Quantive Easing Explained

[Moot]

Hillarious....and yet not.


A Hilarious Animated Take On The Federal Reserve: Xtranormal (VIDEO)

The video made a good point, everything seems to going up in price...except housing. Banks are lowering home prices so homes are undervalued and in negative equity and the rising prices for everything else.....??? So what exactly are the Feds basing their CPI on?

And then the Feds buying the treasuries from the banks for a higher price than what they sold them for.....um, wtf? How is that going to help anyone but the F@#%ING BANKS that got us into us into this mess and are the only ones making billion profits in this economy???


Something really stinks and it isn't in Denmark.

 

[phattonez]

Those voices were really annoying, even if I really liked what they were saying.

 

[CriticalThought]

Beware the military industrial complex.

When the leaders of the private sector and the leaders of government pretty much play musical chairs with their positions, why is anyone surprised when this kind of thing happens?

It's the same in every industry. Do you know how many psychiatrists go to work for pharmaceutical companies after their work with the NIMH?

That is the number 1 way of becoming a millionaire in this country. Get a government job where you can help private corporations sell their products or services and then get a cushy job with one of those corporations after you help them do it. If a corporation wants to get around some regulations or scrutiny, then one of its leaders can go work for the government.

 

[Moot]

Those voices were really annoying, even if I really liked what they were saying.

Too robotic and simple?

 

[oldreliable67]

The video made a good point, everything seems to going up in price...except housing. Banks are lowering home prices so homes are undervalued and in negative equity and the rising prices for everything else.....???

The banks aren't lowering prices on houses; the housing market is lowering the prices on houses. In areas in which there is an abundance of foreclosures, house prices are
weaker; in areas where there are fewer foreclosures, house prices are less weak. Compare the well-known weak areas (California, Nevada, et al) to, say, Maryland, Virginia and a few others. Even within those states, you will find pockets where house prices have declined relatively modestly (only 10% or so in certain parts of Maryland and Virginia) and other near-by locales in those same states where prices are down 25% - 30% from their peaks. The explanation lies in the relative strengths of the local economies and the resulting lower level of foreclosures.

And then the Feds buying the treasuries from the banks for a higher price than what they sold them for.....um, wtf? How is that going to help anyone but the F@#%ING BANKS that got us into us into this mess and are the only ones making billion profits in this economy???

The Fed doesn't sell treasury securities, except from their portfolio in the course of executing monetary policy. Since they haven't done so in a while, I assume you refer to the securities sold by the Fed in their function as the Treasury's fiscal agent. It is an important difference. In the former, when the Fed sells securities from it's portfolio, it is draining reserves from the system. Typically this is part of monetary policy, one which seeks to move rates higher.

The latter does not involve the Fed's holdings. The Fed, as noted, is merely acting as the Treasury's fiscal agent, managing the sale of securities for the benefit of the Treasury. These securities have no impact on the Fed's holdings (their open market account).

The securities the Fed is buying as part of QE2 were all sold previously by the Fed in its role as fiscal agent for the Treasury; they are now trading in the secondary market. Prices in the secondary market fluctuate daily, minute by minute and second by second. The market for U.S. government debt is the largest secondary debt market in the world, trading many billions daily. When the Fed goes into the market to purchase (or sell) treasury securities, the primary dealers are asked to submit offers (or bids) on the securities in which the Fed has indicated an interest. After all the offers (or bids) are submitted, the Fed simply ranks them in order of their attractiveness, then goes back to the winning primary dealers and completes the trades. These buys (or sells) have nothing to do with the Treasury. Given that the securities are trading in the secondary market (and may have been for years), the price at which they were originally sold is completely irrelevant.

Re: housing prices declining and everything else going up. It's just different markets. Differing influences on supply and demand. Bank stocks are down; basic materials and commodity-related stocks are up. Same difference. Nothing sinister or magic.

 

[Moot]

The banks aren't lowering prices on houses; the housing market is lowering the prices on houses. In areas in which there is an abundance of foreclosures, house prices are
weaker; in areas where there are fewer foreclosures, house prices are less weak. Compare the well-known weak areas (California, Nevada, et al) to, say, Maryland, Virginia and a few others. Even within those states, you will find pockets where house prices have declined relatively modestly (only 10% or so in certain parts of Maryland and Virginia) and other near-by locales in those same states where prices are down 25% - 30% from their peaks. The explanation lies in the relative strengths of the local economies and the resulting lower level of foreclosures.

