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Ben Bernanke and the coming 5 to 10 years of taper effect

Fed Chairman Ben Bernanke began “Taper Talk”.

Part 1 of 3

Why does tapering matter?

Today we discuss the pending Fed tapering started by Chairman Ben Bernanke. Market reactions and the high volume of strydent commentary continue to confuse investors.

The U.S. Federal Reserve Bank continues to pump massive amounts of money into the economy. This stimulus program will have an end. That will be when the economy picks up and shows progress without needing the continuing massive Fed funding.

Tapering describes the planned slow reduction of that programed Fed spending. The current phase of the Fed program has them deeply involved in funding virtually all the mortgage market. The Fed continues buying mortgages at the rate of $85 billion per month.

Think of that program as buying or strongly influencing the purchase of virtually every 5 year mortgage bond available in the U.S. market

That massive Fed fund flow has kept the mortgage market alive. That keeps housing alive. That in turn keeps the economy alive. And that keeps the stock market alive.

What is normal?

In normal times mortgages are funded by private capital. A substantial portion of all funds raised in the bond market provide the capital for most mortgages. As part of the 2008 financial crisis that market collapsed.

To get the market going the Fed uses their massive spending power. The current immense purchasing program serves as an important part of the ongoing Fed economic stimulus program.

Fed stimulus turns housing

The Fed rescue led by Ben Bernanke succeeded in turning the housing market. As a direct response to the 2008 disaster, a time of massive bankruptcies and foreclosures, has slowly been put behind us. Now housing continues to revive with solid signs of growth.

As a result, the Fed now wants to get out of the mortgage business.

This will happen as private capital comes back to fund mortgages. Recent interest rate increases are part of the normal process of attracting more private capital.

The May announcement of the pending tapering gave the first indication that the Fed was preparing to move towards withdrawing from the market.

A bit of background

It helps your understanding to know the Fed and Chairman Ben Bernanke have a dual mandate. By using various economic and banking tools the Fed financially stimulates the market to encourage economic expansion or withdraws funds to inhibit economic growth and contract the economy.

The mandate requires the Fed to do what it can to stimulate full employment and control inflation. For practical purposes full employment generally means under 5.5 – 6% unemployment. Controlled inflation means annual price increases running over 2% but not significantly higher.

Given that employment continues to remain stubbornly below the guideline and inflation has remained fairly quiet, the Fed has no choice. They must keep pumping money into the market. That is the law.

Slowly change will come

Once the guidelines are eventually met, change will come but do not expect any sudden moves. Tapering will be slow. The Fed will very slowly ease off the stimulus. That tapering or easing will extend over many months and perhaps over a year later they will finally stop buying.

Then the massive inventory of mortgages on the Fed balance sheet will remain for at least another 5 years after the spending ends. The Fed program will certainly extend for 5 years minimum but could carry on for as long as 10 years yet.

Get used to it. This huge presence in the market will remain for some considerable time yet.

Tomorrow we will continue our discussion of the Fed.

When do you think the Fed program will end? Let’s talk about it.

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Bryan
White Top Investor
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