The Fed Does Not Need QE3 And Can Fund Debt Monetization Merely From Rolling Debt And MBS Prepayments? Wrong

Tyler Durden's picture

Recently there has been a meme spreading in the internet that the Fed does not really need to do QE3 as the central bank can maintain bid interest at sufficiently high levels by merely rolling and extending maturing debt, a form of QE Lite Version 2, where the Fed's balance sheet is kept constant even as MBS are prepaid and Treasuries mature. The argument goes that based on some "logic" and lots of estimates it is "reasonable" to assume that $750 billion in MBS prepays and Treasury maturities will depart the Fed's balance sheet and need to be repurchased in the open market in keeping with a pro forma QE Lite V2.0 mandate. This is false. Here's why.

First: one does not need to engage in complex calculations of what the maturity profile of the Fed's holdings are - it is there available for anyone with an internet connection to see for themselves. In each and every H.4.1 update (go ahead, click) the Fed lists the maturity portfolio of its assets. The most interesting for the purposes of this analysis is the securities due in under one year. This includes in addition to Treasurys, MBS and Agencies, also the following items completely irrelevant for this exercise: Reverse Repos , Term Deposits, Liquidity Swaps and Other loans. As the chart below shows, and as anyone with a calculator can estimate, there is $141 billion in Treasury, Agency and MBS maturities in under one year (and just $108 billion in purely Treasury holdings). This number is one tenth of the ongoing monetization of $900 billion in USTs and MBSs in the November-June period, or $1,350 billion annualized. In other words: simply rolling MBS and Treasuries will have one tenth the impact of the ongoing quantitative easing program. Period. End of Story.

So what about MBS prepays? Well, as we had thought we had made abundantly clear, the level of Fed MBS prepays is directly correlated with prevailing mortgage rates: the lower the mortgage rate, the more willing the end consumer is to "put" an existing mortgage to the Fed and open a cheaper one. And vice versa: the higher rates go, the less prepays the Fed experiences. Lo and behold: actually looking at the data, confirms precisely this. As the chart below shows, while in H2 2010, when 10 Year, and thus Mortgage rates, were dropping fast, prepays to the Fed, and thus the rate of QE Lite activity was very high: peaking at $45 billion in December. Alas, since then, due to surging rates, the prepay rates has plunged, and the February and March total of $40 billion is less than all of December. Should rates continue to rise, which they will if fears of no QE3 accelerate, and Bill Gross ends up being right, this number will plummet and could potentially hit zero as nobody has an incentive to prepay a mortgage when the existing one is far more economic.

So putting it all together: assuming no QE3, and just continued rolling and transforming MBS in UST purchases, means that the Fed will have about $12 billion in average UST purchases per month from maturity extension, and about $20 billion from MBS prepays. This is at best one quarter of the amount the Fed monetizes per month currently and is largely inadequate to continue funding the US deficit. Also, should the 10 Year rate jump to over 5%, QE Lite will halt indefinitely, meaning the only source of dry powder for future monetization will be rolling maturity extensions, which are about one tenth of current monthly funding needs.

Lastly, and people tend to forget this, the primary reason why the Treasury needs the Fed to be the buyer of only resort is that no matter what happens to interest rates, and cash outlay to the Fed ends up being a revenue item for the Treasury! In fact, the higher the rate, the greater the purported revenue from Ben Bernanke, even though in reality it ends up being a wash transaction. For Tim Geithner the ideal situation would be one where the Fed owned all US interest paying instruments, as interest expense would be shortly reclassified as Treasury revenue. Should the Fed not be a key player in monetization, this is money that would ultimately leave the US. And if rates were to jump the annual interest outlays would actually be quite dramatic.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Alcoholic Native American's picture

QE 1 never stopped. stop bullshittin.

jus_lite_reading's picture


AND they are saying NOW THAT RADIATION HAS BEEN LEAKING AT HUGE AMOUNTS! 10,000 terabecquerels of radioactive materials per hour!!! WHOA!

Lets see them throw a few trillion yen at this problem!



SheepDog-One's picture

No one cares anymore, Japan has been deemed 'priced in' and old news....nevermind nothing has been priced in and Toyota shutdown, along with Nissan surely, Honda, and others not to mention that which shall not be spoken....Apple computer parts shutdown, has not been priced in at all and is a disaster looming! The nuclear poisoning of everything hasnt even been looked at yet, really true evil.

jus_lite_reading's picture

MFers only care about money and GDP!!!!!!!!!!! This shits gotta end

tiger7905's picture

Great clip from Arnie at Fairwinde Associates on an experiment of the fuel rods and how brittle they got.

jus_lite_reading's picture

I know! I saw that too on fiatfire! Thanks! Did you see the video from Mises? HOLY MOLY!

spiral_eyes's picture

oh it's okay japanese central bankers can print clean air, clean water, and an alternative energy structure. john maynard keynes said so.

mdwagner's picture

For those that would rather see a non-alarmist looking blog source,

Bendromeda Strain's picture

I'm not sure ZH and the Fight Club theme is right for you, Nancy.

