> http://www.usatoday.com/money/economy/2010-11-03-fed-risks_N.htm
>
> Would somebody on LBO explain the above.
>
> It sounds to me like bullshit that will just encourage another bubble and
> crash. In my theory lending isn't going to business because the rate of
> return is lower than other uses of money.
>
Here's an explanation from some important advisors to the U.S. Treasury, the Treasury Borrowing Advisory Committee (http://www.treas.gov/offices/domestic-finance/debt-management/adv-com/members):
“The Committee finally addressed the fourth question in the charge regarding the implications of a second round of quantitative easing. The member provided a presentation that considered market expectations of QE2 and its impact over the medium- and long-term horizons.
....
"The presenting member thought that over the medium term (one to two years), QE2 would force Treasury yields lower and would likely lead the curve to flatten in the five- to ten-year sector. Meanwhile, the risk premium in 30-year bonds would likely increase given concerns about inflation and the value of the U.S. dollar. The presenter stated that financial markets generally believe that QE2 will push swap spreads wider as the float of U.S. Treasury supply declines. It was also noted that there could be some tightness in the repo market. Credit spreads are also expected to tighten alongside other risk premiums. While mortgages will initially trade wider versus Treasuries, the presenter expected that mortgage spreads should narrow relative to both the Treasury and swap curves. The presenter further noted that rate volatility will decline as market rates approach zero, with realized volatility in the long-end remaining higher as uncertainty and re-inflation fears increase.
"According to the presenting member, liquidity issues could arise as the projected scope of QE2, along with MBS reinvestments, may exceed the entire combined expected net issuance of Treasuries, Agencies, Agency MBS, and Investment Grade Corporates. The member noted that potential illiquidity in the intermediate sector of the Treasury curve could push some investors into bills, 30-year Treasuries, and/or riskier assets."
The last sentence alludes to the "portfolio balance channel effect," an idea to which Ben Bernanke seems to be partial. As the theory goes, investors will try to rebalance their portfolios with riskier assets when short-term risk-free assets yield nothing. The Fed may believe that the same effect could occur following QE2.
I've done some work on the shadow banking system and I've come to the conclusion that the maturity transformation service provided by securitization is pretty much dead. The capitalist system can't connect short-term lenders with long-term borrowers any more. This doesn't necessarily appear in economists' general equilibrium models.
I'd be more optimistic about QE2 if it were accompanied by an initiative by the powers that be to consult with all of the players in the securitization chain (e.g., asset originators, servicers, sponsors, lawyers, investors, rating agencies) to rebuild the shadow lending system so that maturity and liquidity transformation (i.e., banking) can resume. It's beyond me why this isn't a top priority. These transformations are a valuable service to capital accumulation...
M.