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The official QE3 discussion thread


Liberty
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I think we'll need this thread now..

 

QE3 is here.

 

The Federal Reserve announced a new bond buying program at the conclusion of its two-day meeting of the bank’s rate-setting committee, the FOMC, and it seems like a pretty big program.

 

The central bank essentially announced that it will buy up to $85 billion in securities per month through the rest of the year, and left open the option to keep going if it doesn’t see enough economic improvement.

 

It also pledged to keep interest rates where they are through mid-2015.

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My first thought on implications is they are diluting the cash hoards which companies supposedly have.

 

Additionally, diluting the value of the dollar. What do members of this board do (if anything) to manage risk that your portfolio is held in USD?

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Personally I would have called it the "Bernanke cheering thread".

 

Eric, sorry if you've addressed this elsewhere, but I'm curious to know what is your view on how all this QE stuff will impact financial institutions (like BAC) that own lots of financial assets denominated in dollars.

 

I have a few guesses, but I'd love your insights..

 

f.ex. 1) It's bad for BAC because it makes all their fixed rate assets worth less, but the margin of safety in the price is so big that it doesn't matter too much, and if this jolt helps revive animal spirits in the economy, it might be good for BAC on balance.

 

2) Maybe it's good for BAC in a direct manner. Can they unload some crap from their balance sheet to the federal reserve?

 

3) ???

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I think for banks, at least in the short term, QE will make their balance sheet stronger because it supports real estate or mortgage based securities (the Fed can buy mortgage-backed securities directly). So if the market is pessimistic about the quality of a bank's book because they are afraid that a downturn may make things go sour, they can be a bit more confident because QE guarantees that those assets will not go down too much as the Fed is a huge buyer. However, QE is not good for the margins of the banks going forward because it means "extraordinary low interest rates for an extended period of time". You need to wait until QE is over, and then some time after that, before you can reasonably expect the Fed to raise rates, so more QE means that this is further out.

 

So it works both ways. It supports banks from the bottom, but also holds them down from the top. For a stock like BAC, it's probably a good thing because the market is valuing them below tangible book, but it doesn't really help the top line. BAC would probably prefer interest rates to be 75 basis points higher if the regulators are not breathing down their necks about capital requirements. The stock may go up on QE due to less fear about the bottom falling off, but it is not exactly good for earnings over the next year.

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Personally I would have called it the "Bernanke cheering thread".

 

Eric, sorry if you've addressed this elsewhere, but I'm curious to know what is your view on how all this QE stuff will impact financial institutions (like BAC) that own lots of financial assets denominated in dollars.

 

I have a few guesses, but I'd love your insights..

 

f.ex. 1) It's bad for BAC because it makes all their fixed rate assets worth less, but the margin of safety in the price is so big that it doesn't matter too much, and if this jolt helps revive animal spirits in the economy, it might be good for BAC on balance.

 

2) Maybe it's good for BAC in a direct manner. Can they unload some crap from their balance sheet to the federal reserve?

 

3) ???

 

I am getting a bit excited for a short term rally so that I can write very far out of the money (like perhaps $17 or $20 strike) BAC covered calls and use the premium to pay off the WFC put liability. 

 

Then the market sells off and I can leverage up on my BAC stake again because I'll still have my puts.

 

I personally don't like the selloffs that much (I find it emotionally disturbing), but objectively it does earn me extra money.

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For the banks this is great.

 

I will not even talk about the benefits for the balance sheets, they have already the best in decades. The banks only problem is that they have more than 30% of their assets in securities, mostly short term, waiting for the opportunity to resume loan growth while suffering a slow net interest margin compression thanks to low interest rates.

 

Without monetary intervention, since fiscal policy and mortgage restructuring seems out of the question, we would be seeing low interest rates and anemic loan growth for years if not a decade. With QE3, earnings might be negatively affected short term but the expectations of seeing a period of loan growth and higher interest rates over the next years has been increased.  And the banks and their low leverage can be an important factor in the recovery if loan growth starts to kick in.

 

Milton Friedman has spoken.

 

---------

 

Michael Woodford has spoken too:

 

http://www.businessinsider.com/michael-woodford-on-the-federal-reserve-2012-9

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In 2009 I started buying gold miners and continued to add over time, I am finally prepared to let them go with this rally.  II haven't really made or lost much money on this investment but I can say that I've learned a tremendous amount.  It has taught me how I want to invest and how difficult it is not to become emotionally involved.  I find myself actually hating these miners lol.  I think from this point onward I'll focus much more on quality businesses.

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In 2009 I started buying gold miners and continued to add over time, I am finally prepared to let them go with this rally.  II haven't really made or lost much money on this investment but I can say that I've learned a tremendous amount.  It has taught me how I want to invest and how difficult it is not to become emotionally involved.  I find myself actually hating these miners lol.  I think from this point onward I'll focus much more on quality businesses.

 

Ironically you may be pitching them just in time for a large rally....

