The Fed’s campaign to hold short-term interest rates near zero is a loser for taxpayers. A rise in rates would also burden taxpayers, but it would come with a benefit for those who save.
Low rates keep alive the banks that the government considers too big to fail and reduce the cost of servicing the burgeoning federal debt. Low rates also come at a cost, cutting income to older Americans and to pension funds. This forces retirees to eat into principal, may put more pressure on welfare programs for the elderly, and will probably require the government to spend money to fulfill pension guarantees.
Raising interest rates shifts the costs and benefits, increasing the risks that mismanaged banks will collapse and diverting more taxpayers’ money to service federal debt. On the other hand, higher interest rates mean that savers, both individual and in pension funds, enjoy the fruits of their prudence.
No matter which way interest rates go, taxpayers face dangers. The question is where we want to take our losses. For my money, saving the mismanaged mega-banks should be the last priority and savers the first. Of course breaking up the big banks or letting them fail also imposes costs and low interest rates benefit many Americans, though mostly those with top credit scores, but policy involves choices and rescuing banks from their own mistakes and subtly siphoning wealth from the prudent is corrosive to the ethical and social fabric.
ON THE RISE?
The federal government paid $454 billion in interest on its debt in 2011. That is the equivalent of all the individual income taxes paid last year through the first three weeks of June
If rates return to, say, 6.64 percent, the level they were in 2000, one year’s interest costs would equal the individual income taxes for all of 2011 plus the first few weeks of 2012.
Last week , rates took a step in that direction. The yield on the 10-year bond, a benchmark for other interest rates, jumped to 3.3 percent, from 2.57 percent in early November, raising the government’s cost of borrowing in that sale by one fourth.
The average maturity of federal bills, notes and bonds is just five years, with just 7 percent of debt financed for more than 10 years, the equivalent of an adjustable rate mortgage with no upside limit.
PRUDENT PEOPLE
The low interest rates since the financial crisis already have imposed a cost on the prudent people who saved for the future, both those who saved as individuals and those who put their money in pension funds.
Banks are paying less than one percent interest on savings, which means rates are negative in real terms, forcing retirees to dig into their nest eggs or cut spending.
Across the country, some fundraisers have told me of benefactors who called to say that expected bequests would not be forthcoming because they had been forced to dig into their savings.
Tax returns, too, show a disturbing, if logical, trend toward less saving. The share of income from taxable interest fell from 3 percent in 1999 to 2.2 percent in 2009, the latest year for which tax return data are available.
More troubling is that the number of taxpayers grew by more than 13 million over those years, while those reporting any taxable interest fell from 67.2 million to 57.8 million. The share of taxpayers earning interest plummeted from 52.9 percent to 44.1 percent.
RAVAGED PENSION FUNDS
At the same time, low interest rates, on top of weak stock prices, have ravaged pension funds.
Overall, state and local public employee plans lost 22.7 percent of their value in 2009, the Census Bureau reported in October. Their assets fell to $2.5 trillion from more than $3.2 trillion, while annual payments to retirees and survivors rose 6.7 percent to $187 billion.
In 2007 California’s three main funds had from 96.6 percent to 102 percent of the funds needed to pay benefits. As of last June 30, however, two of the funds held less than two-thirds of the assets needed to pay benefits, while the teachers’ fund had just 69.5 percent.
Eventually, inadequate endowments will require taxpayers to pay more so state and local governments can keep their pension promises.
The Pension Benefit Guaranty Corporation, which insures corporate plans, owed $106.7 billion to retirees as of Sept. 30, but had only $80.7 billion of assets, a $26 billion shortfall. Just four years earlier it reported a surplus of nearly $10 billion, or 87 percent.
The guaranty corporation also reported that its “reasonably possible exposure” to plans that may fail increased by a third last year to $227.2 billion. Low interest rates are a key part of that risk.
