- The Washington Times - Thursday, March 10, 2011

Last week, economist and bond expert William H. Gross, warned that when the Federal Reserve ends its second round of “quantitative easing,” any recovery momentum in the economy may reverse. Quantitative easing is the term used to describe the Fed’s policies of buying huge amounts of Treasury bonds in hopes of creating a demand for these instruments, keeping interest rates - including mortgage rates - down.

Since the beginning of the second phase of quantitative easing, dubbed QEII, in late 2010, mortgage rates have risen by about 0.5 percent. In the big picture, though, rates have remained at very low levels.

Low mortgage rates have done little, if anything, to stimulate the depressed housing market. Low rates also have fueled a wave of refinances, which lower homeowners’ borrowing costs and encourage spending. But the overreaction to the mortgage meltdown has made far fewer homeowners eligible for a refinance than in previous refinance waves, lessening the positive impact on the economy.

According to Mr. Gross, a continuing economic recovery after the end of QEII is hinged upon “a successful handoff from public to private credit creation.”

This is a very interesting statement. Mr. Gross, in my interpretation, is saying the credit crunch is still very much alive and is a threat to the economy. On the mortgage front, the only significant entities extending credit are mortgage giants Fannie Mae and Freddie Mac, which are being supported by the federal government.

Mr. Gross goes on to say that the “successful handoff from public to private credit creation has yet to be accomplished.” This sounds to me as if he is saying private creditors have not yet thawed their wallets and still are reluctant to extend credit. When QEII ceases, the demand for bonds and mortgage-backed securities will fall, resulting in higher rates.

“Who will buy Treasuries when the Fed doesn’t?” he asked. “I don’t know.”

Even though the stock market has soared during QEII, a significant increase in interest rates will, indeed, kill the possibility of any rapid recovery in the housing market and remove any refinance activity that would pump more money into the economy.

Stay tuned.

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

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