LudwigVon's picture

QE 1 never stopped. stop bullshittin.


The monthly round number I came up with was 50 Billion, I like TD's details as well and no matter the number we all can agree that it is a far cry from POMO, rates will rise as no one is there to step into the gap. I say QE3 is leaked before fall semester starts.

NOTW777's picture

ponzi eventually fails

Hugh G Rection's picture

It DOESN"T need QE3...


They will just pull out the Keynesian thesaurus and change the name again.

spiral_eyes's picture

this is likelier than some might admit.

dumpster's picture

a big pile of bull crap by any other name is still a big pile of bull crap

Robot Traders Mom's picture

Great analysis Tyler, this is why ZH is the best.

Bad Lieutenant's picture

Tyler et al,

It's awesome that zh has engaged Rickards' "Stock and Flow" analysis and put it into the debate.  That said, I have a lot of respect for Rickards and his first-hand experience with the Fed, yet as this zh story details, his thesis has major problems that he never outlined on KWN a few weeks ago when he initially unveiled it.  

So I think you'd do the zh community a huge service if you two worked together rather than get agressive with fingering who's wrong.

So how about zh interview Rickards privately and transcribe it into a zh piece. It'd be great for Rickards and the minds at zh to put their heads together and figure June out! Or perhaps, get Rickards to to a guest post for zh?

Bob's picture

It was a very impressive interview, but I recall very clearly that he took pains to note that his firgures were "typical" based upon his previous work at the Fed.  IIRC, he was using an average 3 year maturity "rule of thumb" to estimate the maturity profile of the Fed's holdings.

narapoiddyslexia's picture

+1 agreed. He was working BOTE

LudwigVon's picture

you'd do the zh community a huge service if you two worked together rather than get agressive with fingering who's wrong.

WOW, pay attention, TD agreed with Rickards as one factor in the simple algebra.

Now TD is getting aggressive? Wait OK, read this again:

you'd do the zh community a huge service

As if this is not already the case? 


Bad Lieutenant's picture

Oh jeez, I'm not trying to rain on anyone's parade...  I'm basically just commenting on the fact that the piece's title bluntly ends with "Wrong" comes off as a bit hostile.  Anyway, I'm still not sure what your point is because this zh piece is directly at odds with Rickards' thesis on why he thinks the Fed has the abilty to take a hiatus from QE for some time. Personally, this zh piece makes a very convincing case, further puzzling me on how Rickards can be confident about his view.

In Rickards' second interview, he does clarify his position to say that the Fed will use their "stock" buying power to gun US paper prices up. So maybe the debate should shift to: is the Fed's buying power from runoff enough to keep US paper prices out of the danger zone that would ignite panic (in which case most of us here would be the cue for QE3).. 

And finally:


WOW, pay attention, TD agreed with Rickards as one factor in the simple algebra.

Now TD is getting aggressive? Wait OK, read this again:

you'd do the zh community a huge service

As if this is not already the case? 


Oh cmon...  I said they'd be doing us a service for that one thing, not that they're NOT already also awesome!  Ease up guy -- we're on the same team.

narnia's picture

Rickards didn't say the Fed would be able to monetize the debt with roll overs from a $3T balance sheet.  He said they would have adequate liquidity to keep interests rates low (shaping the yield curve). He also said that they never put a maximum on QE2, so further expansion did not have to be in the form of QE3.

If China or Japan dumps securities or inflation comes in hot, obviously they won't be able to keep a lid on rates.  But, if it's just existing Treasury issuances + 2011 deficit, the Fed probably does have enough to purchase on the margin to temporarily keep interest rates down at the peril of the $.

This isn't a matter of ZH being correct or Richards being correct.  Both can be correct.  If we are still staring at this same scripted yield curve next year at this time (without a major Fed balance sheet expansion), that will tell the tale.  Seems to me that they'll be too many forces pushing rates up, but I would have said that this time last year as well.

ivars's picture

Japan may rise nuke accident severity level to higest 7 from 5!

Took them some time to count the radioactive releases.



SheepDog-One's picture

'Damned if you do, damned if you dont' time.

jus_lite_reading's picture

Yup! That is why this ends badly for them banksters!

strannick's picture

In this corner..Tyler 'ZH' Derdan. And in this corner...Jim 'Roll-over' Richards. And refereeing, with the bulbous red nose, and striped blooperpants, The Bernanke! Oops, Durdan just grabbed the clown and piledrove him into the mat, while Richards flies in with an elbow to the head from the top rope. The clown's seeing stars and looks confused, but continues to formulate monetary policy nonetheless

dalkrin's picture

Stick-boy Timmeh enters the ring, repeating "Dear Mr. Leader", as he assists Bernanke back to his corpulent eminence.  The Bernank, with quivering lower lip, claims that according to his PhD thesis, Keynesian theory implies both contenders are disqualified, and to be sent to the silver mines under Blythe.

truont's picture

and cash outlay [from] the Fed ends up being a revenue item for the Treasury!

