First we need to look at what the Federal Reserve statement actually said. Here's the key part about what they're going to do.

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

So the bottom part says they're just going to continue what they've been doing, and hasn't been working for awhile, and the top part is the new and supposedly stimulative part. They're going to buy Mortgage Backed Securities at a rate of $40 billion/month, until hell freezes over, or unemployment drops, or they change their minds.

By now, just about everyone knows what a mortgage backed security (MBS) is. For those that dont, I like to think of them as a whole bunch of mortgages that have been put in a blender, then the mess is divided into a bunch of portions and each portion is sold off like a bond.

Here's where the problem lies. I'm sure a lot of people are thinking that because the FED is going to buy $40B worth of MBS a month, that somehow that's a lot like buying $40B worth of new mortgages a month, and that it will cause a huge amount of new houses to be built. Well unfortunately, that's not remotely the case.

Lets do what Bill Clinton asks us to do, the arithmetic.

According to the census bureau August new home sales were at 372,000/year, or about 31,000/month. The average new home price was roughly $263,000. So if all of these sales were fully mortgaged (which they most certainly are not), and if all the mortgages were converted to MBS, which most probably are, what would this add up to?

31,000 X $263,000 = $8.153 billion.

So even if the Federal reserve were to buy every single MBS produced from every single new mortgage, it would still be a small fraction of the $40 billion they say they're going to buy. So the VAST majority of the $40 billion they're going to spend on MBS is going to be on OLD MBS.

Everybody raise their hand who has some MBS they can sell to Ben Bernanke. What? You don't own any MBS? Well neither do I, and I don't know anyone who does own a MBS. So who does own them, and how are they going to use the money they get from selling them to the FED?

Well, if you remember back in the panic days of 2008, what was it that actually got all the banks in trouble? Right! Their MBS and credit default swaps (bets on MBS) were going bad in a big way. So we know that big banks own MBS, but so does FANNIE and FREDDIE, and hedge funds, and big foreign investors...

Here's one example of a Wall Street type that owns a lot of MBS, the big bond company Pimco. According to Zero Hedge, back in January, Pimco borrowed $88 billion to buy MBS, because they figured Bernanke would do exactly what he just did.

Regular readers of Zero Hedge know that in recent months tracking the portfolio and thoughts of one Bill Gross via the holdings of his flagship Total Return Fund (which just jumped by $6 billion in the past month and is just shy of its all time record north of $250 billion) has meant one thing and one thing only: betting on the Fed monetizing Mortgage Backed Securities or bust. Well, in January he just took it to a whole new level. The fund has now borrowed a record $88 billion, or -35% of its AUM, in cash (shows how much he thinks of the dollar) and used the proceeds (together with dumping European sovereign bonds from 18% to 11% of AUM) to bet on MBS which now stood at a whopping 50% of the entire portfolio - the highest since July 2009 when QE1 was in full force. However, in absolute dollar terms, due to the growth of the fund's AUM, the actual bet on MBS has never been bigger, and at $125 billion, represents the biggest notional bet ever made by PIMCO. Treasury holdings of just over $100 billion with an effective duration of 6.33 complete the epic bet that the fund has now put on QE3.

So will buying $40 billion worth of MBS from Wall street investors lower Mtg rates? Probably a little, but will that cause people to go out and buy a lot more houses? Here's what some analysts in this article from the New York Times are saying.

...
“The incremental benefit of slightly lower mortgage rates will be small,” wrote Paul Diggle, a property economist at Capital Economics, an international research firm, in a note to clients.

“After all, most borrowers in a position to refinance have probably already done so. And it’s not obvious why a would-be buyer who wasn’t tempted by a 3.7 percent mortgage rate would be by, let’s say, a 3.25 percent rate,” he wrote.

...

Jed Kolko, the chief economist at Trulia, a real estate analytics firm, anticipated a muted effect on sales.

“The big obstacles for people who want to buy are saving enough for a down payment and qualifying for a mortgage, because credit is still tight,” Mr. Kolko said, saying that the Fed program would not directly address those problems.

So lowering interest rates a little won't make much of a difference. The big question becomes, what will all those Wall Street investors do with the money they'll get from selling those MBS (after they took a big jump this week) to the Federal Reserve. Will they invest it in new companies, or new technology, or hire a bunch of people...? Not likely. Corporations are flooded with cash, and Wall Street investors have recovered almost everything since the depression of 2008 began, and yet they've done nothing to help the productive economy, and have simply found new ways to place bigger and riskier bets.

Another huge problem with this approach is, it's too little and the wrong kind of QE. This is very similar to what happened with the stimulus. It was too small and misdirected toward tax cuts, and although it stopped the economic slide, it wasn't nearly big enough to get the economy growing on it's own. The Republicans are shouting about how big of a failure the stimulus was, so you can imagine what's coming when QE3 doesn't work because a whole lot of money is going to people who already have a whole lot of money.

If QE3 fails because it's too little and misdirected, which I think it is, the Republicans will shoot down any further chance of monetary policy, just like they've shot down any further chance of fiscal policy. If these timid approaches to both fiscal and monetary policy lead to a forced abandonment of Keynesian style stimulus, we are going to be in deep, deep trouble. The only good thing I can see with this is, the belief that it will work may very well help reelect President Obama.

Ben Bernanke will give $40 billion a month to the casino on Wall street, and he'll cross his fingers and hope they'll invest to create jobs. I'm not betting on it.