The name makes no sense…

Quantitate Easing, a name that effectively describes little about the program it’s named for. Fed Policy can be a confusing subject, sometimes especially for the Feds. Let’s take a 30,000 foot fly-by and try to grasp the overall concept of Quantitative Easing and the purpose; I’ll leave the politics of the program to the people that scream at each other and make loud noises.

Definition: Quantitative Easing is just another fancy name for Expansionary Monetary Policy. Bored yet? So, recall the supply and demand graphs from college: When supply goes up, prices go down and visa-versa. When the Fed wants to reduce the price of money (interest) they increase the supply of money. One of the ways that the Fed accomplishes this goal is called Quantitative Easing otherwise known just as QE.

History: QE is a relatively new method the Fed has implemented to tinker with the money supply. Before QE the Fed increased/decreased the money supply by targeting the short term interest rates with the purchasing of Treasury Bills. However, in 2007-2008 the Fed had lowered the interest rate basically to zero and so they had to implement additional methods to continue increasing the money supply: thus Quantitative Easing. In addition to purchasing Treasuries, the Fed began purchasing Mortgage Backed Securities (MBS) as well.

What is a mortgage backed security? In the old days the big banks would lend their own money to home buyers (back then, rollerblades were still cool). The bank would write a mortgage for you and then receive principle and interest for the duration of the term (15, 30 years). They earned revenue from the interest you paid but the opportunity cost was tying up their capital for 15 or 30 years. Now-in-days, (besides using the secondary market…different blog post) the big banks sell their mortgages to investors after grouping them together by the 100’s sometimes 1000’s into a single bond or MBS. This clears these mortgages off of their books while also freeing up their capital to make more loans.

How it works: With QE, the Federal Reserve themselves purchase these MBS directly from the banks putting the securities on their own balance sheet. In this third round of Quantitative Easing…appropriately known as QE3, the Fed is buying $40 billion per month in mortgage backed securities and $45 billion in Treasury Bills for a total of $85 billion every single month. The FOMC (Federal Open Market Committee) announced yesterday (12/18/2013) that the Fed will taper their bond buying program by $10 billion beginning in January, 2014.

Does QE work? What will tapering do to interest rates? Where is this money supply coming from? All great questions. Click around on Investopedia.com and read some economic blogs like the Wall Street Journal. Some of it is boring, most of it is interesting and if you find a graph like this one, it makes you really start to think. Just sayin’.

 

Jeremy Sankwich

Hello, I’m Jeremy – I manage the business development efforts for Verity’s mortgage department.  My passion is in helping Verity members down the path to financial freedom and home ownership. I try to go beyond the mortgage loan when helping members as I discuss real estate and financial education.

I have a degree in financial services and financial management from California State University.  I currently live in Auburn, WA with my wife and baby on the way.

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