Explaining quantitative easing, bonds and what it means to you

We’ve heard a lot of talk about our US debt, bonds and quantitative easing lately. But few understand the workings behind the words and what it means to us individually.

When the US government, local municipalities (or you) spend more money than we have on hand we need to borrow from someone — but borrowing is not free — we pay a premium to borrow.

It’s true. Money doesn’t grow on trees or appear out of thin air — except in quantitative easing — but we’ll get to that later.

Every borrower has a lender. The money comes from someone else.

You can only do two things with money: buy stuff or not (i.e. stockpile/save). A borrower buys stuff by borrowing from the person who saved. The borrower pays a premium for money while the saver (lender) gets a premium for his money.

A lender receives payment for letting others borrow their money. If you put your money in a CD or savings account you receive interest because YOU are now a lender.

A borrower, basically, may use a credit card while the government or municipality will issue bonds in anticipation of future revenues. A fee or interest rate is attached to the privilege.

On a municipal level, the city, county, redevelopment agency, school district, public utility district, or publicly owned entity may issue bonds or short term notes. But it’s not free money.

Should you live in a city that you voted to OK the issuance of bonds, you are now responsible for the added cost (interest) for the privilege of the city to borrow money it does not have. Because your city functions through fees and taxes imposed on you to run, YOU are now the borrower. The city will pay a premium for the bond and will have to generate that premium through higher taxes and fees it gets through you. The people who buy the bonds (called bond holders) are the lenders and they will receive a handsome premium for investing (i.e. saving) in bonds.

Now about Quantitative easing… it’s a policy used when normal methods to control the money supply have failed. It has been termed the electronic equivalent of simply printing money. Read what the rest of the world thinks of the QE2

In the current situation, the Federal Reserve will be buying $600 Billion in treasury bonds.

The Federal Reserve (the “Fed”) is the central banking system of the United States. The US Department of the Treasury creates the currency the Federal Reserve uses.

Read it again: The Fed is using money printed by the Treasury to buy Bonds for sale by the Treasury.

It would be like vender selling energy drink. He has a pitcher of energy drink that he’s selling by the cup. The pitcher is now half full and he decides to top it off with water. The energy drink is now diluted and the new buyers are only getting half as much energy benefit but it looks the same and costs the same.

Likewise with your money. Inflation (watering down) will set in and you will have much less “buying power” for your dollar.

In the case of all the failed mortgages? Someone lent the original amount of money to the borrower. When homes default the lender is “out” that amount of money. It would be like you borrowing $100 from your mom and not paying her back.

Most mortgages are held by Fannie Mae and Freddie Mac — the two companies buy home loans from lenders. Fannie Mae stands for Federal National Mortgage Association and  Freddie Mac stands for Federal Home Loan Mortgage Corporation.

It would be like saying your child guaranteed the loan made to you by your mother. You borrowed the money but never paid it back so your child will pay your mother back for you. YOU got off scott free while someone else had to pay off your debt.

All those failed mortgages? The someone who lost all that money is now you, the taxpayer. You’re now responsible for the debt because the government guaranteed them. YOU guaranteed your neighbors home loan.

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