On Wednesday, the Federal Reserve unveiled its latest $267 billion effort to lower interest rates and make it cheaper for people and companies to borrow. The program is an extension of one the Fed launched last fall, nicknamed Operation Twist. Rates do appear to have dropped. The question is whether Fed's program will make banks want to lend. It might do the opposite.
At the Fed's press conference, chairman Ben Bernanke was asked whether he thought the extension of Operation Twist would affect the banks' willingness to make loans. "I have heard the argument by lowering interest rates, you make it unattractive to lend, " said Bernanke. "I don't think that is right." Instead, Bernanke argued that by lowering Treasury rates, Twist makes banks more interested in lending in order to seek higher returns, versus just parking their money in government bonds.
First of all, it's not clear that the choice banks are making is between government bonds and lending. Just ask the London Whale. But even by Bernanke's logic, Twist may be failing. Back in mid-August when the Fed started hinting about Twist, the spread between 10-year Treasury bond rates and the average mortgage loan was 2.3 percentage points. The spread today: 2.3 percentage points, which means it's not any more profitable for banks to lend out money today, as apposed to holding onto relatively risk-free Treasuries, than it was 10 months ago.
QE2, on the other hand, did seem to have an effect on lending profits. But it's not clear it was a positive one. During QE2, the difference between mortgage rates and Treasuries actually dropped to 1.7 percentage points, from 2.2, making lending less profitable. But that may have actually been a win for Bernanke. The drop in the lending spreads may have indicated that banks were willing to make loans, even at lower profits.
But whatever way you look at it, it doesn't appear Twist is having a similar effect. Bank lending, for instance, fell in the first quarter of this year, and is up only 1% from what it was in the three months before Twist was launched. That may make sense given how weak the economy has been. But in terms of the Fed's stimulus program, that's not a great twist.
Keeping interest rates near zero doesn't help much if people are too spooked to spend. A more radical solution may be in order.
By John Cassidy, contributor
FORTUNE -- Can Ben Bernanke pull the U.S. economy out of its double dip? Some investors are betting he will. The Fed's announcement that it intends to keep short-term rates close to zero until mid-2013 was widely interpreted as a signal that further action is MOREAug 22, 2011 5:00 AM ET
How low would stocks have to go to bring Ben Bernanke off the sidelines?
A 17% drop in the U.S. blue chips would probably suffice, say big fund managers surveyed this month by Bank of America Merrill Lynch.
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What do surging bond prices and tumbling bank stocks tell us about the economy?
Nothing good, posits Gluskin Sheff economist David Rosenberg. He notes that over the past two months, with the stock market pushing toward its highs, the KBW bank stocks index has tumbled 12%, while 10-year Treasury yields have dropped 40 basis points to a recent 3.17%.
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For all the attention policymakers have placed on the Fed's actions over interest rates, the cost of borrowing is far from the problem.
FORTUNE – In textbook economics, lower interest rates typically spur higher investments. Money is cheap. So the assumption is that people, banks and companies will spend more, therefore helping the economy grow.
But that doesn't always work. Sometimes cutting the rate of interest, even to zero, won't necessarily pull MORENin-Hai Tseng, Writer - May 9, 2011 11:27 AM ET
Higher oil prices are igniting a fierce debate inside the Fed: Will continuing QE2 lead to higher inflation, or will it prevent it?
Up until recently, there was pretty overwhelming support by central bankers to keep U.S. interest rates low by buying up bonds in a second round of quantitative easing with the goal of boosting our slow-growing economy.
But the debate over the right policy prescription is about to get MORENin-Hai Tseng, Writer - Mar 9, 2011 12:04 PM ET
The economy is finally starting to move forward. But don't be shocked to see stocks go the other way.
Friday's jobs report shows welcome evidence that the struggling real economy is starting to catch up with our roaring, Fed-backed financial markets. Nonfarm payrolls rose by 192,000 jobs in February, the biggest gain since last May.
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Kansas City Federal Reserve Bank President Thomas Hoenig has a message for Ben Bernanke, and he's not afraid to say it over and over: Raise rates.
At a party where it feels as though virtually nobody is having much fun, how soon is too soon to take away the punch bowl? When the spiked goodness sets everyone in easy laughter? Or even sooner than that?
If Kansas City Federal Reserve Bank President Thomas Hoening MORENin-Hai Tseng, Writer - Mar 2, 2011 3:27 PM ET
Bill Gross says stocks and bonds could be in for a world of hurt this summer.
Gross, who runs the world's biggest bond fund at investment manager Pimco, said in his March investment outlook that when the Federal Reserve's quantitative easing program ends in June, bond yields are likely to go "higher, maybe even much higher."
That will spell pain for bondholders because rising yields reflect falling prices. But it could also MOREColin Barr - Mar 2, 2011 10:56 AM ET
It's getting more expensive to eat around the world. But there are bright spots -- a few food staples have remained relatively steady in price even as inflation sweeps the globe.
At the start of this year, global food prices hit a record high, according to the United Nations. The trend is worrisome – not only for the millions of unemployed Americans struggling to recover from the latest economic recession, but MORENin-Hai Tseng, Writer - Feb 9, 2011 5:00 AM ET
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