The bank's appraisers aren't supposed to use foreclosures in their comparison analysis. Instead, they're supposed to use comparibles that had recently sold in the same area. So if appraisers are using foreclosures then it is the banks who are lowering home values.

The Fed doesn't sell treasury securities, except from their portfolio in the course of executing monetary policy. Since they haven't done so in a while, I assume you refer to the securities sold by the Fed in their function as the Treasury's fiscal agent. It is an important difference. In the former, when the Fed sells securities from it's portfolio, it is draining reserves from the system. Typically this is part of monetary policy, one which seeks to move rates higher.

The latter does not involve the Fed's holdings. The Fed, as noted, is merely acting as the Treasury's fiscal agent, managing the sale of securities for the benefit of the Treasury. These securities have no impact on the Fed's holdings (their open market account).

The securities the Fed is buying as part of QE2 were all sold previously by the Fed in its role as fiscal agent for the Treasury; they are now trading in the secondary market. Prices in the secondary market fluctuate daily, minute by minute and second by second. The market for U.S. government debt is the largest secondary debt market in the world, trading many billions daily. When the Fed goes into the market to purchase (or sell) treasury securities, the primary dealers are asked to submit offers (or bids) on the securities in which the Fed has indicated an interest. After all the offers (or bids) are submitted, the Fed simply ranks them in order of their attractiveness, then goes back to the winning primary dealers and completes the trades. These buys (or sells) have nothing to do with the Treasury. Given that the securities are trading in the secondary market (and may have been for years), the price at which they were originally sold is completely irrelevant.

Okay, so let me get this straight. The Federal Reserve acts as an agent for the Treasury to sell the Treasuries securities. These securities are bought by banks like Goldman Sachs. Goldman Sachs then sells the securities back to the Treasury presumably at a higher price than what they purchased the securities for. Is that the gist of it?

Re: housing prices declining and everything else going up. It's just different markets. Differing influences on supply and demand. Bank stocks are down; basic materials and commodity-related stocks are up. Same difference. Nothing sinister or magic.

But bank stocks aren't down. And prices for almost everything except housing prices, seems to be going up, not down. So where is the deflation?

 

[liblady]

The bank's appraisers aren't supposed to use foreclosures in their comparison analysis. Instead, they're supposed to use comparibles that had recently sold in the same area. So if appraisers are using foreclosures then it is the banks who are lowering home values.



Okay, so let me get this straight. The Federal Reserve acts as an agent for the Treasury to sell the Treasuries securities. These securities are bought by banks like Goldman Sachs. Goldman Sachs then sells the securities back to the Treasury presumably at a higher price than what they purchased the securities for. Is that the gist of it?

But bank stocks aren't down. And prices for almost everything except housing prices, seems to be going up, not down. So where is the deflation?

oh boy. a lot of wrong information here.

 

[phattonez]

But bank stocks aren't down. And prices for almost everything except housing prices, seems to be going up, not down. So where is the deflation?

Bank stocks are still down from their high, but some would say that this is where they should be because of their poor business decisions.

 

[Moot]

Bank stocks are still down from their high, but some would say that this is where they should be because of their poor business decisions.

Compared to a year ago, almost everything is higher except home prices and wages.

 

[Moot]

oh boy. a lot of wrong information here.

LOL Come on, Liblady you got some splainin to do. I'm trying to understand, so why is the information wrong?

 

[phattonez]

LOL Come on, Liblady you got some splainin to do. I'm trying to understand, so why is the information wrong?

Because inflation is always good of course.

 

[liblady]

LOL Come on, Liblady you got some splainin to do. I'm trying to understand, so why is the information wrong?

ok......when foreclosures happen, house prices in the surrounding neighborhood go down. comparables are just what houses sold for, and they are selling for much less than they used to. banks don't cause that, not one bit.

and banks stocks ARE down.

