Bernanke's Exit Plan

by: Acting Man

By Ramsey Su

Last week, Fed Governor Sarah Bloom Raskin gave a bleak report on employment. In the speech she highlighted all the dire conditions that contradict the so called recovery, a theme currently promoted by her Fed Chairman.

In summary, she said the poverty rate now "…stands at 15%, significantly higher than the average over the past three decades. And those who are fortunate enough to have held onto their jobs have seen their hourly compensation barely keep pace with the cost of living over the past three years."

The unemployment rate is bogus. 12 million are unemployed, not including nearly a million workers who have given up looking are not counted. 8 million can only find part time work. It all adds up to a real unemployment rate of 14.3%, commonly known as U6.

"About two-thirds of all job losses resulting from the recession were in moderate-wage occupations, such as manufacturing, skilled construction, and office administration jobs. However, these occupations have accounted for less than one-quarter of subsequent job gains. The declines in lower-wage occupations–such as retail sales and food service–accounted for about one-fifth of job loss, but a bit more than one-half of subsequent job gains. Indeed, recent job gains have been largely concentrated in lower-wage occupations such as retail sales, food preparation, manual labor, home health care, and customer service."

"….. the rebound is being driven by the low-paying nature of the jobs that have been created. …… while average wages have continued to increase steadily for persons who have remained employed all along, the average wage for new hires have actually declined since 2010."

"Today, about one-quarter of all workers are considered "low wage" …in 2011, low wage was defined as $23,005 per year or $11.06 per hour."

Bernanke, as expected, has a slightly different version. During his post FOMC press conference last week, he claimed that:

"The jobs market has also shown signs of improvement over the past six months or so: Private payrolls are growing more quickly, total hours of work have increased, the rate of filings of new claims for unemployment insurance has fallen, and the unemployment rate has continued to tick down."

I know I sound like a broken record but every time I look at the numbers, something new pops up. The Federal Reserve provides a detailed account of the MBS purchases under QE3. For the 26 weeks since the start of QE3 in September 2012, the Fed has purchased $441.6 billion of agency MBS, or $210.6 billion more than the announced pace of $40 billion per month.

On the surface, these additional purchases are just replacing prepaid MBS from previous purchases. In reality, it is a form of operation twist where high yielding MBS originated years ago are now replaced with new and much lower yielding refinances. In dollar terms, on a monthly basis, holders of $33.6 billion of higher yielding agency MBS are forced to compete with the Fed for the purchase of the lower rate MBS, or go chase yield somewhere else. The total amount that the Fed is deploying, with the supposed objective of driving long rates down, is not $85 billion but rather $45 billion in treasuries, $40 billion in MBS and $33.6 billion in the new and improved operation twist, totaling $118.6 billion per month. I will finish the math, that is a whopping $1.423 trillion per year.

When asked recently about an exit plan, Bernanke said he does not have to sell anything, just let the bonds mature. At the moment he is clearly not allowing the MBSs to mature or prepay. He is replenishing. This is very significant when you put the actual numbers in the proper perspective. Assume we have roughly $1.5 trillion in mortgage originations, including refinances, and the agencies are originating 90%, or $1.35 trillion per year. Bernanke is purchasing almost 2/3 or all agency loans.

Refinance volume has accounted for over 70% of all loans last year. The reason this is so high is not only because of the decline of mortgage rates but also due to the HARP program. There were 1 million HARP refinances in 2012. Without HARP, these borrowers would not qualify for a refinance due to negative or insufficient equity. Both HARP and regular refinance volumes are dropping. If rates remain stable at current levels or increase, the refinance volume may vanish. If then Bernanke continues on with his QE3 purchases, it is conceivable that the Fed could be purchasing 100% of all agency MBS originations in the immediate future.

In September 2012, at the starting point of QE3, the 30 year fixed rate mortgage was at 3.38%. In February 2013, the 30 year fixed rate mortgage was at 3.56%. On March 23, 2013, 26 weeks into QE3 and $441.6 billion of Fed purchases later, the mortgage rate stood at 3.64%. (all data from Mortgage News Daily)

It is not enough to conclude that QE3 has failed to bring mortgage rates down, one must consider where rates might be today if not for the infusion of $441.6 billion over this short period into specifically the agency MBS market.

To the housing bulls, regardless of their reason for being bullish, I have only one question: How do you factor in a Fed exit, or do you think that the Fed should, and can, purchase all agency MBS forever?

In conclusion, the Federal Reserve has NO exit plan. Fortunately for Ben Bernanke, his personal exit plan is 313 days away when his term as Chairman ends on January 31, 2014. His term as a Board member ends on January 31, 2020. Between now and then, he can write about how he saved the world while remaining on the public payroll.

A closing thought, instead of all these complicated large asset purchases, why can't Bernanke just take the $1.423 trillion and hire 14 million people at $100k per year to sweep the sidewalks in front of the Federal Reserve? There, unemployment drops below 6.5%, these street sweepers can buy houses unassisted and he does not have to do any QE anymore.

Addendum, by PT: Keynesian Ditch Digging

To Ramsey's question in the final paragraph, namely why the Fed doesn't just finance the functional equivalent of Keynesian ditch-digging directly, we want to point out that this would not jibe with the pretense that something fundamentally "sound" or "scientific" is going on in the temple of "flexible currency management."

Instead, the Fed monetizes (inter alia) government debt, so it is actually the government that is expected to employ the ditch diggers (Bernanke's frequent admonitions to lawmakers that the administration must embark on a sound fiscal policy just as long as it doesn't do so “now” is a constant reminder to the fiscal authorities to do something along those lines). By employing this indirect method, the Fed has "assets" on its balance sheet for the liabilities it issues in the form of bank reserves – even if those assets in the form of government bonds are in principle nothing but a promise of the confiscation of whatever future wealth creation the overburdened (and tiny) wealth-generating portion of the citizenry manages to scrounge up in coming decades.

With regard to MBS monetization, this is a deliberate attempt to subsidize specific sectors of the economy, namely the ones that are in most urgent need of being left alone so that they can downsize and adapt to actual consumer demand in the wake of the expired bubble (from banking to home building and everything in between). This has created the "feel good" property markets in selected cities that are currently subject to investor stampedes, but at the same time ensures that these markets will fold like origami in a hurricane once the artificial support ends. The Keynesian "solution" to that particular problem is to simply never end the support, so we certainly agree with Ramsey that it looks like there is never going to be an exit.

There may be plans (ever-changing plans we might add) as to how such a putative "exit" could be accomplished, but these are so far just words designed to keep a very specific bogeyman at bay, namely the dreaded "unanchoring of inflation expectations." And yet, if no exit occurs and instead ever more excuses are dished up as to why the policy must continue, this is going to be the inevitable outcome anyway.

About this article:

Problem with this article? Please tell us. Disagree with this article? .