"Quantitative easing" program let households spend more during the last recession. Could it work again?
A new study shows that the central bank tool known as quantitative easing helped consumers substantially during the last big economic downturn - a finding with clear relevance for today’s pandemic-hit economy.
The introduction of quantitative easing during the Great Recession was a notable expansion of the tools used by central banks. Rather than limiting its holdings to treasury securities, the U.S. Federal Reserve’s purchase of mortgage-backed securities - bonds backed by home loans - gave it more scope to boost the economy, by lowering interest rates in another area of the bond market.
The first round of quantitative easing, QE1, which began in November 2008, included $1.25 trillion in mortgage purchases. The second round, QE2, which started in September 2010, focused exclusively on treasury securities. The third round, QE3, was initiated in September 2012 and was a combination of mortgage and treasury security purchases.
To conduct the study, the researchers drew heavily on a database from Equifax, the giant consumer credit reporting agency, which includes detailed individual-level information about mortgages. That includes the size of individual loans, their interest rates, and other liabilities. The database covered about 65 percent of the mortgage market.
"It basically allowed us to trace the flow of Fed mortgage purchases down to individual households - we could see who was refinancing when the Fed was intervening to make interest rates lower," Palmer says.
The study found that refinancing activity increased by about 170 percent during QE1, with interest rates dropping from about 6.5 percent to 5 percent. However, the Fed purchasing activity was highly focused on "conforming" mortgages - those fitting the guidelines of the GSEs, which often mandate having loans cover no more than 80 percent of a home’s value.
With the Fed not aiming its resources at nonconforming mortgages, much less refinancing occurred from people with those kinds of home loans.
"We saw a really big difference in who seemed like they were getting credit during quantitative easing," Palmer says.
That means QE1 bypassed many people who needed it the most. Consumers with nonconforming mortgages, on aggregate, were in worse financial straits than people who could put more equity into their homes initially.
Checking the data geographically, the researchers also found that much less refinancing occurred in the "sand states" where a huge number of subprime, nonconforming mortgages were issued - especially Florida, Arizona, Nevada, and the Inland Empire region of California.
"People who are outside the conforming mortgage system are often those who need help the most, whether that’s because their loan size is too big, or their equity is too small, or their credit score is too low," Palmer says. "They often needed the stimulus most and yet couldn’t get it because credit was too tight."
Take it easy
Given both the success and targeted nature of QE1, Palmer suggests that future interventions could be broadened.
"One of our takeaways is that if the Fannie and Freddie requirements can be temporarily loosened, then Federal reserve QE purchases can do a lot more good, because they can reach more borrowers," Palmer says.