 

[oldreliable67]

Okay, so let me get this straight. The Federal Reserve acts as an agent for the Treasury to sell the Treasuries securities. These securities are bought by banks like Goldman Sachs. Goldman Sachs then sells the securities back to the Treasury presumably at a higher price than what they purchased the securities for. Is that the gist of it?

Nope. They sell them to the Fed; the Treasury is not in the picture at all. A different owner entirely. And not axiomatically at either a higher or lower price - depends on where the market has moved to in the interim. Some of those securities may have been outstanding for years and traded at well over, or well under their initial auction price. The current five year, for example, was initially sold at 100; it is now trading at about 98 3/4.

But bank stocks aren't down. And prices for almost everything except housing prices, seems to be going up, not down. So where is the deflation?

Most bank stocks that have exposure to residential real estate (BoA, Citi, WFC, et al) are well off their highs - and lows. Most are trading in the middle of the range set by their lows at the worst of the crisis (before the Fed provided liquidity that got interbank lending going again) and their highs of some weeks/months ago (before it became evident that foreclosures weren't going so well and the banks may have some exposure there).

The deflation is a risk in the eye of the beholder. You're looking for it in stats. You won't find it in the CPI or PPI. You will find hints in the CPI measures calculated by the Cleveland Fed, which is the measure now most often thought to be the one on which the Fed focuses. The Cleveland Fed Median CPI estimate came out today, in fact. it was +0.1% month/month, or 1.1% annualized, in Oct. Their 16% trimmed-mean CPI was virtually unchanged for the month, or 0.6% annualized. It is still not deflation, per se, but it does represent a risk of deflation, which is what the Fed is concerned about. Remember, the Fed wants the economy to get back closer to a 2% inflation rate.

MEDIAN CPI UP 0.1% IN OCTOBER
According to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.1% (1.1% annualized rate) in October. The 16% trimmed-mean Consumer Price Index was virtually unchanged at 0.0% (0.6% annualized rate) during the month. The median CPI and 16% trimmed-mean CPI are measures of core inflation calculated by the Federal Reserve Bank of Cleveland based on data released in the Bureau of Labor Statistics’ (BLS) monthly CPI report.

 

[Moot]

ok......when foreclosures happen, house prices in the surrounding neighborhood go down. comparables are just what houses sold for, and they are selling for much less than they used to. banks don't cause that, not one bit.

and banks stocks ARE down.

And who is doing the foreclosing? I could be wrong, but I think it's the banks. Have you read the news about the banks rushing foreclosures without the paperwork and botching the foreclosures on homes. Nevertheless, I was recently told by my broker that appraisers were not supposed to use foreclosures in their comparative analysis unless foreclosures define the neighborhood or there were no other recent sales to compare. But that is not what seems to be happening. Since few or no homes are being sold in a given area that has few if any foreclosures, the appraiser goes to an area that does and uses that area for it's comparative analysis even if that area is miles away and doesn't compare with any other criteria. So in short, what appears to be happening is the banks are forcing foreclosures in one area and then devaluing the homes in other areas based on the sales of those foreclosures. So how can you say it's not the banks?

 

[liblady]

And who is doing the foreclosing? I could be wrong, but I think it's the banks. Have you read the news about the banks rushing foreclosures without the paperwork and botching the foreclosures on homes. Nevertheless, I was recently told by my broker that appraisers were not supposed to use foreclosures in their comparative analysis unless foreclosures define the neighborhood or there were no other recent sales to compare. But that is not what seems to be happening. Since few or no homes are being sold in a given area that has few if any foreclosures, the appraiser goes to an area that does and uses that area for it's comparative analysis even if that area is miles away and doesn't compare with any other criteria. So in short, what appears to be happening is the banks are forcing foreclosures in one area and then devaluing the homes in other areas based on the sales of those foreclosures. So how can you say it's not the banks?

the banks aren't the boogeyman here. yes, they've made mistakes, but they also aren't the ones defaulting on their loans. and regardless of what an appraiser uses, the actual home value in a neighborhood with foreclosures in lower. first, banks are blamed for loaning too much, now, they are blamed for driving home prices lower?

ask youself this, what does a bank have to gain by driving down home prices. nothing.

