WASHINGTON/NEW YORK (Reuters) - The Federal Reserve's new economic stimulus plan involves printing vast sums of money to help people buy homes, but over the next year the program could do more to boost the economy by lifting stock prices.
The Fed said last week it would buy $40 billion every month in mortgage backed securities until the labor market improves substantially. The program, known on Wall Street as "QE3", will likely lower interest rates for mortgages and also help some people refinance their home loans.
Although the Fed's open-ended buying program represented an unprecedented bid to get the U.S. economy growing more quickly, many economists are skeptical it will have a big impact on housing market which is held back to a large degree by tight lending standards by banks. Mortgage rates are already near record lows, they point out.
But it is also quite possible QE3 will help the economy in other, potentially more powerful ways.
By giving an open-ended commitment to pour money into the market for mortgage-backed securities, the Fed will likely keep on supporting stocks and other asset classes by keeping returns low on MBS. Investors in search of yield will have more reason to buy equities and to lend money to companies.
Peter Hooper, an economist at Deutsche Bank in New York, thinks the Fed's bond buying program will add at least a half a percentage point to gross domestic product over the next year, largely by boosting stock prices and making people feel more wealthy.
"The main transmission mechanism is through the stock market," Hooper said.
Many economists believe people will spend an extra few cents for every dollar of wealth they gain. Because so many people have retirement funds connected to the stock market, a boost in share prices can lead people to spend more money.
Fed Chairman Ben Bernanke said on Thursday policymakers hope QE3 will help people buy homes, but he acknowledged the aim is also to boost asset prices like stocks and to make families and businesses more confident in the future of the economy.
"If people feel that their financial situation is better ... they are more willing to spend," he said.
U.S. stocks spiked more than 1.5 percent on Thursday after the Fed unveiled QE3, and closed last week near five year highs.
The Fed has previously completed two bond-buying programs, dubbed QE1 and QE2, that have expanded its balance sheet by about $2.3 trillion. After the first was announced in November 2008 during the height of the financial crisis, U.S. stocks initially spiked but then continued to decline until March 2009.
Since then, however, U.S. stocks have been on an upward trend, and Bernanke last month took some of the credit for the rally. "It is probably not a coincidence that the sustained recovery in U.S. equity prices began in March 2009, shortly after the (Fed's) decision to greatly expand securities purchases," Bernanke said in a speech in Jackson Hole, Wyoming.
The Fed is expected to buy a total of $600 billion of bonds under QE3, according to the median of forecasts from a Reuters poll.
Bernanke said the Fed would also like housing prices to go up, which would have a similar "wealth effect" on consumer spending as an increase in stock prices. The housing market, which crashed in 2006, has recently shown signs of recovery as home prices have started to stabilize. The pace of sales of existing homes is rising, although it remains about 40 percent below its 2005 peak.
Many economists, however, are unconvinced the bond buying will kick the housing market into a higher gear anytime soon.
On Friday, yields on MBS fell the most in one day since late October, according to Barclays. That will probably mean lower rates on mortgages, which the Mortgage Bankers Association estimates averaged 3.75 percent for 30-year fixed rate loans in the week through September 7.
Still, a lot of people will nevertheless struggle to qualify for loans. The 2007-2009 recession hurt many Americans' credit histories and many lenders now require sterling credit to qualify for a mortgage.
"Unless they have an unblemished credit record and access to a substantial deposit, most mortgage-dependent buyers remain sidelined by credit conditions," said Paul Diggle, an economist at Capital Economics in London.
He said QE3 will likely help the housing market. "Just don't expect it to mark a step change in the housing recovery," he said.
Michael Feroli, an economist at JPMorgan in New York, thinks QE3 could add a tenth of a point or two to GDP growth over the next two years.
"It's positive, but it's a marginal positive. I don't think it's overnight going to turn the housing market around," said Feroli.
Bernanke has cautioned that QE3 would not fix all the economy's ails, but he said a recent policy shift by housing regulators could help the Fed's bond buying program gain traction. The Federal Housing Finance Agency, which regulates the government-backed enterprises that guarantee most U.S. mortgages, said last week it would give banks more clarity on which type of mortgage loans they would be required to buy back if the loan sours. This could make banks a little more willing to extend mortgages.
"That is one factor that could make our policy more effective rather than less effective over time," Bernanke said on Thursday.
Yet even if QE3 doesn't quickly give the housing market a big boost, there are probably good reasons for the Fed to target mortgage backed securities.
Keeping rates low could help protect the modest gains seen recently in the housing market, which is a big store of wealth for many households.
Ryan Sweet, an economist at Moody's Analytics, expects QE3 will add about 0.3 percentage point to economic growth per year, mostly through the wealth effect until job creation picks up and people have more money to spend buying houses.
It is important, he said, to keep mortgage rates low until that happens.
"They need to keep them rock bottom until the job market turns around, because that's when you're really going to get the benefit to the economy," said Sweet.
Additional reporting by Richard Leong in New York; e