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DECEMBER 9, 2010
Markets Defy Fed's Bond-Buying Push
By J ON HILSENRATH And MARK WHITEHO USE
The Federal Reserve's decision to spur the economy with a $600 billion round of bond buying was among the
most controversial in its history.
Fed officials quarreled over whether to proceed. At worst, some members argued, such a move risked whipping
inflation to dangerous levels.
Six weeks later, the bond program looks more like a water pistol
than a cannon—and the reasons explain the immense and
strange challenges of steering monetary policy in the aftermath
of a financial crisis when short-term interest rates are already
near zero.
The purchases of government bonds are meant to drive down
long-term interest rates, which did happen in the lead-up to the
Nov. 3 move. But since then, long-term rates are up sharply.
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As Fed officials prepare to assess the program next Tuesday, they
confront the latest counterweight to their interest-rate plan: the
tax agreement between congressional Republicans and the
White House that would extend Bush-era cuts and reduce
payroll taxes. This has sent bond yields higher, not lower, by
leading investors to expect more growth and inflation and to fret more about budget deficits.
Federal Reserve Chairman Ben Bernanke, pictured at
a Korea conference six weeks ago, pushed for a bond
-purchase plan to drive down long-term interest rates;
so far its effects have been only modestly helpful.
The bond purchases were also expected to result in a weaker dollar, which proponents said would boost U.S.
exports and which critics warned was inflationary. Confounding both camps, the dollar, after an initial fall, has
risen.
The stock market has rallied, as Fed officials expected. Yet whether households are heartened by that is
questionable.
Larry Stewart, a retired oil executive in Vienna, Va., says a 15% gain in
his stock portfolio since late August, when the Fed broached the bondbuying idea, has given him little added confidence. Because of worries
about his savings, Mr. Stewart says he is holding off on buying a new
smart phone he wants and is cleaning his own house instead of paying a
cleaner. "I still worry about having to dip into cash reserves to cover my
living expenses," he said.
His concerns speak to broader obstacles standing in the way of the
central bank. Its hope is that its purchase of Treasury notes and bonds
will drive their prices up and send interest rates, which move in the
opposite direction, downward—thus spurring both consumer spending
and business investment.
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Critics of the plan doubted it would work and warned it could fuel a
speculative asset bubble in addition to inflation. But the early results
suggest another outcome: The program might produce neither the burst
in growth that officials so desperately want nor the inflation their critics
so vociferously fear.
"The effect of the [bond buying] program itself is small enough that it is
easily swamped by the bigger news from Europe over the last month as
well as the political challenges that the program seems to have run up
against." said James Hamilton, a professor at the University of
California of San Diego.
In October, Mr. Hamilton estimated the program would keep long-term
interest rates 0.2 percentage points lower than they would otherwise be.
Today, he says the impact is probably a bit less than even that.
Fed officials have had modest expectations themselves. In what has
become a common refrain, Vice Chairwoman Janet Yellen said in a midNovember interview, "I don't think this is a panacea."
On Tuesday, at their final policy meeting of the year, Fed officials are
likely to leave the program unchanged. It calls for the Fed to buy $600
billion of bonds through next June, plus perhaps $300 billion more by reinvesting funds received as bonds from
an earlier program mature.
The challenge the Fed faces is clear: The economy grew at an annualized rate of just 2.1% from the end of March
through September, leaving unemployment stubbornly high.
Mixed Signals
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Economic data have been looking better of late, with gains in
consumer confidence, retail sales and some manufacturing
indexes. To the extent that these improvements—or the
stimulative result that could result from the new tax plan—are
blocking the Fed's quest for lower rates, it's hard to complain.
A Federal Reserve Bank of Boston study estimates that through
2012 the bond purchases will result in 700,000 jobs that
wouldn't otherwise be created, a big number, yet a fraction of the
8.3 million jobs wiped out in the recession. In a December Wall
Street Journal survey of private economists, 42 of 52 called the
estimate too optimistic.
The effort to spur spending and investment is constrained by fragile confidence and a hangover of the earlier debt
boom.
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At Ford Motor Co., "We've got to get debt down," Neil Schloss,
the company's treasurer, said in an interview last week. Although
Ford's car-finance unit tapped bond markets in September as
interest rates fell—and although Ford on Thursday said it would
invest $600 million in a Louisville plant—executives are averse
to doing much borrowing because they want to win back an
investment-grade credit rating. Ford's overall borrowing is down
by $15 billion from a year ago.
China Rate-Rise Rumors See Stocks Slide
While companies are grabbing cheap credit, many are investing
and hiring outside the U.S. Chemical company Huntsman Corp.
leapt at the chance to refinance $530 million of long-term debt
in September and November. This reduced interest costs and
pushed out repayment dates, helping Huntsman to invest in its business, according to its chief financial officer,
Kimo Esplin. But the Texas company's biggest investment plans, which could result in roughly $400 million of
spending in 2011, are for fast-growing economies in Asia. "Companies like Huntsman have easy access to capital
markets, but they're taking that capital and they're funding growth outside the U.S.," Mr. Esplin said.