 

[Moot]

the banks aren't the boogeyman here. yes, they've made mistakes, but they also aren't the ones defaulting on their loans. and regardless of what an appraiser uses, the actual home value in a neighborhood with foreclosures in lower. first, banks are blamed for loaning too much, now, they are blamed for driving home prices lower?

ask youself this, what does a bank have to gain by driving down home prices. nothing.

And who bundled up those bad loans and sold them with +AAA ratings and then bet that those loans would default? Was that a mistake, too?

 

[Moot]

Nope. They sell them to the Fed; the Treasury is not in the picture at all. A different owner entirely. And not axiomatically at either a higher or lower price - depends on where the market has moved to in the interim. Some of those securities may have been outstanding for years and traded at well over, or well under their initial auction price. The current five year, for example, was initially sold at 100; it is now trading at about 98 3/4.

I just want to make sure I'm clear on this one point before I go on. Refering to the Feds open market monetary policy:

The Fed doesn't sell treasury securities, except from their portfolio in the course of executing monetary policy.......snip.... when the Fed sells securities from it's portfolio, it is draining reserves from the system. Typically this is part of monetary policy, one which seeks to move rates higher. ...snip....


The Fed, as noted, is merely acting as the Treasury's fiscal agent, managing the sale of securities for the benefit of the Treasury. These securities have no impact on the Fed's holdings (their open market account).

So where does the Fed get the Treasury securities for it's portfolio?

Regarding QE2:

The Fed, as noted, is merely acting as the Treasury's fiscal agent, managing the sale of securities for the benefit of the Treasury. These securities have no impact on the Fed's holdings (their open market account).

The securities the Fed is buying as part of QE2 were all sold previously by the Fed in its role as fiscal agent for the Treasury; they are now trading in the secondary market.

So the Feds are buying Treasury securities that they previously sold as agent for the Treasury. Were these the same Treasury securities that were sold during the first rounds of quanitive easing?

Most bank stocks that have exposure to residential real estate (BoA, Citi, WFC, et al) are well off their highs - and lows. Most are trading in the middle of the range set by their lows at the worst of the crisis (before the Fed provided liquidity that got interbank lending going again) and their highs of some weeks/months ago (before it became evident that foreclosures weren't going so well and the banks may have some exposure there).

Yes, I understand why a few of the big banks are still in trouble. But what about Goldman Sachs, since they were bundling toxic loans too, how did they come out relatively unscathed by all this?

http://www.investorguide.com/stock-charts.php?ticker=GS

The deflation is a risk in the eye of the beholder. You're looking for it in stats. You won't find it in the CPI or PPI. You will find hints in the CPI measures calculated by the Cleveland Fed, which is the measure now most often thought to be the one on which the Fed focuses. The Cleveland Fed Median CPI estimate came out today, in fact. it was +0.1% month/month, or 1.1% annualized, in Oct. Their 16% trimmed-mean CPI was virtually unchanged for the month, or 0.6% annualized. It is still not deflation, per se, but it does represent a risk of deflation, which is what the Fed is concerned about. Remember, the Fed wants the economy to get back closer to a 2% inflation rate.

So the Feds are using Cleveland Ohio, one of the most depressed states in the country even before the recession, to determine CPI and inflation/deflation trends for the entire country? Why Cleveland, I wonder?

It also appears the Feds are mainly using housing Owners Equivalent Rent (OER) as the basis for their CPI, which I understand to be rent of primary housing and yet they exclude food and gas. Why? House prices are about the only thing that is deflationary, so are the Feds trying to keep house prices from deflating further with QE?

 

[drz-400]

So the Feds are using Cleveland Ohio, one of the most depressed states in the country even before the recession, to determine CPI and inflation/deflation trends for the entire country? Why Cleveland, I wonder?

It also appears the Feds are mainly using housing Owners Equivalent Rent (OER) as the basis for their CPI, which I understand to be rent of primary housing and yet they exclude food and gas. Why? House prices are about the only thing that is deflationary, so are the Feds trying to keep house prices from deflating further with QE?

The cleveland fed uses the same BLS data that is used to calculated the CPI, but instead of using a weighted average they use the median. The cleveland fed used the number in the exact middle of the data set to report its measure of inflation.

