QE3 is a Hidden Bailout

The latest FOMC statement announced another round of quantitative easing or money creation, without actually using those words.  It said that it would start buying an additional $40 billion per month in mortgage-backed securities (MBS), without saying for how long.  I wrote on this the day the statement was released.

One of the things I touched on was that I thought this might be a bailout for the banks.  I have not seen anything to the contrary to change my mind about this.  Let's look at it further.

The Fed is going to buy $40 billion worth of MBS each month.  Or is is really $40 billion worth?

After the fall of 2008, the Fed started buying MBS, but they were paying the amount that was shown on the books of the banks.  In other words, the Fed was paying a much higher price than they were worth.

Mortgage-backed securities are essentially many mortgages lumped together.  It is like a mutual fund of mortgages.  When the real estate bubble crashed, starting around 2006, these assets went way down in value because many people were defaulting on their mortgages.

If someone gets a mortgage and makes a down payment in the purchase of a house, then the bank making the loan is usually safe.  They have the house itself as collateral, in case the person defaults on the mortgage.  However, the real estate crash caused a major problem.  If someone took out a loan for $200,000 and the house is now only worth $140,000, then the bank holding the loan is going to take an approximate hit of $60,000 if the person paying on the loan defaults.

In the above example, the bank was still holding the value of the loan on its books at approximately $200,000.  However, because there was a default, the bank can really only recover $140,000 (not counting other expenses and commissions).  But the Fed came in and bought this loan from the bank for $200,000.  The Fed paid the book value instead of the actual market value.

This is a bailout for the bank.  The crash of the real estate bubble and the major defaults on mortgages was probably the primary reason that so many major banks were on the brink of insolvency about 4 years ago.  (I am not including the fact that banks were lending on fractional reserves, which doesn't help the insolvency.)

So the Fed bailed out the banks and one of the primary ways of doing so was by buying these so-called toxic assets.  It overpaid for these mortgage-backed securities.

So the big question is: what value will the Fed pay now with QE3?  I have seen nothing to indicate that the Fed will pay market value.  If anyone has anything to prove me wrong on this point, please present it.  As far as I'm concerned, the Fed will be buying these securities based on a previous value that is no longer realistic.  They might pay $40 billion for securities in a month that are only worth, say, $25 billion.

The Fed's primary reason for its existence is to support the big banks.  Its secondary reason is to fund Congress and its deficit spending.  QE3 is being implemented to support the big banks, along with Fannie and Freddie.

It almost makes me laugh to hear everyone debating the reasons for QE3 and whether it will work.  The whole thing is a facade.  The Fed isn't doing this to help the economy, except maybe in the sense that it is keeping the big banks afloat.

My theory is that the Fed took a lot of heat for the bank bailouts that happened almost 4 years ago.  So instead of calling this a bank bailout, they are just implementing policy to help the stagnating economy, or so they say.  However, the real reason is to prop up the big banks.

Now, I don't know if the big banks are on the verge of collapse and this is being done to prevent that, or if this is just a way to make the banking executives richer.  But I am rather certain that the main purpose of QE3 is to bail out the big banks.

The rationale for buying mortgage securities doesn't even make much sense.  Mortgage rates are already near all-time lows.  Is lowering the rate by another half a percent going to really stimulate the housing market enough to significantly affect unemployment?  If the Fed wants to create money out of thin air and stimulate the economy, why can't it just buy government debt as it has traditionally done?  There is no doubt that there is plenty of it to buy.

In conclusion, QE3 is another bailout of the big financial institutions.  The Fed has pulled one over on the American people.  I do not see this being discussed elsewhere, even amongst libertarians.  While many people understand that QE3 will not work to help the economy and will only make things worse, QE3 will work exactly the way that the Fed intends.  It will help the big banks.