This week Ben Bernanke announced his well-telegraphed QE2: $600 billion in fresh buying power, and the re-investment of roughly $300 billion.
While the move may be beneficial economically, there was far more to be gained by a surgical strike than the broad strokes of buying Treasuries.
Bernanke could have used some of his dry powder to directly address the US consumer and the cost of existing debt.
So much of consumer debt is tied to the prime rate, yet the Fed chief has not looked to lower it to free up cash-strapped consumers.
The prime rate is, per the Fed, the “rate posted by a majority of top 25 insured US-chartered commercial banks.” Prime is one of the base rates used by banks to price short-term business loans.
More commonly, it refers to the prime lending rate calculated by the Federal Reserve and published daily.
The prime rate stands at 3.25 percent, which is the Federal Funds rate plus 3 percent, and has not changed since Dec. 17, 2008.
As the name implies, the prime rate is for highly qualified borrowers.
It is used in calculating changes to adjustable rate mortgages (ARM), small business loans and other variable-rate short-term loans such as auto and student loans.
Many credit cards and home equity lines of credit have their rates specified as the prime rate plus a fixed value, commonly called the spread or margin.
So if Bernanke wanted to help out the consumer and have a direct economic impact on the vast majority of Americans, he could flex his monetary muscle with the banks and ask them to reduce the prime rate by 0.75 percent to free up consumer spending.
Lowering the prime rate would allow QE2 to reduce the borrowing costs of consumers and instantaneously help their balance sheets, which is where one of the economy’s biggest problems resides.
Some of the extra money in consumers’ pockets could find its way to stores and malls during this holiday season.
To date, Bernanke has clearly been the only adult in the room when it comes to economic policy. For the economy to have sustained meaningful growth in gross domestic product and employment, we need to foster an environment where consumers and businesses are encouraged and supported — not blamed — for Washington’s unfortunate policy decisions.
When we look at QE2 in its delivered form, it is a plus for the economy — buying $600 billion of anything pretty much is — but it misses the mark in a couple of respects.
A notable omission is it does not aid the failing mortgage market as directly as it could have.
So while using $600 billion, plus the rollover of about $300 billion of maturing issues the Fed already owns, to purchase Treasuries is helpful, it’s not optimal.
For starters, the Treasury market is extremely healthy and robust with interest rates very low and volumes very high.
Treasuries don’t really need a boost. Logically it is better to treat an open wound than one that’s already healed.
Perhaps a mortgage purchase program of $400 billion wouldn’t have had more of an impact on the US economy than $600 billion in Treasuries will, but both have their political pitfalls. Treasuries directly affect the dollar and numerous currency markets around the world.
Retooling the prime-rate calculation is not a simple thing, but it is an economic adjustment that this Fed could engineer and handle. Understandably, the prime rate is not the Fed Funds rate, so this would have to be directed to the major banks.
However, compared to taking over AIG and Bear Stearns, this is a highly achievable nuance that would make a major economic difference.
The US cannot have a vibrant self-sustaining economy until unemployment is below 7 percent. Markets may do well with a 7 percent unemployment rate, but 7 percent is still too high and, with an economic slip, we could be near double digits very quickly.
We need GDP north of 4 to 5 percent for several quarters and millions more jobs. That will only come with real growth.
With an unemployment rate still at 9.6 percent, the Fed is doing the right thing, but we would have preferred a form of easing that was more qualitatively rich than quantitative.
Jonathon M. Trugman is the President of Pendulum Capital Management.