Here are some of the relevent graphs:

edit:

Here is one more that shows the trend a little better, with more years.

 

[cpwill]

Because inflation is always good of course.

what astonishes me is that the same people who will talk about how inflation is good for employment then turn around and insist until they are blue in the face that raising the minimum wage isn't harmful.

:thinking:

 

[oldreliable67]

So where does the Fed get the Treasury securities for it's portfolio?

They bought them in the secondary market.

So the Feds are buying Treasury securities that they previously sold as agent for the Treasury. Were these the same Treasury securities that were sold during the first rounds of quanitive easing?

Irrelevant if they were or not. In fact, some might have been, but not necessarily so. When the Fed tells the primary dealers that they want offers on treasuries, they typically couch it in terms of "Please show us offerings of maturities between date-1 and date-2. The total size we are interested in purchasing is xxxx." Then the dealers look at their positions, the securities they are long, and/or those they would like to be short, and submit their list of issues back to the Fed. The Fed then simply ranks the offerings so gathered, from cheapest (highest yield to lowest yield) and notifies the winning dealers. Some of the issues bought by could have been outstanding and trading daily in the secondary market for days, some could have been outstanding for months, some could have been outstanding for years.

Is it possible for the Fed to restrict their purchases to securities recently issued, say during QE1? Difficult but not impossible, but mainly very illogical. Every month and every quarter, the Treasury sells securities across almost the entire maturity spectrum, from a few weeks to 30 years. Were the Fed to focus only on those recently sold (or specific issues), this would become quite evident in short order, resulting in those perceived selected issues trading at exorbitant premiums in the secondary market, because they would seem to carry with them a 'Fed put.' This would defeat the Fed's objective of getting all rates lower and lower risk premiums for all asset classes.

So the Feds are using Cleveland Ohio, one of the most depressed states in the country even before the recession, to determine CPI and inflation/deflation trends for the entire country? Why Cleveland, I wonder?

Of course they are not using Cleveland, Ohio to determine CPI. See drz's good post, above. They are using research done at the Cleveland Fed, by Cleveland Fed economists, who are formulating alternative measures of the BLS CPI.

 

[liblady]

And who bundled up those bad loans and sold them with +AAA ratings and then bet that those loans would default? Was that a mistake, too?

i'm sorry, who bet they would default? what?

 

[oldreliable67]

And who bundled up those bad loans and sold them with +AAA ratings and then bet that those loans would default? Was that a mistake, too?

The folks making the most money of this strategy were a handful of hedge funds. The strategy is often referred to as the "Magnetar" strategy, named for one of the first hedge funds known to employ it. Basically, it worked like this: the hedge fund bought certain the riskiest portions of CDOs and then bought credit default swaps against them. The strategy at this point, is simple: if the market keeps going, the riskiest tranches provide a handsome rate of return, well in excess of that necessary to pay for the CDS insurance. If the market bombs, the CDS kicks in and the owner makes a handsome rate of return that way. Critics of Magnetar accuse them of helping the trade along by insisting that the underwriters include ever more risky deals in the CDO, thereby shifting the odds for default in Magnetar's favor. You can read an interesting description of the trade here.

Magnetar was not the only hedge fund to do this trade, Paulson being perhaps the other best-known one. Once they figured it out, mainly by observing what their hedge fund clients were up to, several dealers did it as well. The dealers though, had left themselves open to considerable market risk in the totality of their CDO dealings, and this trade mostly just kept them from losing as much when the market did go south.

On balance, the biggest money on these trades was made by a relatively small group of hedge funds, not the banks.

 

[imagep]

The folks making the most money of this strategy were a handful of hedge funds. The strategy is often referred to as the "Magnetar" strategy, named for one of the first hedge funds known to employ it. Basically, it worked like this: the hedge fund bought certain the riskiest portions of CDOs and then bought credit default swaps against them. The strategy at this point, is simple: if the market keeps going, the riskiest tranches provide a handsome rate of return, well in excess of that necessary to pay for the CDS insurance. If the market bombs, the CDS kicks in and the owner makes a handsome rate of return that way. Critics of Magnetar accuse them of helping the trade along by insisting that the underwriters include ever more risky deals in the CDO, thereby shifting the odds for default in Magnetar's favor. You can read an interesting description of the trade here.

