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.