The Fed's Stimulus Starts To Work—Three Years Later

Call it a slow-release stimulus.

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Slipping indicators may nudge Federal Reserve Chairman Ben Bernanke and his colleagues at the Fed to take action.

Call it slow-release stimulus: More than three years after the Federal Reserve first began "quantitative easing," the strategy may finally be starting to have the intended result.

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The Fed started its unusual bond-buying program at the end of 2008 and ramped it up in the first half of 2009. Since then, it has continued QE in a variety of forms. The plan is basically to buy a ton of bonds, in order to accomplish two things: First, force investors to put their money into riskier assets like stocks, as the Fed's huge demand for bonds drives down yields. That part worked: Since bottoming out in March 2009, the S&P 500 stock index has risen by 103 percent.

The other part of the plan was to push down mortgage rates, which are closely linked to the interest rates on bonds. But lower mortgage rates only stimulate the economy if consumers take out new loans, either to refinance the mortgage they have or to buy a home. That's where the scheme broke down.

Many consumers have simply been unable to take advantage of the low rates engineered by the Fed, because skittish banks spooked by a weak economy won't lend to them. So while mortgage rates have fallen to near-record lows of about 3.7 percent, home owners with a mortgage are still paying an average rate of about 5 percent, according to investing firm Jefferies.

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Home buyers, meanwhile, have been sitting on the sidelines, waiting for prices to stop falling and the economy to pick up. Even buyers who do qualify for a loan have been on hold, as they worry about job insecurity or making a big financial commitment amidst so much uncertainty.

But two things may finally be happening that will let more consumers take advantage of low rates. First, there's convincing evidence that home prices have hit bottom, six years after they started falling. Prices aren't likely to skyrocket any time soon, and they may still fluctuate near low points. But in many markets, home prices are back to levels of 2002 or 2003, before the housing bubble inflated prices.

Second, banks have started to ease up on lending standards. The latest survey of banks by the Fed shows that banks are more comfortable granting most types of consumer loans, as the economy gradually improves and a lot of Americans pay off old debt. Banks are still tight with mortgages, but that should change as fears about homes losing value recede. "There's a growing consensus that the housing market has bottomed out," says Keith Leggett, senior economist at the American Bankers Association. "That gives lenders a lot more confidence when extending loans."

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More buyers are applying for mortgages, too, with applications for refinancing close to a three-year high, according to the Mortgage Bankers Association. In the Fed's latest survey, the percentage of banks reporting higher demand for mortgages is the highest since 2009—when a temporary home-buyer tax credit artificially boosted demand. Absent that spike, the numbers in the Fed survey would be the highest since 2003.

This may signal the start of a self-reinforcing pickup in the housing market, which economists have been looking for since the recession officially ended in 2009. As prices stabilize, more banks will lend and more buyers will materialize, in turn firming up prices and boosting demand even more. That's how it's supposed to work, anyway.

Many economists expect the Fed to announce a third round of quantitative easing—perhaps in September—to further aid an economy that's getting weaker when it ought to be getting stronger. But the first two rounds still haven't kicked in completely. If they do, better late than never.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.