At MoneyNews: RIP QE

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By Ed Moy,

Quantitative easing (QE), a hero or scoundrel to many but an undeniably controversial presence during America’s financial crisis and Great Recession, died Wednesday afternoon, Oct. 29, 2014, in Washington, D.C. QE was almost six years old.

The cause of death was assisted suicide.

QE played a key role helping the United States weather the impact of the financial crisis of 2008 and the following Great Recession. Its impact included injecting needed liquidity into the near-frozen financial system, which probably saved the nation from slipping into a depression, but caused many unintended consequences that will be felt for years to come. QE also provided significant stimulus to the economy, but disproportionately benefited Wall Street with little direct benefit to Main Street.

After years of low inflation and stable growth, the federal government promoted policies to expand home ownership among low-income buyers by easing regulations and lowering lending standards. Encouraged by the government, the banking industry increased lending to buyers who struggled to pay their mortgages. These risky mortgages were repackaged by big banks, given artificially high credit ratings and sold to investors. When the housing bubble burst, these mortgage-backed securities became worthless and triggered the financial crisis. This was the extraordinary environment that QE was conceived.

QE was born on Nov. 25, 2008, as a result of the marriage between the monetary policy of the Federal Reserve and the fiscal policy between the president and Congress. However, soon after QE’s birth, fiscal policy became an absentee parent never to return during QE’s lifetime.

QE was groomed from an early age for heroic work tackling the struggling American economy. During its early years, it would initially buy $600 billion in mortgaged-backed securities and U.S. Treasury securities before expanding to $1 trillion. However, it had modest impact on the economy.

Without the support of fiscal policy, QE took on more responsibility during its middle years. It bought $600 billion of longer-dated U.S. Treasurys from November 2010 through June 2011, which had a small impact on the economy.

Operation Twist, QE’s little brother, was born on Sept. 21, 2011, and tried to pick up where QE left off by purchasing $400 billion in long-term government bonds while selling short-term government bonds in the family’s portfolio. After adding an additional $267 billion in purchases, Operation Twist ended in 2012.

By that time, QE reached maturity and started buying $40 billion of mortgage-backed securities per month starting on Sept. 13, 2012. Again, with modest results, it launched an “all-in” effort on Dec. 12, 2012, by buying $45 billion in long-term Treasury securities each month in addition to its monthly purchases of $40 billion of mortgage-backed securities.

A year later, it was evident to the Fed that while QE had some positive impact, its impact was diminishing over time, in spite of heroic efforts, and there were serious unintended consequences. So the Fed determined that QE had outlived its usefulness and began a slow process to end its life. It also began thinking about how to clean up the excesses of QE’s behavior.

Experts agree that will take years to experience all the impact of QE, both positive and negative. The Fed forecasts that it will take years, if not decades, to unwind QE’s $4.5 trillion of liquidity.

Historians will debate for decades about QE’s legacy. While accomplishing its twin goals of strengthening the labor market and stabilizing prices, there is continued underlying weakness in both. Many suspect that QE created some asset bubbles, especially in the stock market. Finally, while the dollar has strengthened and inflation remains tame today, only time will tell if QE will lead to uncontrolled inflation.

QE is survived by its twin, Zero Interest Rate Policy, and its parent, the Federal Reserve. Fiscal policy continues to be an absentee parent but there is hope that it might return because of a newly elected Republican-led Senate.

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