Why the Fed Needs to up Quantitative Easing at This Meeting

Posted by Michael A. Kamperman on September 22, 2009

I’m not holding my breath.  The Fed seems more concerned about pundits and speculators hyping potential hyper-inflation than about poor working stiffs in America with no job.  But at this meeting the Fed needs to take a stand and up its program of quantitative easing rather than signal a plan to unwind it.  At the last meeting the Fed extended the deadline to complete its purchases of $300 billion in Treasury bonds from the end of September to the end of October to soften the impact when it withdraws support for the Treasury market.   Many expect the Fed will similarly extend the purchase of federally guaranteed mortgage-backed securities into next year to taper out of that program.  For the Fed to withdraw support for the markets it needs to affirmatively answer two key questions; is the real economy experiencing a sustainable recovery and is there sufficient capital from other sources to replace the extra cash the Fed has been pumping into the market?  The answer is a clear no to the question of whether the economy is experiencing a sustainable recovery.  The answer is probably no to the question of whether or not alternative capital resources are available to replace the Fed’s printed cash.

 

Over the weekend Edmunds reported that September auto sales are running at an annual rate of 8.8 million units, the lowest annual sales rate of the year.  This is the worst year for per capita auto sales in the post World War II era, and this month is looking to be the worst month during the worst year for auto sales.  That is not a sign of an economic recovery, it is a sign the economy is starting to resume its slide.  And it is real time data.  I look for a slide in homes sales to follow the slide in auto sales as soon as the first time home buyers tax credit expires on November 30.

 

The more interesting question is does the cash exist outside of the Fed to support the needs of the mortgage markets and the bond markets?  While we won’t know for sure until the Fed pulls its support, it certainly doesn’t look like the funds exist.  The FHA has reported its reserves are close to falling below the regulatory minimum.  Rather than asking Congress for more money the FHA has decided to tighten its lending standards.  That won’t be very supportive for lower priced home sales.  Additionally, the NYT reported a shocking story that the FDIC was considering borrowing money from the banks it regulates because it is running out of reserves.  The FDIC has a line of credit from the Treasury but is apparently reluctant to tap it.  The Whitehouse wants to save any additional deficit spending for healthcare reform.  It is afraid that the votes in Congress won’t materialize to spend more money if the Congress believes the economy needs a lot more deficit spending.  At the same time there is going to be a push at the G-20 meeting to raise the capital reserve requirements on banks to reduce their overall risk.  On the surface this seems like good policy.  But in a debt-induced deflationary depression the last thing governments should be doing is adopting policies that will further shrink the money supply by further deleveraging the banks.  This policy will only exacerbate the powerful deflationary forces already unleashed in the economy.  The only way out of a deflationary depression is to spend one’s way out.  Yet people cannot spend money they don’t have and investors cannot purchase mortgage-backed securities with cash they don’t have.  The ball is in the Fed’s court and I am concerned they are about to fumble it.