Is The Fed's QE Working? Part 2

Includes: FMCC, FNMA
by: John M. Mason

Yesterday, I posed the question, "Is the Fed's QE Working?" Today, I would like to follow up on this discussion. My point is that quantitative easing is ultimately about faster economic growth and lower levels of unemployment … as the Federal Reserve officials have stated. The Federal Reserve officials would like to you focus on these issues.

However, as I have written over the past few years, the real, short-term issue for the banking authorities is the solvency of the financial industry and the solvency of the financial industry depends upon the solvency of households and small- and medium-sized businesses. In the majority of cases the solvency of households and small- and medium-sized businesses depends upon the value of the real estate they own and have borrowed against. Thus, we are looking at the debt behind these assets, home mortgages and commercial real estate mortgages, because this is what banks and other financial institutions hold. Solve these solvency problems and you will go a long way towards producing greater economic growth and lower levels of unemployment.

In about twenty-five percent of the cases concerning home mortgages the value of the homes are below the amount of debt owed on the mortgages on the home. This, connected with high levels of under-employment and low earnings, has made it next to impossible for these homeowners to sell their homes because, in most cases, all the equity the household had was tied up in their home. If they had to sell their homes, either willingly, or, unwillingly, they would be bankrupt. The situation was somewhat similar in the case of small- and medium-sized business owners.

Thus, getting the value of real estate to stabilize and then rise has been a crucial short-run move toward allowing these homeowners and business owners to get their lives back in some kind of order. They, obviously, will not be "out-of-harm's-way," but this is just a first step. The policy prescription for achieving this result has been to flood the financial system with liquidity. I have described this policy as a policy of throwing spaghetti up against the wall to wee what sticks.

In essence, this was the policy prescription of the economist Milton Friedman in depression-like situations. His work on the Great Depression convinced him that in such depressed circumstances, the central bank could not err on the side of injecting too little money into the banking system. Another economist that wrote about the Great Depression, Ben Bernanke, came to the same conclusion.

So far, we have seen little or no impact on the real economy of the Federal Reserve's attempt "throw spaghetti against the wall". In this respect, analysts have been discouraged about the Fed's policies and have questioned the usefulness of the efforts.

Yet, we have this solvency problem and this solvency problem has been with us for a long time. For example, my first blogpost on Seeking Alpha on February 8, 2008 was about the solvency problem the Federal Reserve was facing. This was the second month of the Great Recession.

My post from yesterday, mentioned above, argued that we finally might be seeing some results from the Fed's efforts at quantitative easing. The post focused upon the recently announced profit performance of Freddie Mac (OTCQB:FMCC) and the action taking place in the mortgage component of the capital markets. Freddie Mac made a $2.9 billion profit in the third quarter, paid the Treasury a $1.8 billion dividend, and maintained capital of $4.9 billion. And, for the second quarter in a row, it did not have to request some form of bailout from the government.

Now, Fannie Mae (OTCQB:FNMA) has released its third quarter results. Profits were $1.8 billion, about $7 billion higher than the results from last year and Fannie Mae is expecting a profit for the year as a whole, its first annual profit since 2006. In addition, the agency paid the government a $2.9 billion quarterly dividend, and, for the third quarter in a row, it did not need to request a bailout for the government. The quarter ended with Fannie Mae holding a net worth of $2.4 billion.

Along with this good news, the National Association of Realtors announced that the medium price of an existing home rose, year-over-year, by 7.6 percent to $186,000. This is the largest year-over-year increase since 2006. The report stated that single-family home prices rose in 120 of the 149 metropolitan areas covered by the survey. This is up from 110 in the second quarter of 2012 and up from 39 one year ago.

The report goes on to say "there is little doubt that the housing market has improved in the past year. There are fewer 'distressed' homes for sale-such as foreclosures and bank sales that tend to drag down prices-and that has whittled the inventory of unsold homes. In addition, rising rents and low interest rates have spurred buyers to return to the market." But, this has been achieved without the benefit of QE3.

Therefore, I concluded my post yesterday by stating, "quantitative easing seems to be having an effect. QE3 is a more focused effort to push more money into the housing market and, given what seems to be a positive beginning, it seems to be having some success."

Warren Buffet seems to think the housing market is something to invest in. Maybe we should all be paying a little more attention to this. After all, the rule is "Don't bet against the Fed."

What about economic growth and lower rates of unemployment? Well that can come later. First, there needs to be an end to the solvency problem.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.