Today I have answers to reader questions on what the Fed is doing, whether new mortgage rules apply to private lenders and loans for students attending college outside the United States.
Q: Victor T. writes, "I have been wondering where the Federal Reserve gets all that money to buy $80 billion worth of bonds. I'm getting hints that they're printing it, but if so, how are they keeping track of it?
"How will they deal with the inevitable, or will they not ever have to deal with a 'day of reckoning'? I understand they got the authorization to do this in 2008, but I don't recall hearing anything concerning an event of such major significance."
A: Yes, the Fed is essentially creating or printing money to buy longer-term Treasury and mortgage-backed bonds under a series of programs known as quantitative easing. It began the first round in November 2008 after its traditional tools, such as lowering short-term interest rates to near zero, failed to revive the economy.
The goal is to lower longer-term interest rates and stimulate the economy (especially housing) by putting more money into the hands of banks and investors.
As an independent entity, the Fed did not need authorization from Congress or the president to undertake this unprecedented action.
The Fed is now on its third bond-buying binge. All have been announced in news releases, though not always in ways a layperson could understand. In this round, it is buying $85 billion worth of bonds per month. Unlike the two previous rounds, this one does not have an end date, which leads to endless speculation about when the Fed will begin to taper its purchases.
This bond buying has caused an explosion in the Fed's balance sheet, which you can see in a dramatic chart from the Cleveland Fed (http://tinyurl.com/c3awms). Before late 2008, the Fed kept its balance sheet steady, at about $800 billion in assets. Today it holds almost $4 trillion in assets.
Most of the money the Fed has created is sitting idle on bank balance sheets as excess reserves. Banks must hold a certain percentage of the dollars they take in as a reserve requirement. The rest, called excess reserves, can be loaned.
Before 2008, excess reserves in the banking system were negligible, as banks loaned out almost everything they could. Today, they exceed $1.8 trillion. You can track the buildup in this chart from the St. Louis Fed chart (http://tinyurl.com/pzqonnd).
Banks hold their required and excess reserves at the Fed. In October 2008, the Fed started paying banks interest on these reserves, which might have discouraged lending. Since 2009, the interest rate has averaged 0.25 percent.
If banks loaned out all of their excess reserves, it would be inflationary, says Peter Rupert, an economics professor at UC Santa Barbara. But as long as the reserves sit idle, "there is no day of reckoning."
Suppose the economy revs up, banks start lending like crazy and inflation heats up. The Fed could cool the economy by shrinking its balance sheet in several ways. It could stop buying new bonds, let bonds it holds mature without reinvesting the proceeds, or act more aggressively and sell bonds.
These actions would probably raise interest rates and put a damper on the economy and inflation. The Fed also could discourage banks from lending by raising the interest rate it pays on reserves.
Whether the Fed could pull this off without sparking another recession, or worse, remains to be seen.
"They have never been in this position," Rupert says. "We kind of think we know what's going to happen, but we are not positive."
Q: In response to my Sept. 16 column on mortgage-underwriting rules that take effect Jan. 10, Mike B. writes, "I am a real estate broker originating and servicing loans funded with private investors. I, and some of my peers, are uncertain as to whether the new rules will affect the private lending business.
"I tried to get a response from the Consumer Financial Protection Bureau, but was unsuccessful. Can you tell us if we are included with the normal lending institutions under these rules?"
A: The bureau would not answer this question directly but said lenders can find out if they are subject to the new rules by contacting its office of regulations at (202) 435-7700, or via e-mail at cfpb_reginquiries@cfpb.gov.
In general, the bureau's new ability-to-repay rule applies to most mortgages made on or after Jan. 10. But it excludes certain types of loans such as home equity lines of credit, time-share plans and reverse mortgages. Certain creditors are also exempt in some cases, but these are mainly nonprofits and community development organizations. For exemptions, see Pages 26 and 27 of the bureau's compliance guide at http://tinyurl.com/oxlqfx2.
Any lender can get greater legal certainty when they underwrite a qualified mortgage. To be deemed a qualified mortgage, the loan must meet stricter criteria than the ability to repay rule.
Q: Muna T. writes, "My son is in second-year medical school at the American University of Antigua in the Caribbean. He took out loans from banks, but the interest rate is around 9.5 percent, which is very high. Do you have any ideas of where to shop for better loans?"
A: In general, federal Stafford and Plus loans are a better deal than private loans from banks and other lenders. The rate on new loans taken out this year is 5.41 percent for graduate student Stafford loans and 6.41 percent for Grad PLUS loans.
But students can get them only if their school is eligible for federal student aid. Some overseas schools are, but it appears that the American University of Antigua is not. You can find a list of eligible schools at http://tinyurl.com/px84tbb.
"To be eligible for U.S. aid, the foreign schools must have signed a program participation agreement and satisfied certain requirements," which in some case exceed the requirements for U.S. schools, says Mark Kantrowitz, publisher of Edvisors.com.
For the reader, "private student loans may be the only option," he says. "U.S. students should be careful about enrolling in a foreign institution that is not eligible for US Title IV federal student aid. They should verify that the accreditation and education provide sufficient preparation to take and pass the medical boards and that they'll be able to obtain an internship and residency."
Deborah Fox of Fox College Funding says that "the only options that make sense would be the loan offered by the school and other personal loans offered by banks or credit unions. Credit unions usually offer the better interest rates."
She says the student "will almost certainly need a co-signer on the private loans. However, some lenders will release the co-signer after a certain number (such as 48) of on-time payments have been made."
Fox says a rate of 9.5 percent "is actually reasonable if the student hasn't established much credit or is not employed."
The parents also could consider lending funds to their student at a rate that is lower than the commercial loan rate but higher than what the parents are earning on the money. To be considered a loan and not a gift, the parents must charge at least the applicable federal rate, which you can find at http://tinyurl.com/o4jwfo2.