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I'm in the process of building a home right now and don't lock in my rate until mid-October, so this announcement couldn't come at a better time....that being said, I don't see how this is anything but negative for banks' earning power. Yes they may get some gains on asset sales, but the longer ZIRP goes for, A) the more NIMs decline as higher-yielding securities continue to roll off and B) the longer it will take for the banks to cycle through to eventually higher yielding securities. You don't just flip an entire loan portfolio yielding 3% to a 6% portfolio (I'm exaggerating yes) just like the 6% portfolios of yesteryear didn't immediately flip into what they are today. Who knows....but something just doesn't smell right with ZIRP and LSAP as far as the eye can see....

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well I haven't sold out yet, I'll probably not start unloading for a few weeks.  Capex and mining costs rose much quicker than I anticipated, rookie mistake I guess...

 

Which is why I won't even look at the miners. That business is too hard. I prefer either service companies that sell picks & shovels to miners (I'd rather be the guy selling shovels than the guy buying them, so to speak), or royalty/streaming companies that are basically merchant banks with options on the upside if things go better than planned and downside protection if things go south (they are not responsible for any capex after initial investment).

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Liberty - your preaching to the choir.  Miners were my first investment (I was in college still).  It has really taught me the importance of staying in industries with good economics & places where I can actually predict the future with some reasonable success rate!

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So, if QE2 didn't produce the expected results why is QE3 suppose to do a better job?

 

Former Federal Reserve Chairman Alan Greenspan calculated that as of July 2012 there was "very little impact on the economy" and noted "I'm very surprised at the data.

http://finance.yahoo.com/news/alan-greenspan-sees-two-separate-161122638.html

 

The definition of foly is doind the same thing twice and expecting different outcomes

Albert Einstein

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So, if QE2 didn't produce the expected results why is QE3 suppose to do a better job?

 

Former Federal Reserve Chairman Alan Greenspan calculated that as of July 2012 there was "very little impact on the economy" and noted "I'm very surprised at the data.

http://finance.yahoo.com/news/alan-greenspan-sees-two-separate-161122638.html

 

The definition of foly is doind the same thing twice and expecting different outcomes

Albert Einstein

 

I suppose Greenspan has earned the right to criticize a guy who can't build a housing bubble to save his career  :)

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Do the QE policies lead to faster deposit growth at the banks?

 

If yes...

 

Then might deposit growth stall or fall without QE?

 

The importance of which is... look at how BAC is able to replace long term debt with low cost deposit funding.  And would they be in a pickle these past few years if those debts were coming due at a time with a shrunken deposit base?

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In Soros' words, we have entered a new phase in Europe's crisis future of the Euro is now assured.

 

That happened last week.  This week we have QE3.

 

Are they connected in timing?  Will Europeans now move some deposits back to the European continent (taking them from US banks).  And if so, so the Fed doing open-ended purchases of mortgages allow the US banks to delever an offsetting amount of assets without disruption if some deposits are pulled back to Europe?

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I'm in the process of building a home right now and don't lock in my rate until mid-October, so this announcement couldn't come at a better time....that being said, I don't see how this is anything but negative for banks' earning power. Yes they may get some gains on asset sales, but the longer ZIRP goes for, A) the more NIMs decline as higher-yielding securities continue to roll off and B) the longer it will take for the banks to cycle through to eventually higher yielding securities. You don't just flip an entire loan portfolio yielding 3% to a 6% portfolio (I'm exaggerating yes) just like the 6% portfolios of yesteryear didn't immediately flip into what they are today. Who knows....but something just doesn't smell right with ZIRP and LSAP as far as the eye can see....

 

Everything I've seen (and you can only conclude so much from data if you can't literally observe the channels through which A affects B) says that QE 1 and 2 resulted in increased interest rates - despite the fact that partial equilibrium analysis says increased demand (Fed purchases) -> higher price -> lower yield.  The general equilibrium appears to be that since assets compete, and people believe QE will help the economy, that people dump low-yielding and safe securities for higher yielding, more speculative securities.  In fact, the Fed openly admit to targeting this transmission channel in attempting to apply the "wealth effect".

 

There are lots of marginal effects, but I think we sort of miss the forest for the trees if we don't consider the most important question to be - will it materially improve the economy?  If it does, then it should benefit BAC despite whatever marginal effects it could conceivably have on NIM, deposit base, etc... in the short term.

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There are lots of marginal effects, but I think we sort of miss the forest for the trees if we don't consider the most important question to be - will it materially improve the economy?  If it does, then it should benefit BAC despite whatever marginal effects it could conceivably have on NIM, deposit base, etc... in the short term.

 

Exactly ... and the jump in 10y treasuries yield and 5y TIPS spread suggests that there is a good chance that it will improve the economy.

 

http://www.themoneyillusion.com/?p=16230

http://www.themoneyillusion.com/?p=16202

 

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Gavekal's point of view on QE3, for anyone who might be interested.

 

"Ultimately, we believe QE3 will be counterproductive. The chances of higher investment have fallen and the likelihood of wholesale capital misallocation resulting in a future financial crisis has increased. What the US economy needs (and the global one for that matter) is the confidence provided by a predictable future – not more cheap money."

 

giofranchi

Daily+9.14.12.pdf

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