I have learned a little more about an economic term over the past few weeks: quantitative easing, or QE. QE, in a nutshell, means putting more money out on the streets to stimulate the economy. The more available money, the more people will spend on goods and services. Employers eventually will hire, which will reduce the unemployment rate.
The new QE II, or quantitative easing for the second time around, is expected this month. There are various forms of quantitative easing, such as lowering interest rates. Because rates are already so low, Fed Chairman Ben S. Bernanke and the Federal Reserve Board of Governors are planning on stepping into the market and purchasing massive amounts of government bonds and mortgage-backed securities. The number ranges from $250 billion to $2 trillion, depending on who talks with you.
The Fed controls short-term interest rates, such as the federal funds rate, which is the rate banks charge each other for overnight funds. But long-term interest rates, such as 10-year Treasury bonds and 15- and 30-year fixed-rate mortgages, are controlled by market forces.
How can the Fed control something the entire economic world bids on? The answer is simple. It becomes a customer, and a big one at that. The law of supply and demand always makes sense. If the Fed suddenly becomes a giant buyer of mortgage-backed securities, it essentially is creating a strong demand for the product. This will raise the price of mortgage-backed securities, which will make the yield go down. Mortgage rates then will fall further in hopes of continuing the refinance boom and sparking the housing market.
As of this writing, mortgage rates have risen a bit. That’s because the market anticipates such actions before they happen. A recent article in the Wall Street Journal suggested that the Fed will limit its purchases to $250 billion, not the $2 trillion some have thought. That’s not much demand. The market responded accordingly, and rates went up.
Meanwhile, I have an old friend and college fraternity brother who has a refinance in process with me, and he, being an inquisitive and informed consumer, asked me if I thought rates would plummet. Should he wait before locking in a rate? Despite the fact that the Fed has announced its intention to proceed with QE II, I told him that markets are ahead of the game and there is no certainty where rates will go. He’s dropping his 30-year fixed rate from 5 percent to 4.375 percent with no closing costs, resulting in an annual interest savings of about $2,500.
I relayed my usual expression: “Pigs get fat, and hogs get slaughtered.” He agreed to lock in, and we’ll get his loan closed. By the time this column is published, I might have been able to lock him in at a lower rate. But at least I’m saving him $2,500 annually.
Is there risk associated with a QE policy? Sure. It’s called inflation. Time will tell.
Send e-mail to henrysavage@pmcmortgage.com
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