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Around midyear, Fed Chairman Ben Bernanke began to lay the groundwork for bond purchases as he grew
impatient with scant progress on growth and jobs, and with what appeared to be a deceleration of inflation. (Too
much of a deceleration makes it harder to achieve low "real" interest rates—that is, rates adjusted for inflation—
and could lead to outright deflation.)
In normal times, the Fed spurs the economy by moving short-term interest rates down, but it had already pushed
those close to zero. Moving longer-term interest rates is a challenge, because they are determined by markets,
which respond to a number of influences including expectations about future inflation and budget deficits.
The Fed first launched a bond-buying attack on long-term rates in the depths of the financial crisis. This first
round of so-called quantitative easing ended in March. After Mr. Bernanke signaled in late August that a new
round was coming, long-term rates began falling in anticipation. The average rate on prime 30-year mortgages
stood at 4.36% the day before Mr. Bernanke sent the signal. It got as low as 4.17% in October.
John Donnelly was a beneficiary—and so was a car dealer. On Oct. 12, the retired sales manager in West Hartford,
Conn., locked in a 4.25% rate on a new $240,000 mortgage loan. He used about $45,000 of it to buy a Mercedes
for his wife. Though his new loan was bigger, his monthly payment hardly changed, thanks to the lower interest
rate. "It's like free money," he said.
In Glastonbury, across the Connecticut River, medical-device sales manager Paul Popovich missed this window.
He applied to refinance the mortgage on his home in mid-October, hoping to lop $150 off his $2,200 monthly
payment. But rates started rising again before he could complete the process. "We were hoping for some relief,
and it hasn't occurred yet," he said. Rates on 30-year mortgages now average 4.61%, their highest in six months,
according to Freddie Mac.
Lowering rates can't put money in the pockets of many others because banks won't lend to them. About 11 million
homeowners owe more on their mortgages than their homes are worth, making refinancing practically
impossible.
Steve Ross, an apparel entrepreneur in Eastern Shores, Fla., has a $200,000 mortgage with an interest rate of
6.75%. He estimates the seaside condo he bought for $300,000 in 2006 is now worth $150,000—too little to
serve as collateral for a new loan that could reduce his $2,000 a month in mortgage costs and condo fees. The
Fed's stimulus "is not doing me any good," Mr. Ross said. "The bank isn't going to call me up and lower my
interest rate."
About 70% of U.S. mortgage holders were paying at least one percentage point more than the going interest rate
for 30-year fixed-rate mortgages in October, according to a Wall Street Journal analysis of data from research
firm LPS Applied Analytics.
As for inflation, the economic cross winds are pulling it in different directions. Strong demand from overseas is
pushing up the prices for many globally traded goods, including a white pigment used in paint called titanium
dioxide. Huntsman raised titanium dioxide prices 17% earlier this year, and paint maker Sherwin-Williams Co.
has raised paint prices.
When the Fed buys bonds from banks, it is in effect creating money, because it simply credits with cash the banks
from which it buys the bonds. Flooding the financial system with more money could cause inflation.
The Fed doesn't see that as a risk because other forces are pushing inflation down, including banks' reluctance to
lend and the overhang of unemployed workers, empty homes and unused plant capacity. Also, many domestic
services aren't exposed to the buoyant global demand that is pushing Huntsman's titanium dioxide higher.
Danny Sayag, who runs two hair salons in Rockville, Md., is keeping the price of women's haircuts between $65
and $75. Rent at one of his two salons was reduced because of the soft real-estate market, and labor costs aren't
rising because some other salons have closed and left stylists job hunting.
"It is not the right time to raise prices," Mr. Sayag said. "Why push the clients away from us at this kind of time?"
Across the economy, the cost of a haircut in October was 0.4% higher than a year earlier, after averaging increases
of over 3% for a decade, according to the Bureau of Labor Statistics.
Meanwhile, much of the money the Fed has created is sitting unutilized at banks, in saving accounts or in
corporate coffers, reducing its potency as a source of either growth or inflation. U.S. nonfinancial businesses
increased their liquid assets $1.932 trillion in the third quarter, a jump of $243 billion from a year earlier,
10.12.2010
according to the Fed. Banks' commercial and industrial loans outstanding in November were down 7.2% from a
year ago; their holdings of low-risk Treasurys were up nearly 17%.
Mr. Sayag in Maryland says he has long been trying to get a loan from local Sandy Spring Bank to develop a plot
of land to open a third hair salon, a beauty school and a supply store. He has been turned down, he says, because
of the weak economy. "I don't blame the bank. It was the timing," he said. Since September 2008, Sandy Spring's
portfolio of loans and leases has contracted to $2.1 billion from $2.4 billion, according to filings with the Federal
Deposit Insurance Corp.
The bank's CEO, Daniel Schrider, declined to discuss individual clients, but said the bank's main goal in the past
few years has been to clean up troubled construction and land-development loans. Though that process isn't over,
he said, the outlook for lending is starting to look up. "We have transitioned...toward being much more interested
in growing our business through quality credit opportunities," he said.
Mr. Sayag has restarted the process for a $2.5 million loan, and thinks he will get it this time because business is
better and the cost of building is down. But, he added, "It's not going to happen overnight."
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10.12.2010