In spite of all the media reports which say so, the Federal Reserve did not “end” QE yesterday. QE, the Fed’s massive manipulation of the bond market and credit allocation scheme, will not be at an end as long as the Fed’s balance sheet continues to be bloated. Although the Fed has decided not to increase the bloat further, it has not even stopped new purchases of long-term mortgage-backed securities and government bonds. The Fed wants to maintain the size of its QE bond portfolio, so it intends to make new buys to replace any principal reductions or bond maturities. Thus the $4.5 trillion balance sheet rolls forward.

In that $4.5 trillion of Fed assets are $1.7 trillion of mortgage-backed securities, funded by short-term deposits, making the Fed the biggest savings and loan in the world. This would have been considered impossible by generations of Fed officials, not to mention the fathers of the Federal Reserve Act. It represents a giant government credit allocation to the housing sector. Likewise, the $2.3 trillion of long-term government bonds in the portfolio represents a giant credit allocation to government deficits. Oh yes, QE lives on, though it may not be growing.

When will QE actually be at an end? When the Fed’s balance sheet gets back to normal size and composition. This means about 25% of its current size, with a reasonable amount of short-term Treasury bills, instead of none, and with no mortgages.

That would take selling a really lot of bonds and MBS—not likely, especially if interest rates go higher and the Fed is taking losses on the sales. Or it would mean waiting for a lot of very long-term securities to mature. So the end of QE is a long time from now.

At that time, when QE has actually ended, will it be judged a success or a failure? Nobody, including the Fed, knows.



Alex J. Pollock is a resident fellow at AEI.