End of a QE Era

– Can you feel it? The world is in a different place this morning.

Yes, the sun is still shining, birds still chirp and the hype over Apple’s iPad is still building beyond an already insufferable level. Your world may appear normal. But there’s a qualitative difference to the economy today, brought on by the absence of “quantitative easing,” or QE — our favorite acronym of 2010.

Under the program, the Federal Reserve graciously bought $1.25 trillion of mortgage-backed securities from panicky banks and hedge funds over the last 12 months. But now, it’s over. Today, the stock market lost an important undergarment… and we suspect it will begin sagging dramatically, soon.

In more direct terms, the Fed has stopped “funneling new fiat money into the mortgage-backed security market,” explains short side strategist Dan Amoss, “which, in turn, freed up extra cash for portfolio managers to recycle into bonds and stocks. This fiat money is the illusion of real savings. It goes a long way toward explaining how a country deficient in savings can fund massive government deficits at low rates and aggressively bid up the prices of stocks.”

So what happens now?

“We’ll see a more natural relationship between savings, money flows and stock and bond prices,” says Dan. “It probably won’t be good for bulls.”

That is, if the Fed sticks to the plan.

As soon as quantitative easing came to an end at the close of business yesterday, the Fed came clean on the toxic assets it bought two years ago during the Bear Stearns bailout. This is the stuff JP Morgan didn’t want to risk its own capital on when it agreed to take over Bear… so the Fed agreed to put you, dear taxpayer, at risk instead.

  • Face value of the assets: $75 billion
  • Value when the Fed bought them in March 2008: $30 billion
  • Value at the end of 2009: $27 billion, provided they can now find a buyer

Among the motley assortment of assets now in the Fed’s portfolio…

  • $619 million of securities that were backed by mortgage lender Countrywide. They’re now rated CCC — eight levels below investment grade.
  • A portion of the loan on the Hilton Garden Inn in Panama City, Fla.
  • And a portion of the loan that created this:

The CrossRoads Mall in Oklahoma City. Four anchor tenants have bailed since 2006…
And now you’re on the hook. Love it.

On the grounds it would make it harder to sell these assets in the future, the Fed fought to keep these details under wraps for the last two years. Bloomberg News had to sue to get access.

With QE out of the way, what the Fed needs now is a healthy public audit — a scrub-down behind the ears, between the toes — before the next “rescue operation” is conducted in secrecy. Otherwise, our tickets to the front row as this entire scheme unravels will expire worthless.

Addison Wiggin
for The Daily Reckoning

The Daily Reckoning