What is QE3? What is the Fed doing? How will QE3 affect the housing market or mortgage interest rates?
Lets start with the basics and explain what QE is. QE stands for Quantitative Easing. It is a tool used by the Federal Reserve Bank when their traditional monetary tools are ineffective or have been exhausted. When the Fed engages in QE they purchase financial assets from banks. The goal of QE is to put a specific amount of money on the balance sheets of banks, more specifically around a certain asset. Why is the Fed doing this? The Fed has already brought their target rate down to Zero by purchasing large quantities of treasuries. With a target rate of zero already in place the Fed needs to step outside the box of traditional monetary policy in order to inject money into the system.
How is QE3 different from QE1, QE2 and Operation Twist? With the previous quantitative easing the Fed had a predetermined amount of money that they were going to inject into the system (700billion, etc). The best way to put this into perspective would be to compare it to a doctor shocking the heart of a patient to get it beating again. Typically QE is a large sum of money that has been predetermined and is injected into the economy over a specified period of time (3 months, 6 months, etc). What is unique with QE3 is that it is open ended. The Fed said that they will be buying $40 Billion in MBS (Mortgage Backed Securities) each month until they see employment numbers return. Again the best way to explain this is it is similar to a doctor giving you medication until they see the symptoms of your illness go away.
Will QE3 have an affect on mortgage prices or the housing market? It is difficult to say. The HOPE behind QE3 is that it will push interest rates lower for mortgages and therefore help spur the housing market further. How or why would this work? If the government purchases Mortgage Back Securities the idea is that prices of the average MBS will rise. This in theory will encourage banks to lend more money so they can package the mortgages and sell them making quicker profits. The banks will say “hey we need more loans to sell off and we have all this cash, lets lower rates to make more loans.”
Problem #1: There is no one telling the banks to loan lower or to loan more. The basic forces of supply and demand may encourage them to but there is no definite answer.
Problem #2: The underwriting departments of many banks are currently backlogged. Lender let much of their underwriting staff go and shrunk the size of their mortgage departments during the recession. If the banks cannot handle the increased business then they simply cannot increase their output of lending unless they hire more staff. The question is will the minor increase in profits from QE3 be enough to encourage banks to hire more staff? We don’t know, we will have to wait and see.
Problem & Benefit: The Fed has said that QE3 has no deadline. They said they will continue QE3 until they see improvement in the economy, specially in jobs numbers. If you’re a lender and you need to hire increased staff to handle the increased business from QE3 you’re going to be hesitant to do so because you don’t know how long the Fed will continue with the program. While you can look at economic forecasts and estimate you still don’t have a definitive answer.
Will mortgage rates go lower because of QE3: The answer to this is clearly dependent on how the above problems I posed work themselves out. There have been a few different estimates. Currently 30yr fixed conventional mortgages are hovering around 3.8% APR. Some analysts have said that we could see mortgage rates drop to 3.5% while other see them going even lower to just above 3%. We saw results from Operation Twist push interest rates down roughly half a percent. No matter what it is that we will see, it will definitely happen slowly over time as the money (40 billion a month) is being injected into the economy slowly, over a period of time.