Low interest rates are good for mismanaged banks and for obscuring the cost of servicing the federal debt. But why do we elevate those issues above the interests of society’s prudent people whose personal and pension fund endowments are being consumed prematurely due to government policy?
Other major beneficiaries of Professor Bernanke’s zero interest rate regime include the hedge funds and leveraged-buy-out funds which now go by the euphemism of “private equity”. These entities employ huge leverage to magnify their returns (and losses). Hence we see much increased volatility in the prices of securities, commodities and currencies. The result is a loss of investor confidence, which in turn hampers real economic growth as our capital markets have become little more than a casino. Sadly, the institutional investors who used to be among the most conservative investors, such as pension and endowment funds, have embraced hedge and LBO funds in a big way. Recently, for example, the Yale endowment fund was 2/3rds invested in a category they call “absolute return” which is a euphemism for hedge and LBO funds. The zero interest rate environment reduces the returns available in traditional investments to practically nothing, giving the big institutions little choice but to employ the huge leverage favored by the hedge and LBO funds. It appears that Prof. Bernanke’s zero interest rate policy, designed to support the zombie banks, has not only destroyed the savings of an entire generation but has also skewed the capital markets by making the use of high leverage the only viable option to obtain the needed rate of return. The unwinding of these huge misallocations of capital and resources will not be a pleasant experience.
You state, “For my money, saving the mismanaged mega-banks should be the last priority and savers the first. Of course breaking up the big banks or letting them fail also imposes costs and low interest rates benefit many Americans, though mostly those with top credit scores, but policy involves choices and rescuing banks from their own mistakes and subtly siphoning wealth from the prudent is corrosive to the ethical and social fabric.”
While this may sound like good advice, this course of action would undoubtedly cause the US economy to crash into another recession, or worse.
And you are confusing “moral hazard” with economic policy.
This is why, after bailing out the “too big to fail banks” in 2008, Bernanke locked himself — and the US economy — into a straightjacket in terms interest rates, and of forcing the US to continue to bail out the wealthy.
Hence, the reason for the QE2 program and probably a QE3 shortly, since the wealthy are clamoring for it, and if the eurozone fails, it is a near certainty. (Regardless of the prevailing market opinion, the collapse of the eurozone WILL cause the US to collapse as well.)
The real problem with low interest rates is that it provides cheap money for investment in jobs in 3rd world countries, but not in the US, and simply exacerbates the wealthy/poor divide in the US due to excess profits from their investments.
Bernanke’s incredibly bad choice (plus the Bush tax cuts) are the main reasons why the US is in $15 trillion of debt today. (In fact, the US ran a slight surplus just prior to Bush taking office, so our massive debt IS attributable to him and the bailouts.)
This is the main reason why we must insist the wealthy begin paying their income taxes once again, because we CANNOT compensate for the loss of that revenue in any other way — certainly, not by cutting back on spending (except, of course, in military spending, which will never happen).
Leaving the income tax rates where they are now, and attempting to cut back on social spending as the Republicans want, will create 3rd world conditions in the US overnight.
If you doubt that, take a close look at Romney’s so-called tax plan.
Unfortunately, at this point, for better or worse, we are “wed” to Bernanke’s policies.
Unless and until the US Congress begins to do their job and pass legislation to bring “our” outsourced jobs home, we will be stuck in this “liquidity trap” until the US economy collapses.
PseudoTurtle
Excellent evenhanded explanation of current policy pros and cons.
There has been the public perception of a generational “transfer” of wealth from the young to older Americans as “our” government looks at every possible way to renege on delivering on promises “made and paid”.
You correctly point out how “our” government concurrently benefits by allowing inflation and low rates of interest to steal the historic rewards of prudence and saving from older citizens. It would seem Americans live ever more with “public policy” that careens back and forth between bad faith and incompetency.
Low rates also help keep the retirees and a lot of other people in their homes. I am a retiree and welcome the low rates.
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