How Super-Low Interest Rates Punish Savers
Get a group of adults together in a social setting and the conversation almost invariably gets around to a discussion about the paltry returns savers have been earning on their money in recent years. Three-month certificates of deposits are averaging only 0.23% nationally; one-year CDs are at only 1% if you can get it; and five-year CDs get you only about 2%. And rates have been at or near these depressed levels for the last four years.
When the Fed realized in early 2008 that we were in a financial crisis, it quickly ratcheted down the Federal Funds rate from 5.25% to near zero where it’s been since late 2009. The Fed Open Market Committee (FOMC) adopted a policy of keeping the key rate between zero and 0.25% indefinitely. This is commonly referred to as “ZIRP” – Zero Interest Rate Policy. As the Fed moved to ZIRP, banks, money markets and savings institutions quickly lowered their savings rates accordingly.
The current FOMC, now under the leadership of Janet Yellen, says it plans to keep the Fed Funds rate near zero at least until sometime in 2015. So savers have been punished for over five years now, with the likelihood of at least another year to go. The Fed says that when it does decide to raise rates, it will do so slowly.
I’ve often wondered when someone would calculate just how much savers have lost due to the plunge in short-term interest rates to near zero. Well in late April, MoneyRates.com did just that. In short, MoneyRates estimated that low interest rates have cost savers at least a whopping $758 billion in lost purchasing power over the five years ended in 2013. That number will almost certainly top $1 trillion by the time the Fed starts raising rates sometime next year.
For the past five years, MoneyRates.com has calculated the cost of the Fed’s low-interest-rate policies in terms of how much purchasing power savers have lost to inflation as a result of today’s artificially low bank rates. For each of the five years, those losses have exceeded $100 billion, and the running total at the end of last year was $757.9 billion.
MoneyRates suggests that it has not been the Fed’s intention to hurt savers, but I would argue that the Fed knew very well that its policy of keeping the key Fed Funds rate near zero would cause saving rates to plunge. While there is a lot of support for low interest rates – from stock market investors, home buyers, business borrowers, etc. – it has not been a cost-free policy.
While bank savings rates have traditionally been able to earn savers a little more than inflation, they have consistently lagged behind inflation during this era of extraordinarily low interest rates. That means that depositors in CDs, savings accounts and money market accounts have been losing purchasing power. This lost purchasing power is the hidden cost of the Fed’s policies.
In 2013, there was $9.427 trillion on deposit at U.S. banks. Over the past year, average money market rates have ranged from 0.08% to 0.10%. Inflation, meanwhile, was 1.5% over that same period. Because inflation grew much faster than the average bank savings rate, consumers lost purchasing power. Adjusting that $9.427 trillion upward for interest earnings but then downward to account for the inflation rate yields a net loss in purchasing power of $122.5 billion. When this loss is added to the purchasing power losses from the previous four years, the total comes to $757.9 billion – the effective price of the Fed’s low-rate policies.
Has the Low Interest Rate Policy Been Worth It?
The question is what has this three-quarters of a trillion dollars in lost purchasing power bought us? The results of the Fed’s low interest rate policies are of questionable value:
- · Slow economic performance. Late last year, the real GDP growth rate slipped from 4.1% in the third quarter to 2.6% in the fourth quarter. For the last four years, the economy has grown only 2.3% on average. Four and a half years into a recovery, the economy still cannot sustain any momentum. GDP was up only 0.1% in the first quarter of this year.
- · Too much emphasis on borrowing. The housing crisis was caused by irresponsible borrowing, and yet the Fed’s response is to encourage more borrowing by lowering interest rates. While mortgage debt did decline immediately following the housing crisis (in large part because of foreclosures), total mortgage debt outstanding has begun to creep up again recently. Meanwhile, total non-mortgage consumer debt has risen by more than 20% since 2009.
- · Over-dependency on low interest rates. Low interest rates have helped both the stock market and the housing sector recover, but there are signs that neither recovery would survive a return to more normal interest rates. In essence, those patients are still on life support.
Like any other economic decision, the Fed’s low interest rate policies should be looked at in cost-benefit terms. So far, the net benefits are highly suspect in light of the costs.
Things have been bad for depositors, to the tune of three-quarters of a trillion dollars in lost purchasing power over the past five years. But at the same time, at least some have been able to benefit from record-low mortgage rates, which were also a result of Fed policy.
Now, however, the Fed is cutting back on its bond buying program to keep long-term rates like mortgage rates down. At the same time though, it is continuing to keep short-term rates, such as deposit rates, near zero. The net result is the worst of both worlds for bank customers: It still does not pay to save money in these types of accounts, but it will increasingly cost more to borrow it.
Bailouts were largely seen as a necessary evil in the aftermath of the financial crisis. But at least with the bailouts of Wall Street firms and the auto companies, the price tag was disclosed on the front end.
Super low interest rates are effectively another form of bailout. They have helped to artificially support the banking system and the housing market. In this case though, it has been a stealth bailout, as no price tag has been disclosed until now. As noted above, MoneyRates.com estimates that that price tag now exceeds three-quarters of a trillion dollars. When measured against the shaky results low interest rate policies have produced, the bank depositors who have shouldered the burden of this bailout may well question if the loss has been worth it. And it’s certainly not hard to conclude that it wasn’t.
As noted above, the loss in purchasing power over the five years ended in 2013 comes to almost $758 billion. As also noted above, the loss in 2013 alone was a reported $122.5 billion. If the losses in 2014 and 2015 are also $122.5 billion, that will push the total loss to more than $1 trillion! You would think that would be making news everywhere. It isn’t. The media doesn’t care.
