Wednesday, October 30, 2013

Eugene Fama on Fed Tapering: "It's a Net Neutral"

My wife and I are headed to Charlottesville, Virginia tomorrow to visit our daughter Caroline for the weekend. Caroline is a second year student at the University of Virginia.  My next post will be Monday, November 4.

Nobel Prize winner Eugene Fama was interviewed by CNBC's Rick Santelli earlier this week.

In his usual hysterical fashion, Santelli was trying to get Fama to say that interest rates were set to soar once the Fed ends its "Quantitative Easing" (QE) program.

Problem was, Fama doesn't believe it.

As you will see from the interview, Fama notes that he has been doing research on the possible effects on the credit markets once the Fed starts reducing its holdings of longer term Treasurys.

Fama doesn't believe the markets will be as roiled as Wall Street believes once the Fed stops buying.

He points out that the purchases of Treasurys have been financed by the Fed's borrowing activities in the short term market.  Thus, the $4 trillion in Treasurys that it holds have been financed by $4 trillion in borrowing.  Reducing one side of the ledger also reduces the other side, so the net effect should be relatively neutral.

Here's how Business Insider wrote about the exchange:

Santelli asked specifically about the effects of the Fed's quantitative easing program and the risks associated with it.

"What they are doing... the effects are being greatly inflated by the accounts," said Fama.

"What they've doing is issuing a lot of short-term debt — $85 billion a month — and using it to buyback long-term debt with the goal of lowering the interest on long-term debt," he added. "Now they take credit for lowering interest on short-term debt. But in fact what they've been doing should've raised rates on short-term debt."

Fama argued that the Fed was not affecting the economy that much.

Santelli, however, continued to pursue the idea that there are risks associated with the Fed's actions.

"They're basically neutral events," said Fama. "I don't think they do very much."