The Impact of QE3 Begins to Show

 | Feb 08, 2013 | 11:30 AM EST
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Last September, following the Federal Reserve's surprise announcement of its commitment to purchase $40 billion of mortgage backed securities monthly, I penned the column "Ben Bernanke Saves the World," which quite a few subscribers responded too. 

This week, the banks completed their filings of their fourth-quarter call reports, which looked excellent.

The fourth-quarter call reports also gave us the first substantive view of the impact of QE3 on the balance sheets of the banks and it was substantial.

For our purposes here, the most germane issue is the activity of the money centers JPMorgan Chase (JPM), Bank of America (BAC), Citi (C) and Wells Fargo (WFC) and the composition of their balance sheets. 

At all four institutions the value of deposits, loans and assets increased in the fourth quarter, an indication that bank lending activity is increasing. But most notable is the composition of bank assets.

Every category of bank assets increased substantially, except mortgage backed securities, which actually declined.

Holdings of Treasuries, agency and municipal debt increased by about 4% each, while the holdings of MBSs declined by about 1.5%.

The banks have begun to sell their mortgages and MBSs to the Federal Reserve.  This is making more cash available to the banks to originate more loans, specifically first trust residential mortgages.

But to date, only Citigroup and Wells Fargo have shown a corresponding increase in their residential lending. 

BAC and JPM have so far used the Fed's promise to buy MBSs as an opportunity to offload their mortgages to the Fed without also making new mortgages.

So far, this has pretty well matched the purpose of the Fed's intention of implementing QE3 to get the banks to sell their mortgages to the Fed so they can originate even more mortgages at lower rates and stimulate housing and the economy in the process. 

But we are only one quarter into this and it's not clear what the banks are going to do from here other than offload their retained mortgages to the Fed. 

We need to see a few more quarters of data to determine if the Fed's purchases of mortgages has coaxed the money centers, other than Wells Fargo, to get back in to the mortgage business.

As of right now the residential mortgage business in the U.S. is controlled by Wells Fargo, which has displaced the functions in that market that used to be managed by Bear Stearns, Lehman Brothers, Fannie Mae and Freddie Mac.  

Wells Fargo is by default now the dominant and marginal provider of liquidity to other mortgage lenders and buyer of the mortgages those firms originate with that credit. 

A sole or dominant source of mortgage funds is not healthy, especially for an economy as large as the U.S. 

Putting economic considerations aside, the Fed will likely feel a need to continue QE3 until at least three of the big four money centers have committed to residential mortgage originating and that will most probably ensure that the Fed will continue purchasing mortgages well into 2014 and perhaps beyond.      

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