Some Claim the Fed’s Policies are Corrupt
Even with the huge volume of news I read each and every week, I have found only one story on this topic, which included a link to MoneyRates.com that did the research and came up with the $758 billion figure. It was written by Al Lewis, a columnist for MarketWatch, a division of The Wall Street Journal. He believes that the Fed’s low interest rate policy is “corrupt.” I’ll summarize his position below.
As long as I can remember, there has been a segment of people who believe, for various reasons, that the Fed is a giant conspiracy. And now that MoneyRates has put the price tag for the Fed’s low interest rate policy at three-quarters of a trillion and rising fast, I’m not surprised that a maverick writer like Lewis would label it as corruption. Here’s how he explains it: “How else can one describe a regime that punishes savers and rewards borrowers and speculators for years on end? Our central bank is essentially taking billions of dollars a year from average Americans, who are still struggling to get by in a bombed-out economy, and it is giving it — yes, giving it — to the very banks that helped cause the 2008 financial crisis in the first place.”
Lewis refers to the same MoneyRates.com article, written by Richard Barrington, that I summarized for you above. Lewis goes on: “Money-market rates have been stuck between 0.08% and 0.10% but the annual inflation rate has been, at least nominally, 1.5%. That’s pretty low for inflation, yet this spread eroded the purchasing power of American deposits by $122.5 billion over the last year alone, Barrington said.
Barrington’s analysis, by the way, is conservative. It only counts what inflation has done to savers. It does not include what savers might have made if interest rates were closer to historic averages. And after five years, these costs are only mounting.
He [Barrington] does not attribute this ongoing folly to corruption, as I do. The Fed has been purchasing tens of billions of dollars per month in U.S. Treasuries and mortgage-backed securities from banks. It has been cutting back this program, and many Fed watchers expect it to end by October, but so far these purchases have totaled more than $3.3 trillion. And what does the Fed have to show for this? Economic growth averaging only about 2% a year. A sluggish labor market. And artificially raised stock and real estate prices that may not hold if the Fed ever stops manipulating interest rates to such historic lows. Most Americans, by the way, haven’t participated in these lofty stock market gains…”
Lewis goes on to quote an April BankRate.com survey of over 1,000 households which found that 73% are not inclined to invest in stocks now, even though the S&P 500 Index has more than doubled since the low in early 2009. They found that most of those surveyed either don’t have the money to invest or feel that the market is rigged against them. Lewis continues: “The Fed has responded to a crisis caused by too much borrowing by encouraging even more borrowing. It has allowed too-big-to-fail banks to become even bigger. It has helped inflate the national debt to nearly $18 trillion. It has created a junkie economy that seems hopelessly addicted to historically low interest rates, ever-increasing borrowings, and a non-stop printing press rolling out dollars. You’d think banks would show some gratitude for all the dramatic adjustments made in the economy just to save them, but no. They have responded by raising fees and overdraft charges on customers, wrongfully foreclosing on homes, charging usury rates on credit cards and other consumer loans whenever possible, cheapening customer service, suing each other for the shoddy mortgage-backed securities they sold each other, laying off thousands of their own rank-and-file employees, and handing out fat bonuses to their top executives.”
Lewis believes that all of this was made possible because of widespread corruption at the Fed. He explains as follows: “Now some might ask, what do I mean by corruption? Janet Yellen, she seems like a nice lady. Ben Bernanke, he seems like a nice guy. Other people at the Fed, they seem all right when you hear them speak. Do you really mean to tell me they’re corrupt? That they’re bad people? They may appear well-intentioned. They may even have good intentions, for all I know. But I’ve noticed they rarely, if ever, use the term ‘moral hazard’ anymore. It’s just not part of their calculus. They have blinded themselves even to the law of gravity with the sheer amount of brain power that they put into everything they say and do. And they’re completely trapped in this thinking that trillions for the banks will solve everything. You don’t need to take a class in economics, or even history, to suspect that the Fed can’t hold interest rates to zero for more than half a decade without consequences. And that it can’t keep printing money forever.
The Fed argues it’s all part of a necessary evil, without fully conceding that it is evil nonetheless. The Fed will also say that it saved the world from a financial crisis that could have been far worse. But this remains a hypothetical argument.”
Lewis goes on to argue that we would all be better off if the Fed had simply given the $3+ trillion it has invested in bonds and mortgage securities to ordinary citizens and small businesses. I made essentially the same argument a couple of weeks ago on the somewhat related subject of poverty in America: “Get this: The Census Bureau estimates that our current welfare spending totals four times what would be necessary to give all of the poor enough cash to bring them above the poverty line, eliminating all poverty in America. So if we really want to eliminate poverty, why don’t we do just that?”
Conclusions – Ineptitude or Corruption?
Thanks to the research done by MoneyRates.com, we now know that savers across America lost some $758 billion in interest income due to the Fed slashing short-term interest rates to near zero five years ago at the start of the financial crisis. We also now know that this number is on-track to top $1 trillion in 2015.
Next, we have long known that the people running the Fed – think Volcker, Greenspan, Bernanke, Yellen – are very smart people, misguided perhaps, but very intelligent. For this reason, there is no way that Bernanke and the FOMC did not know that slashing short rates to near zero in 2008-09 would devastate savers.
They also had to know that depriving savers of almost a trillion dollars would have negative effects on the economy. What they didn’t know apparently is that near zero short-term rates would not have a significantly positive effect on the economy. I say “apparently” because what if they did know this, as Al Lewis suggests, and did it anyway?
I’m not ready to conclude that the Fed is corrupt as Lewis believes. I certainly hope not. But the evidence is increasingly pointing to either ineptitude or corruption. Time will tell.
Gary D. Halbert is the president and chairman of Profutures, Inc. Subscription rates for Forecasts & Trends is $197 for 12 issues and may be obtained by visiting his website at www.profutures.com.