Magnetar was not the only hedge fund to do this trade, Paulson being perhaps the other best-known one. Once they figured it out, mainly by observing what their hedge fund clients were up to, several dealers did it as well. The dealers though, had left themselves open to considerable market risk in the totality of their CDO dealings, and this trade mostly just kept them from losing as much when the market did go south.

On balance, the biggest money on these trades was made by a relatively small group of hedge funds, not the banks.

I never understood that strategy. It cost money to purchase the risky CDOs then it cost money to purchase the CDS. So by purchasing the CDS then you are betting that that you are going to loose money on the CDOs. Why would you intentenally purchase a bad investment especially when you have the added cost of having to insure that band investment.

It would be like purchasing a home with the intent of burning it down, and then getting a big insurance policy on it. If the insurance company pays for the cost of rebuilding the home and no more, then have you really made a profit? And didn't you commit insurance fraud?

Insurance companies (in this case the company that issued the CDS) have to make a profit on what they insure. The only way that an insurance company would insure something that is risky is if they charged a really high price to do so, unless they were mislead as to the risk level. If they charge a really high price, and if all they are doing is insuring the investor against a loss, then how does the investor make a profit by having a loss? If the insurance company charged a low rate and/or paid off in excess of the amount of the loss (to provide the investment company with a profit), then isn't that insurance fraud?

Now am I just missing something here? Am I just too stupid to understand all this fancy high falluten high finance stuff?

If something looks to good to be true, then is probably aint true. Whenn B Madoff was asked how he could have above average returns year after year, he explained this complicated "hedging" system where he took opposing positions on stocks so that he made money whether they went up or down. It doesn't work that way. If you bet $100 with even odds on each team to win the Superbowl, your net profit and net loss are both guaranteed to be $0. If you have to pay a transaction fee to place those bets, you are guaranteed to have a net loss. But people wanted to believe in Madoff and bought his story hook line and sinker without ever giving it a second thought.

All that fancy high finance type of stuff is is smoke and mirrors and lies and deciet and fraud. The only one who makes a buck is the lier, and the American sucker, oops I meant "American public" takes the loss.

 

[oldreliable67]

I never understood that strategy. It cost money to purchase the risky CDOs then it cost money to purchase the CDS. So by purchasing the CDS then you are betting that that you are going to loose money on the CDOs. Why would you intentenally purchase a bad investment especially when you have the added cost of having to insure that band investment.

Your not looking at the whole trade. The hedge fund purchased only one tranche of an issue, then purchased CDS on the entire issue. I have a similar-in-spirit trade on just now. I own some preferred stocks of a couple of banks. Because those banks were still under a cloud when I bought them, those preferred stocks were yielding 8% - 12% at the time. Simultaneously, I purchased puts on the common stocks of the underlying banks. So, what are the possible outcomes? First, my yield on the preferred stocks is quite high, almost enough to pay for the puts that I purchased, so I'm able to carry the trade at much lesser cost. Second, if the banks financial condition improves sufficiently, my preferred stocks will go up in value, possibly quite a lot. Third, if the banks financial condition deteriorates further, the preferred stocks will hold their value much better than the common due to the preference features of preferred stocks, while simultaneously, my puts will increase dramatically. The trade loses by the underlying stocks remaining essentially unchanged for a long-enough period of time that my puts continue to expire worthless over that period, thereby increasing my cost of maintaining the trade.

This trade is not unique to me; it is well-known and is done all of the time by many, many market participants. It is perhaps best viewed as a kind of straddle: you are positioned to make money if the underlying common goes up a lot, or goes down a lot. You lose money if the underlying continues to trade in a relatively narrow range. The advantage gained by using the preferred instead of put and call options is the lesser carrying cost.

The CDO/CDS trade is merely a variation on this same trade idea.

 

[phattonez]

The cleveland fed uses the same BLS data that is used to calculated the CPI, but instead of using a weighted average they use the median. The cleveland fed used the number in the exact middle of the data set to report its measure of inflation.

Here are some of the relevent graphs:

I have a more relavent chart.

Courtesy of ShadowStats.com