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3 years of low rates plus QE3

By Sheyna Steiner · Bankrate.com
Thursday, September 13, 2012
Posted: 1 pm ET

The Federal Reserve is ready to rescue the economy with another large-scale asset purchase program.

The rate-setting Federal Open Market Committee, or FOMC, is starting a third round of quantitative easing, making this officially QE3. Quantitative easing, if you've forgotten since the second round was begun in 2010, is a little bit like printing money. It increases the amount of money in the financial system as the Fed buys securities, in this case buying another $40 billion in agency mortgage-backed securities per month.

The central bank will continue the maturity-extension program known as Operation Twist through the end of the year as well as continuing to reinvest returns from its portfolio into mortgage-backed securities.

"These actions, which together will increase the Committee's holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative," the statement from the Federal Reserve said.

For the first time, there will be no limit to the size of the program. Purchases of securities will continue indefinitely "if the outlook for the labor market does not improve substantially," according to the central bank. And the Fed could undertake additional asset purchases as well.

The central bank extended the forward guidance on the federal funds rate, too. The very short-term interest rate that dictates the price that banks pay for overnight loans will remain targeted between zero and 25 basis points through mid-2015. Previously, the Fed had said it would keep the federal funds rate near zero through 2014. The central bank concluded that the economy needs help for longer than previously expected.

So what does this mean for me?

By changing expectations about the path of interest rates, the Fed "helps to address the fact that this is a serious situation; they are going to be much more aggressive about creating growth as opposed to worrying about inflation," says John Stewart, managing director and founder of Vantage Economics. As interest rates are staying exactly the same, consumers can expect no change to the low loan rates they've enjoyed recently and the low savings rates they've come to despise.

Not all loans move in lockstep with the federal funds rate, but monetary policies enacted by the Fed have pushed loan rates down, from mortgages to car loans. Generally, when lenders pay less to borrow, that translates to lower costs for consumers.

The prime rate is tied to the federal funds rate, which means variable-rate credit cards will be unchanged.

On the savings front, it's low yields as far as the eye can see. Savers can expect extremely low rates on savings accounts, money market accounts and certificates of deposit for the next three years.

Will the billions spent on mortgages help me?

Maybe. That's the plan, anyway. When the central bank buys securities, it pushes more money into the financial system. The hope is that all that liquidity will help banks make more loans, so consumers can buy houses and cars and TVs and give money to companies who will then buy equipment and hire more employees.

"We have seen, over the past year and a half, an increase in bank lending after a long period of contraction in bank balance sheets, so the banks have more cash on hand, and then they lend more of it out," says Sam Coffin, economist at UBS, a global investment bank headquartered in Switzerland. Unlike previous easing attempts, the Fed will be focusing mainly on the housing market in QE3.

"Essentially, it would help keep those interest rates lower, so you would hope that it would start to bring people back into the housing market. But the problem is that if you are uncertain about your job and uncertain about your financial situation, you're simply not going to buy another house," says Stewart.

"About 18 percent of mortgages are underwater; there are millions of Americans who are simply waiting for their home values to appreciate more before they even think of selling their home," he says.

Word of the year: Uncertainty

It sounds like a great plan, but the fly in the ointment might be the federal government. Business owners have a hard time making decisions with tax and regulatory uncertainty. Government contractors have a hard time planning their business with looming budget cuts.

"Interest rates are at historic low levels; banks are sitting on a trillion and a half (dollars) of excess reserves just sitting idle. Large companies particularly have enormous cash reserves. The business community does not want to commit those funds without knowing what the federal government is going to do," says William Poole, senior fellow at the Cato Institute and former president and chief executive officer at the Federal Reserve Bank of St. Louis.

"And the federal government doesn't know what it's going to do," he says.

The fate of the economy and the millions of unemployed workers may ultimately hinge, not on monetary policy, but on the federal government.

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North Carolinian
September 16, 2012 at 9:20 pm

Coloraden. As a former drunken sailor, I want to say that I seriously resent your statement. When I ran out of money, the bouncers always threw me out!

George Dylan
September 15, 2012 at 12:49 am

When will Bernanke be held accountable for his crimes?

September 14, 2012 at 5:46 pm

Cd rates are horrible as it is, this is not good news.
What can I do differently with some savings, make a better return than CD's provide and still be able to get to them when I need them ?( usually on a yearly basis )

Ken Pretell
September 13, 2012 at 11:53 pm

Joe's on track. And unlike Coloradan and Jumper (clearly dyed-in-the-wool Democrats couched in Defensive Mode , just like Obama), I don't shy from commenting with my real name. For matters of Economy, Direction, and who led us where (if your primary goal is blame-inspired), I recommend all to read the postings and public statements of Mark Zandi. He's a reknowned economist - well-published - who has been a consistent resource for several presidents. I am hopeful that he will be part of the next Administration, no matter who wins this circus.
Best Regards, KJP

September 13, 2012 at 8:12 pm

I agree with coloradan, you're the one full of it Louise.

Joe Bertini
September 13, 2012 at 7:32 pm

Correction....make that $40Billion per month.

Joe Bertini
September 13, 2012 at 7:23 pm

I'm totally puzzled. Given that banks and corporations have $trillions on hand, but are not lending/spending, what purpose is served by the Feds adding more (printing more) money to the economy to the tune of $80+Billion per month???

How will this help us reduce our $16+Trillion national debt?

Karen Mamalakis
September 13, 2012 at 7:22 pm

They ALL put US in this crisis. Are they feeling financial pain? No!! Are their kids not going to choice colleges? I say, get rid of all of them and vote in normal people to correct their Corrupt decisions. I hate the government!!

September 13, 2012 at 6:41 pm

It sounds like you were drunk with them Coloradan. Unless your still drunk you may know that Obama failed quite some time ago. The democrats put us in this crisis you just have to study the facts a bit to figure that out. This isn't high school where people are trying to calculate a failure this is the real world. I would study a bit prior to blogging this giberish on an article.

September 13, 2012 at 5:59 pm

It's is sad that the Fed has to act to stimulate the economy because the House Republicans refuse to act, hiding behind "fiscal responsibility" after spending according to John McCain like "drunken sailors" during the Bush administration. They feel that they can get away with it because of the high deficit (which they helped create with their foolish tax cuts), when really they just want Obama to fail so badly they can taste it.