By William D Cohan
In the short term, Washington lawmakers are understandably preoccupied with trying to avoid the “fiscal cliff.”
But the decisions that are likely to affect the economy’s long-term health are happening not on Capitol Hill or at the White House, but at the Federal Reserve — specifically, Chairman Ben Bernanke’s policy of continuing to drive down long-term interest rates until unemployment hits 6.5 percent. This tactic, called quantitative easing, could remain in place for years. But is it helping the middle-class Americans who need it most?
Unfortunately, the answer is no. Quantitative easing not only hurts older Americans on fixed incomes and those who have dutifully saved for retirement, it also frustrates younger people who can’t afford to take advantage of historically low mortgage interest rates. Mainly, Bernanke’s quantitative easing helps Wall Street’s banks and traders, a dynamic that could be setting us up for another financial crisis as investors again seek out higher-yielding, lower-quality investments that Wall Street is only too happy to provide.
In the simplest terms, Bernanke’s Fed is creating a huge artificial demand for Treasury securities and mortgage-backed securities — by buying $85bn of them a month — as a creative way of lowering the cost of borrowing money. As in most markets, higher demand for a product should lead to a higher price, especially if supply is limited. That is exactly what has been happening in the US debt markets. The prices for longer-term Treasury and mortgage-backed securities have increased, and since bond yields move in inverse proportion to price, interest rates have fallen. Since November 2008, when Bernanke started quantitative easing, the 10-year Treasury yield has dropped from about 4 percent to about 1.7 percent.
This is very good news for people who want to borrow money. If you are looking to buy a house or refinance a mortgage, the interest rate on that new mortgage has rarely been lower. No matter the size of the mortgage, the monthly savings are palpable — and with extra money in their pockets, borrowers theoretically can spend it on goods and services that they might not have bought when their monthly mortgage payments were higher. (Low interest rates have also helped the government finance its multitrillion-dollar debt.)
An individual decision to buy an iPad or a new car, repeated on a mass scale, raises collective demand and can help persuade Apple or General Motors to hire more workers or build new plants. More people working generally means that people will have more money to spend and more chances to raise their standard of living. And if a company needs to borrow money to build the new plant, then the lower long-term interest rates created by the Fed should help make that easier, too. Abracadabra, a virtuous circle!
That’s the good news. The bad news is that the Bernanke policy is a most unwelcome tax on savers and the millions of older Americans who live on fixed incomes. Have you looked at your bank statements lately? The annual interest on my checking account is 0.01 percent; the national average, according to the Federal Deposit Insurance Corp, is 0.05 percent. And on my savings account, it’s 0.3 percent, while the national average is 0.07 percent. Even at my higher savings rate, an account with $100,000 will earn a mere $300 in annual interest.
Banking giant Capital One is trying to make hay with its humorous ads featuring actor Alec Baldwin and comedian Jimmy Fallon and the promise of interest rates “five times the national average.” It’s a clever campaign, but five times nearly nothing is still nearly nothing. Savers and fixed-income investors are getting very little reward for their prudence and might be struggling financially, because as Bernanke forces interest rates lower, the amount their savings yield on a monthly basis dwindles, too. These low interest rates do no favours for the 56 million Americans who received Social Security payments this year.
So who benefits from the low interest rates on checking and savings accounts? The big, consumer-oriented banks such as Bank of America, Wells Fargo, JPMorgan Chase and Citigroup, all of which were bailed out by the federal government four years ago. The way banks work, of course, is by getting us to park our money there, nearly for free, and then lending that money to borrowers at much higher interest rates. Banks capture the spread — the difference between the cost of the money and what they get paid to lend it — as profit.
Although banks would like us to think they are still struggling, that is a bit of a myth. For instance, in the third quarter of 2012, JPMorgan Chase earned $5.7bn in profit; analysts expect it to earn about $25bn for the year. While the bank is certainly well-run, it has also benefited mightily from Bernanke’s generous interest-rate policies by being able to collect deposits from all of us at virtually no cost to them. What business wouldn’t do well if it didn’t have to pay for its raw materials?
Who else benefits from Bernanke’s creativity? A similar crew: Wall Street’s bankers and traders. The Fed’s policy means their profits and bonuses are higher than they would be otherwise. The bankers benefit because, with interest rates so low, they can reap huge fees by underwriting the explosion of corporate debt that their clients are eager to issue. According to Bloomberg, through the first 10 months of 2012, Wall Street’s biggest banks underwrote more than $3.3 trillion of corporate debt, about $660 billion more than in the same period of 2011, on pace with the record year of 2009.
Traders, meanwhile, know that Bernanke will be there to buy their Treasury securities or mortgage-backed securities — to the tune of that $85 billion a month. They can make a killing buying the securities in the market, for their clients or themselves, sure that when they are ready to sell, the Fed will buy them at the market price, which, thanks to the Fed chief, has been rising steadily.
Since Bernanke started quantitative easing, the Federal Reserve’s balance sheet has grown from $800nn to $2.8 trillion and counting. Nearly quadrupling the balance sheet poses myriad dangers, among them that when interest rates do rise, the Fed will be left with a huge portfolio of securities of shrinking value. Unloading that portfolio to stem the losses could cause the market to collapse.
There is another consequence of Bernanke’s policies that we may come to regret. By artificially stimulating demand in the debt markets, a move that has lowered interest rates to historic levels, not only has Bernanke created a bubble in the price of Treasury and mortgage securities, but he has also forced investors to once again reach for higher yields in corners of the debt market where credit quality is traditionally lower and the risk of default higher.
WP-Bloomberg
