"Short Rates - A Boon for Borrowers, A BUst for Savers"

Sydney M. Williams

Thought of the Day

“Short Rates – A Boon for Borrowers, A Bust for Savers”

April 21, 2010

Janus was an ancient Roman god, noted for his two faces, one looking toward the future, the other facing the past. He has, one might argue, a duplicitous personality – giving to one party while taking from a second. Something Janus-like is going on in the short term interest rate market. Borrowers, especially banks, have benefitted enormously from low rates. Whether it is payments on customer’s deposits, CD’s, or borrowings from the Federal Reserve, bank liabilities have been noted for their low rates and the concomitant interest income they can earn while taking very little risk.

The results have been spectacular. From facing extinction eighteen months ago, just four banks – Citigroup, Goldman Sachs, Bank of America and JP Morgan Chase – generated about $14 billion in the first quarter. The loser, the flip side of this Janus, has been the saver – mostly elderly and retired. They, as much as the government, are funding the enormous profits being made by traders on Wall Street, and getting very little in return.

Banks are in liability Heaven. Money market rates are de minimis. Member banks can borrow from the Federal Reserve at 75 basis points (0.75%); one-year CD’s pay about 1.5%; savings accounts pay around 1.0%. Interest bearing checking accounts pay 10 to 20 basis points. This cheap money can be invested in Five-Year Treasuries and earn 2.5%. It can be put out to earn 3.25% at prime, though most loans are prime plus. A fifteen year mortgage will return 4.4% and a home equity loan 4.6%, for someone with excellent credit. With borrowing costs so low, especially in comparison to Treasuries, banks can generate attractive returns while taking very little risk.

But savers are in income Hell. There are about $7.5 trillion in short term deposits – interest bearing checking accounts, saving accounts and CD’s. Middle class retirees, who often rely on income from savings to augment Social Security and pension benefits, have suffered significant declines in income. For example, a CD which earned 5.5% in December 2006, pays 1.5% today –a 75% drop in income. Little is written about the plight of these savers, but they have been the unsung heroes of this crisis – lending money for little return and no words of appreciation. The President speaks of the risks taxpayers assumed in guaranteeing loans to the banks a year and a half ago, but he has been silent on the matter of those millions of seniors who rely on interest from savings. A steep yield curve suggests banks do not have to make riskier loans, but the opposite is true for savers. The low payments they receive means, to supplement their meager returns, they have to take on more risk – again the reverse of what should be happening, the elderly assuming risk, while the young and strong were able to reduce risk, though we know that is not what they have done.

The collapse we faced in the fall of 2008 was unprecedented. The Federal Reserve and the Treasury from both administrations deserve credit for saving the financial system. We did not collapse, banks survived (or most did) and the economy is now in its third quarter of recovery.

No one doubts the importance of keeping the recovery going. No one wants the economy to slide into a double-dip recession. But the plight of savers deserves more attention than it has received. On December 16, 2008 the Federal Reserve lowered Fed Funds to a range of 0.0% to 0.25% and the Discount Rate to 50 basis points. On February 18, 2010 the Fed did raise the Discount Rate to 75 basis points, but it has kept Fed Funds at the same level for sixteen months, despite noticeable improvement in both credit markets and the economy. Mr. Bernanke’s greatest fear is the possibility of deflation, similar to that which ripped through our economy during the 1930s and something none of us want to revisit. But the problem is that much of the low cost money has gone to fund speculative bets at bank trading firms, generating returns that benefit a few with extravagant bonuses. And the concern of savers is that their income has dwindled, as they read of these Wall Street traders making enormous profits; their taxes are rising, their Medicare benefits are scheduled to be reduced and huge Federal deficits risk rising inflation, further demeaning their savings.

Much has been written about transfers of wealth – in inheritance from one generation to another, from tax payers to recipients of government’s largesse, but this has been perhaps the largest transfer of wealth on record – certainly the least recognized.