Dear Readers: I’ve received many questions about the Federal Reserve. This single response answers several dozen queries.
In March 2016, Federal Reserve officials agreed they should begin selling their $3.5 trillion quantitative easing portfolio of mortgage securities toward the end of this year. Note that I wrote “should” rather than “will.” Also note that Fed officials haven’t agreed on how much of the $3.5 trillion in mortgage bonds they may sell or how quickly they may reduce their position. The Fed is guarded on how it will reduce its massive bond position purchased via the 2007-10 quantitative easing strategy, which saved the banking system from collapse and many bank presidents from prison.
As the Fed was buying $3.5 trillion worth of bonds (from the big banks), the money supply increased by $3.5 trillion, giving the banks more cash than they could lend. There was so much excess money floating around that interest rates collapsed, and some banks were charging depositors fees to hold their money. Meanwhile, all that cash went sloshing around the economy, begging for things to buy. So prices for art went ballistic. The stock market nearly tripled. Real estate prices detonated. Hermes, Versace, Fendi and Prada had record revenues. And Mercedes-Benz, Bentley, Aston Martin, BMW and Porsche couldn’t keep premium editions in their showrooms. All that money kept interest rates low and inflation nearly nonexistent. And the only Americans who got hurt were retirees who depended on interest from safe 5 percent certificates of deposit.
There’s going to be hell to pay when the Fed sells the trillions in mortgage bonds it bought nearly a decade ago. And when the Fed sells bonds back to the banks from which they were purchased, the banks will return that money to the Fed by transferring trillions of the selling proceeds from their accounts to the Fed’s account. This will reduce the amount of cash available in the economy, and the declining money supply will make bank loans (interest rates) more expensive. Bond prices are declining slightly. Income-sensitive issues — such as utilities, municipals, preferreds, business development companies, some exchange-traded funds, some closed-end funds and some master limited partnerships — will decline in anticipation of higher rates. Over the years, easy money and low rates have encouraged $1.4 trillion in student loans, $1.2 trillion in auto loans and $1.2 trillion in credit card balances, and a lot of those balances are in the “trouble” category. That $3.8 trillion (those loan rates will rise) exceeds the balances of all the troubled mortgage loans repaired by quantitative easing. And the Fed’s selling off even some of its $3.5 trillion worth of bonds will be a delicate task that could cause long-term rates to rise uncontrollably if not executed properly.
