Quantitative Easing (QE): What's going on here?

[Blue Peter]

My understanding of quantitative easing (QE) is that it provides a further way of reducing interest rates (at longer maturities) when base rates are at or close to zero. There’s no room for further base rate cuts, so to get rates down further, the central bank buys longer-dated bonds, with money it creates for the purpose, at a goodly price, pushing down the yield.

Technically, this is printing money, but we are assured that it won’t lead to inflation because when the job is done, they’ll sell back the bonds, regaining the cash, which they’ll put in the furnace (metaphorically speaking).

(If the above is wrong, I’d be very grateful if someone in the know could correct me).

This sounds reasonable, but, after what’s been happening for the last ten years or so, and then with the current bailouts, we’re all very suspicious of financiers and regulators and central bankers, and, technically or not, it is printy printy. And we can’t help noticing that some governments (especially the US and the UK) are going to need to borrow an awful lot more this year, just at a time when creditors are finding themselves a bit short too (China et al. suddenly doesn’t have so many dollars to park now that its exports have fallen so greatly). The amount the UK intend to use in QE (2 x £75 bn) just happens to match, I believe, the projected gilt issuance this year. The US tells us that it expects the recession to end this year, that it wants to see what effect everything else its done has and then it suddenly comes out with massive QE (e.g. see Stephanomics).

And, finally, of course, QE is all wrapped up in mumbo-jumbo, smoke and mirrors, it is printing, it’s not printing, etc.

So, what’s the view here? Is QE just what it says on the tin? Or is it something more?


Peter.

[Dr Price]

In USA universities the common thread goes like this...There's some feeling that the UK started the depression because when the UK bond market failed because of unseen market pressures the UK treasury had a clandestine agreement with the USA reserve to help cover obligations.The USA obliged expecting to cash in later. ..with the crash of 1929 the US had to rescind,the decline of the stock market had exposed the US T-bills to volatility and the USA did not have enough money to honor the commitment to the UK(because The UK could not pay) or owners of USA T-Bills. the only recourse for the USA was to print money which in turn spurred Inflation...could this be deja vu?

What Quantitative or measureable proof is available to show the USA can meet their obligations and offer investors a safe haven on their Tbills this time around?
 

[Alan Shipman]

There can't be any proof (that the US can meet its obligations), but there can be a strong faith that the US recession will be short. Obama has a reasonable chance of keeping alive that belief - which, due to the role of 'animal spirits' in invstment, could be self-fulfilling.

What motive would the US have, this time round, for underwriting QE in the UK? Could it arise from the extent to which UK banks - operating a genuine 'originate-and-distribute' model - managed to sell their own subprime debt to American banks and insure their less secure assets via AIG? And is that why the UK government was able to move first with nationalising the commercial bank and exchanging their bad debt for good?

[Blue Peter]

Is it perhaps worth noting that today we've had an uncovered Gilt auction:

The UK Debt Management Office (DMO) attracted just £1.67bn in bids for its sale of £1.75bn of 2049 gilts this morning, its first uncovered auction of conventional gilts since 1995.

The cover of just 0.93 times is believed to be the lowest in history and far worse than the 0.99 times in 1995. The average cover of the last three auctions was 2.1 times.

Telegraph Link

This was for 40 year gilts, which I don't suppose make up the bulk of those on offer, but could it be taken as a warning shot across the bows?


Peter.

Edit for 2nd time to remove edit about 10 year gilt auction, which I had misunderstood.

[Dr Price]

There can't be any proof (that the US can meet its obligations), but there can be a strong faith that the US recession will be short. Obama has a reasonable chance of keeping alive that belief - which, due to the role of 'animal spirits' in invstment, could be self-fulfilling.This will be an interesting show

What motive would the US have, this time round, for underwriting QE in the UK? Could it arise from the extent to which UK banks - operating a genuine 'originate-and-distribute' model - managed to sell their own subprime debt to American banks and insure their less secure assets via AIG? And is that why the UK government was able to move first with nationalising the commercial bank and exchanging their bad debt for good?Likely and interesting to consider that AIG holds USA federal pension funds which leads me back to my first concern in that insurance companies have a more relaxed standard in relation to debts versus solid assets on hand and less fiscal responsibility than other groups...to me this seems like a recipe for financial irregularity when claims expand and the financial noose tightens

[Alan Shipman]

Dr Price's concerns about AIG are clearly widely shared, and the Bush administration's Treasury team won't b allowed to forget that they prioritised the AIG rescue over that of Lehman Brothers, whose bankruptcy is widely viewed as having deepened the banking crisis.

Regulators weren't watching insurers closely, I suspect, because their 'business model' appears inherently very safe. A bank has liquid liabilities (customer deposits) and illiquid assets (term loans), so is inherently vulnerable to liquidity crisis - via a bank run, or just an unusual clustering og withdrawals - even if its balance sheet looks healthy. An insurance company has illiquid liabilities (customers are obliged to pay premiums regularly and predictably to keep their policies current) and relatively liquid assets (a proportion of investment designed to be liquidated quickly in the event of large claims). Until...

The picture changes radically when insurers are underwriting credit default swaps for banks that have bought high-risk debts, like collateralised debt obligations involving sub-prime mortgages. Or when they'e counting investments in CDOs as part of their liquid assets. And if banks are lending to insurers (as they did with the 'monolines') to buy CDOs or to insure those who do, then the banks are not really moving those risks off their own balance sheets. It seems that the US government, when Henry Paulson was still Treasury secretary, realised that AIG was underwriting many banks, if not behaving like a bank itself - and realised that letting it collapse would do even wider systemic damage than letting Lehman collapse, if the scale of the implied rescue effort made it necessary to choose.   

[Blue Peter]

If this blog is to be believed:

ZeroHedge

For those to whom this is merely a lot of mumbo-jumbo, let me explain in layman's terms:
AIG, knowing it would need to ask for much more capital from the Treasury imminently, decided to throw in the towel, and gifted major bank counter-parties with trades which were egregiously profitable to the banks, and even more egregiously money losing to the U.S. taxpayers, who had to dump more and more cash into AIG, without having the U.S. Treasury Secretary Tim Geithner disclose the real extent of this, for lack of a better word, fraudulent scam.

In simple terms think of it as an auto dealer, which knows that U.S. taxpayers will provide for an infinite amount of money to fund its ongoing sales of horrendous vehicles (think Pontiac Azteks): the company decides to sell all the cars currently in contract, to lessors at far below the amortized market value, thereby generating huge profits for these lessors, as these turn around and sell the cars at a major profit, funded exclusively by U.S. taxpayers (readers should feel free to provide more gripping allegories).

What this all means is that the statements by major banks, i.e. JPM, Citi, and BofA, regarding abnormal profitability in January and February were true, however these profits were a) one-time in nature due to wholesale unwinds of AIG portfolios, b) entirely at the expense of AIG, and thus taxpayers, c) executed with Tim Geithner's (and thus the administration's) full knowledge and intent, d) were basically a transfer of money from taxpayers to banks (in yet another form) using AIG as an intermediary.

Then AIG has also proved very useful as a covert way of bailing out the banks. Whether this positive was "discovered" after the fear of the negative or not, it does not look good,


Peter.