- The Washington Times - Thursday, November 11, 2010

Last week, the Federal Reserve Board of Governors announced it would commence purchasing $600 billion in long-term Treasury and mortgage-backed securities until the middle of 2011. Known as quantitative easing (QE), the maneuver is a repeat of something the Fed did a couple of years ago.

Fed Chairman Ben S. Bernanke recently published an article explaining the board’s strategy. Here’s a quick recap:

The economy, in recent years, has been showing some signs pointing to the possibility of future deflation, when prices and wages spiral downward. As much as the opposite - inflation - is a concern, most economists say deflation can have even worse consequences. The U.S. economy recently has experienced stagnant growth, unemployment of nearly 10 percent and a general inflation rate of less than 2 percent.

The traditional method to spur economic growth and employment is to increase the money supply. The Fed does this by reducing short-term interest rates. The problem is, short-term interest rates already are near zero - and the economy is still stuck in the mud.

QE is the Fed’s next weapon. Purchasing massive amounts of long-term securities, such as Treasury bonds and packaged mortgage loans, creates a demand. A strong demand leads to a higher price. Because the price and yield of financial securities move in opposite directions, the Fed is betting QE will keep interest rates, including mortgage rates, down.

According to Mr. Bernanke, lower rates “will make housing more affordable and allow more homeowners to refinance.” He also acknowledged that QE is a “less familiar monetary policy tool.” Because of this, he writes, the Federal Open Market Committee “has been cautious, balancing the costs and benefits before acting.”

He declared that “some concerns about this approach are overstated.” Some critics assert QE will cause runaway inflation. Mr. Bernanke defended the policy by stating that the first round of QE, in which a trillion dollars of securities were purchased, did not have any inflationary effect.

I welcome the policy in the mortgage world because refinances abound when interest rates are low. If mortgage giants Fannie Mae and Freddie Mac would apply a little more common sense to the underwriting guidelines, today’s low rates would benefit a lot more Americans. Unfortunately, the overreaction to the subprime meltdown has made it more difficult for perfectly qualified homeowners to purchase a home or refinance a loan.

Mr. Bernanke should look into that problem if he wants these low rates to stimulate the economy.

Henry Savage is president of PMC Mortgage in Alexandria, Va. Send e-mail to henrysavage@pmcmortgage.com.

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