Isn't Enron accounting the best!

Cone of Uncertainty's picture

We have a winner--yeahhhhhh chicken dinner.

Treasury sells to PD's, PD's get digital dollars from Fed, Fed gets interest pmt's from Treasury, Fed remits back to Treasury, what it got from Treasury.

Fucking priceless.

LawsofPhysics's picture

Assuming no QE3.  Hhhmm.  The name will change, the QE3 (really QE4 now) will come.

Cone of Uncertainty's picture

It puts the QE3 lotion in the basket.

It does this whenever it is told.

Hot Shakedown's picture

I believe Jim Rickards started this meme that QE3 was not essential in his most recent discussion on King World News. I am not capable of offering an opinion on either side of the argument. Did you hear Rickard's case?

DonutBoy's picture

Is this in response to Rickards?  Why are the other loans irrelevant - would their proceeds not be used to buy treasuries?

Either way - I don't think QE can be closed out.  The second chart in this article is pretty dramatic:


Tyler Durden's picture

Two reasons: i) there is a total of $18 billion on the Fed's BS of "other loans", and ii) the Fed does not have a mandate to monetize these loans. On the other hand, the latter never stopped the Fed before...

Monetary Lapse of Reason's picture

Tyler,  Unless I am missing something, you are still not addressing one of the points
Rickards made in his second KingWorldnews interview, namely that the FED can sell something on it's balance sheet that is not maturing soon, buy back something maturing in a month or two.. then have that (increased) amount available for QE rolls.  I realize this could not go on forever.. but he seems to have a point there.  Just looking at the current maturity schedule could be misleading, no?    

Monetary Lapse of Reason's picture

In to the "market".  When you don't care about making a profit.. you can sell anything.  

Double down's picture

I guess they could sell or swap but fuck, who would want to be the counter party to that shit.  It screams "party over boys, time to carry some real risk".  In fact it would be counter productive as putting out the fire in one spot will light another up further down the curve.

And then, so what, 1.6 trillion or so is coming down the pipe.  Were I a PD I would charge the fuck out of them to hold that bag.  PDs do not do social service and the currency risk alone seems nuclear. 

Tyler Durden's picture

The Treasury sells debt. For the Fed to "sell" debt means it would need to start unwinding the asset side of its balance sheet. All $2.9 trillion of it once QE2 is over. That's $2.9 trillion (and probably more due to near record margin debt again) that will come out of the S&P.

That won't happen.

Correction: it won't happen unless oil is above $200.

tmosley's picture

Why do you think it would happen at oil $200?

By that time, the MSM will be talking hyperinflation, and people will literally be starving in the streets.  If anything, they would increase the monetization at that point, and pump the money directly into food stamp benefits.

There is no stopping the monetization train once it has started.  By the time the "engineers" see the brick wall, they are far past the point where they could have thrown on the brakes.  Their only hope is to pile on more speed and hope to break through.

Sadly, this never works.

greased up deaf guy's picture

"If anything, they would increase the monetization at that point, and pump the money directly into food stamp benefits."

all of the fed's measures to date have done nothing but hurt the bottom seventh of the population, so why would they start helping them now?

Clockwork Orange's picture

They just increased the benefits to the states last week to cover the Snappies, a pseudo-admission that rising food prices cause people to be hungry. Unfortunately for the people just over the poverty line that do not qualify, they now pay an elevated portion of their income for food.  

Too bad, they lose I guess.  Along with every saver in the god-damn country.

When are Ben and his minions tried for treason?

Certainly, they at a minimum will not be allowed to leave the country they are destroying?

Eternal Student's picture

As I recall from the interview on King World News, Rickards was throwing around a number in the range of $700-800 billion that the Fed had to play with here. It was never clear where he got that number from, and yes, it did seem excessive at the time. I have never heard how he justified this number; your article is the closest examination to date to date that I have seen. Thank you for it.

But note: even though the Fed doesn't have the money needed, it doesn't mean they won't try. Perhaps they are irrationally exhuberant about how well the stock market can stand on its own legs.

MarkS's picture

I get slightly different numbers starting from the 2.8T at the end of QE2:

Source            Annual        Mnth

Maturities         $141B        $13B

Prepaid MBS     $240B        $20B Refi and maturity rate at 2xs historic average rising rate enviroment

Coupons           $100B        $ 9B  4% avg coupon on 2.5T which is likely high

Total                $480B        $40B  40% of current QE2 rate

I think that the biggest source is also the one that is the most questionable.  If we go back to the period between QE and QE2 when the FED said they would roll over maturities and coupon payments they were about $400B or so annually (if I recall) which also fits the $300B they added into QE2.

So add in the new purchases and the slowing level of refis and I think that the 480B is as good an estimate as any.  And still, we are only at 40% of QE2 over a 12 month period...

Milton Waddams's picture

What impact has the increase in crude oil prices had on the finances of oil producing nations?  Probably just enough to cover a few quarters, and growing, of new debt I bet.