You may have heard that the Fed announced a new round of quantitative easing yesterday. I hope you've been able to get your fill of QE3 elsewhere; I suspect you have but if not I recommend Cardiff Garcia and Greg Ip, though also a million other people, and maybe stay away from Marc Faber. It's not my area of expertise; what little I know about economic matters comes from working in the financial industry, whose concern is less with how humans turn their efforts into money than with taking a bit of it from them in the process of moving it from one place or time to another. But of course central bank policy involves quite a bit of moving money between times and places, with many stops along the way where some of that money can fall off the truck, so this piqued my QE3 interest:
That's from an interesting Credit Suisse note on the latest quantitative easing, which of course consists of the Fed buying agency securities, and shows unsurprisingly that banks are uniquely well positioned to make money on it.1 Here's another chart from Bloomberg:
I don't entirely understand why this chart looks the way it does - was there an un-easing today that I (and equities) missed? - but it looks like if you owned Fannie 3% paper you made something like 50bps in the last two days, or much more if you got out at the top; if you imagine that that's typical paper and you squint at that CS chart and see about $1.7 trillion of agencies in banks' coffers, then that's really quite a bit of money - $8 billion or so - that US banks have made in the last two days without the Fed actually buying any agency MBS yet. I guess if you owned equities you did better. (If you owned bank equities you did even betterer.)
That's the money coming in, and there's some reason to think a lot of it will stay there. Here's Peter Eavis:
The Fed’s purchases of [agency mortgage] bonds have helped their yields fall to 2.2 percent. But the cost of mortgages to borrowers hasn’t fallen anywhere near as much. The banks are choosing not to reduce mortgage rates further. One reason: By keeping the rates elevated, they are able to earn much larger profits when they sell the mortgages into the bond market.
So, I mean, that's some fancy microeconomics right there ("charging higher prices leads to much larger profits," CLASS DISMISSED), but I guess not wrong. The backdrop to Eavis's point is, as far as I can make out, that once upon a time banks just took money from GSE-guaranteed mortgage pools and gave it to any miscreant off the street, pocketing a small spread to pay their utility bills but not otherwise worrying much about whether the miscreants had any prospect of paying off the loan that, after all, was really the GSE's problem. In the post-2008 environment where the GSEs sue the banks over trifles like lying about their underwriting standards and the fact that the miscreants were unemployed and/or dead, the banks need to do more to grease that move from GSE pool to homeowner. And more intermediation value-add means more money for intermediaries. The Fed's reducing the cost of GSE pool money, in an environment where banks are still figuring out how to move that money to homeowners and how much of it to keep for themselves, does seem like a nice opportunity for those banks to keep more for themselves.
Collateral transformation seems like a related area: pre-2007, you wrote your derivative contract on a napkin and assumed prices would only go up. Now - and, crucially, more so in the future - you'll have to post collateral for your derivatives, to a clearinghouse, who is not set up to evaluate your hedge fund's collection of emerging market junk bonds. So someone needs to do that evaluating, and then loan you information-insensitive collateral - Treasuries and agencies - against the security of those information-sensitive junk bonds. No one should be surprised that that someone is JPMorgan (or Bank of America or BoNY or Deutsche Bank or Goldman or State Street or Barclays), or that they'll charge you for it. Or that, now that that information-insensitive collateral is going to be worth a bit more since the Fed is increasingly buying all of it, they'll be charging more for that service.
I dunno. One simple dumb thing to think is that if you change your background set of institutions in a way that increases the distance travelled between the risk-free security the Fed buys, and the risky borrower it's trying to stimulate, then quantitative easing does less easing and more paying banks for their efforts than it would do in the previous equilibrium. Though in fact the risky borrowers seem to be doing just fine.
Those Credit Suisse analysts think that, once central banks get bored of the current "conventional" QE, we'll move on to:
- Stage 2 (which the UK is moving towards): setting up a bank funded by the central bank to lend to SMEs directly, as in the UK ‘funding for lending’ scheme, thus providing cheap funding for corporates. This is what the Federal Reserve did in 1935.
- Stage 3 (where we might be in a few years): the setting up of a central bank-funded infrastructure fund.
Maybe? One theory you could have is that once banks look healthier, the impetus to micromanage them via regulation and the impetus to enrich them via monetary policy may fade in tandem, and central banks might actually want to get more into the direct-lending business. (Though, I mean, tough to do in the US these days, politically and legally, no?) Another theory, though, would suggest that the intermediation - here meaning mostly evaluation of credit risk - can be valuable, and that part of what led to the last crisis was that no one was doing it. And perhaps that the Fed should be happy to pay banks to do it, as long as it's getting its money's worth.
Synchronised QE and how to play it [CS via Long Room]
The day after: lingering thoughts and questions about QE3 [FTAV / Cardiff Garcia]
How Much Does the Fed’s Plan Really Help Main Street? [DealBook / Peter Eavis]
Citigroup Puts the Fun Back in Taking Huge Losses [Bloomberg View / Jonathan Weil]
Big Banks Hide Risk Transforming Collateral for Traders [Bloomberg]
Marc Faber: If I Were Bernanke, I Would Resign [CNBC]
1.Besides banks, they note that 44% of Treasuries are held overseas, versus 13% of agencies, so "Purchases of the latter would therefore likely place less downward pressure on the dollar," and that "Households hold a lot more Treasuries relative to Agency debt and GSE-backed MBS. However, MBS purchases should help maintain downward pressure on mortgage rates, reducing non-discretionary spending by households."