on the open market. The Federal Reserve, in order to move these securities off the banks’ balance sheet (and since the banks can’t sell them) simply prints up the money and gives it to these agencies, and in return, the Feds get billions in mortgages. If it sounds like a bank bailout, it is (and you thought the bank bailouts where over).
The more mortgages they buy, the higher the Federal Reserve’s balance sheet goes. You could call the Federal Reserve’s balance sheet a garbage meter. The higher it is, the more garbage it holds. A higher balance sheet also means it printed more money, and that eventually causes inflation down road.
The other assets it is buying are U.S. Treasuries. These are simply IOUs from the government. The Federal Reserve prints up more money (causing more inflation) and gives that money to the Treasury to spend (finances the government), and in return, the Federal Reserve now amasses trillions more in U.S. government debt.
Together these Treasuries, along with the mortgage-backed securities, pile up ever higher on the Fed’s balance sheet. What used to be about $600 billion in assets prior to the crisis now is about five times higher — exceeding $3 trillion, a stunning amount indeed.
Every month, the Federal Reserve is creating another $85 billion or so and buying even more mortgages and Treasuries, and it’s all this money being used to purchase these assets, which is supposed to goose the economy.
As Paul Harvey used to say: “And now you know the rest of the story.”
As to whether all of this is working or not is a story for another day.
This article expresses the opinions of Marc Cuniberti. He hosts “Money Matters” on KVMR FM 89.5 and 105.1 FM on Thursdays at noon. He has been featured on NBC and ABC television and on a host of made for TV documentaries for his economic insights. His website is www.moneymanagementradio.com.