|How the economy has reacted each time the Fed announces a new QE effort|
All of the articles out there on this topic assume that you received an MBA from Harvard School of Business, so we're going to break down how the Fed works and how buying mortgage bonds (ie. "mortgage-backed securities") can lower interest rates for home buyers and affect the overall economy. So the goal of this post is to give you, the reader, all of the facts on this latest move by the Fed and then to let you make the call as to whether it is a good idea or not.
Now let's stop right here and unpack a few things. First of all, what the heck is the Fed? The Fed is a nickname for our Federal Reserve System. It is America's Central Bank where the U.S. Treasury keeps all of its money much like you or I would keep our money in a checking account. It has been here since 1913. In addition to being the place where the government keeps its money, it has also been charged with the obligation of regulating all other banks, keeping the banking system from collapsing, stabilizing our markets, and setting interest rates for the banks. This last component -- setting interest rates -- is central to our discussion here.
But before we go there, let's break down another question that many people have about this announcement - what the heck are mortgage bonds and how will buying them help the job market? Mortgage "bonds" are another way to say "mortgage-backed securities." Wait, aren't those the things that sunk our economy in 2008? No, not exactly. You may be thinking of the subprime mortgage-backed securities which tanked our economy 4 years ago. Those were a particular type of mortgage-backed securities comprised of mortgages which were targeted at low-income home owners. For purposes of our discussion here, all you need to know about mortgage-backed securities (aka "mortgage bonds") is that they are securities (like stocks) that are "backed" by home loans. And when we say "backed by home loans" what we mean is that the security/bond is guaranteed by somebody's ability to pay their home loan. "Subprime" mortgage-backed securities failed because they were largely comprised of home loans that were marketed (often times illegally) towards poor people who couldn't pay their home loans. Regular mortgage-backed securities/mortgage bonds, by contrast, are considerably more stable. For a more in-depth explanation on how your personal home loan can be transformed into a security that is traded like a stock on the stock market, see THIS VIDEO.
And so how does the Fed's act of buying these mortgage bonds affect the economy? Well that is good question because it requires you to know a few basic principles that the media has failed to explain.
(for a more in depth discussion about how mortgage bonds affect interest rates, see THIS VIDEO)
So there you have it. The Fed will buy $40 Billion worth of mortgage bonds each month which will ultimately cause the interest rates on home loans to go down, which will (in theory) allow more people to buy more homes and/or refinance their homes at better rates for more equity. And since home ownership is seen as the cornerstone of wealth-building for most Americans, the expectation is that the more access people have to home ownership then the more the economy will improve.
Is QE3 a good idea?
How do you think this will affect the economy?
If you were in the market for a home right now, would this encourage you to buy a home?
If you already own a home, would this encourage you to refinance your home?
Since interest rates are already near all-time lows right now, will this cause more people to buy homes?
Assuming that QE3 does lower interest rates, will the banks play along and lock themselves into 30-year home loans at these extremely low interest rates when they know that interest rates will rise a few years down the road?