QE3 Is Still Coming
That doesn't mean that there won't be another round of easing. It's just that the March 13 meeting was not the time to discuss it. In fact, I continue to believe there will be more easing, both quantitatively and through duration extension of the fed's balance sheet; and that ultimately this will require the Fed to double its balance sheet again from the current level of about $2.6 trillion.
To date, the Fed's balance sheet has nearly tripled from where it was (around $850 billion) before the subprime crisis ensued. In the process, the Federal Reserve also expanded the kinds of assets it carries on its balance sheet from being almost exclusively Treasury debt to include government-sponsored enterprise (GSE) debt and mortgages, as well as non-GSE mortgages and mortgage-backed securities.
This process provided the banks with liquidity and prevented the banking and mortgage markets from seizing. It also gave the federal government access to funds through the banks, which it used to meet fiscal stimulus objectives by selling Treasury notes.
In the process, the Fed provided a capital bridge to the banks and the federal government. The federal government was supposed to use the funds made available through the issuance of new Treasury securities to stimulate economic activity that would provide a multiplier to the private economy that would be in excess of the government's spending.
Simultaneously, the banks were supposed to use this bridge to repair their balance sheets, raise private sector equity capital if necessary, and expand their lending to productive enterprises. The goal was to create income for the banks that would allow for the absorption of the known losses that needed to be taken on their real-estate related assets and allow for the unwinding of the repurchase agreements entered into with the Fed in swap for the illiquid mortgages.
While this was going on, the legislative and executive branches were supposed to be engineering a path for the economy to absorb the losses related to the real estate bubble collapse so that housing would stabilize. This would have helped to increase consumers' and investors' confidence.
To date, almost none of this has happened to the extent necessary for the economy to grow. The banks and the federal government have used the funds afforded by way of an expanded Fed balance sheet to punt the structural issues facing the banks and the economy into the future. Apparently, the expectation is that eventually the housing crisis and associated losses would be absorbed naturally by the economy and without concerted effort.