A Painful Effect of the Ultra Low Interest Rates

27.08.2010
When people talk about how Washington has helped its friends on Wall Street (and elsewhere) at the expense of the little guy, the discussion usually centers on taxpayer-funded bailouts and the various liabilities taken on by the government (think AIG and Fannie Mae) that are bleeding the public coffers dry. But that is not the …

When people talk about how Washington has helped its friends on Wall Street (and elsewhere) at the expense of the little guy, the discussion usually centers on taxpayer-funded bailouts and the various liabilities taken on by the government (think AIG and Fannie Mae) that are bleeding the public coffers dry.

But that is not the only way that the masses are getting shafted. Other policies that have been described as good for the economy as a whole have had unwelcome consequences. Aside from delaying the inevitable and creating even bigger imbalances than those which spawned the financial crisis to begin with, ultra-low interest rates are costing Americans who have taken a responsible approach to managing their finances a lot of money, as the New York Times’ Gretchen Morgenson reports in Debt’s Deadly Grip:

For consumers who are cutting debt and trying to save, it is dispiriting…that they generate so little on their money. Those living on fixed incomes are also in a bind.

It is not lost on these consumers that their minuscule returns are a direct result of the Federal Reserve’s attempt to shore up troubled banks’ financial standing. Sharply cutting interest rates vastly increases banks’ profits by widening the spread between what they pay to depositors and what they receive from borrowers. As such, the Fed’s zero-interest-rate policy is yet another government bailout for the very industry that drove the economy to the brink.

Todd E. Petzel, chief investment officer at Offit Capital Advisors, a private wealth management concern, characterizes the Fed’s interest rate policy as an invisible tax that costs savers and investors roughly $350 billion a year. This tax is stifling consumption, Mr. Petzel argues, and is pushing investors to reach for yields in riskier securities that they wouldn’t otherwise go near.

In short, the Fed’s interest rate policy may be causing more economic problems than it’s solving.

Here’s how Mr. Petzel calculated the amount that savers are losing: Some $14 trillion in debt issued by the Treasury, federal agencies and municipalities is held by investors here and overseas. Rates are currently near zero on short-term Treasuries, compared with an average of 3 percent over time. Therefore, Mr. Petzel says, it is reasonable to estimate that rates are too low by 2.5 percentage points. On $14 trillion, that’s $350 billion a year in lost income.

Yes, we’re talking real money. It’s more than 2 percent of gross domestic product and almost 3 percent of disposable personal income, Mr. Petzel noted.

“If we thought this zero-interest-rate policy was lowering people’s credit card bills it would be one thing but it doesn’t,” he said. Neither does it seem to be resulting in increased lending by the banks. “It’s a policy matter that people are not focusing on,” Mr. Petzel added.

One reason it’s not a priority is that savers and people living on fixed incomes have no voice in Washington. The banks, meanwhile, waltz around town with megaphones.

Savers aren’t the only losers in this situation; underfunded pensions and crippled endowments are as well.

Of course, the federal government is a huge beneficiary of low rates; if they were higher, our already ballooning deficits would be heftier still. Nevertheless, raising interest rates a bit would be beneficial on several counts, Mr. Petzel maintains. It could help increase consumption and would reduce the appeal of higher-yielding and dicier investments.

The Fed may be fearful, Mr. Petzel surmised, that higher interest rates could push some teetering banks off the cliff. “But saving a few more zombie enterprises with strong Washington voices at the expense of millions of savers’ consumption may be missing the forest for the trees,” he said.

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