February 8, 2012

War of Borrowers Against Savers: News Analysis

A zero percent rate, under strictly limited terms, is about the best borrowers can do under the current financial repression

Federal Reserve building in Washington. (Photo: AP) Federal Reserve building in Washington. (Photo: AP)

When Federal Reserve Chairman Ben Bernanke announced two weeks ago that the Fed expected to maintain its near-zero interest rate policy at least as long as the end of 2014, it was the latest salvo in our loose monetary regime’s increasing repression of savers.

Like the Syrian army unleashing heavily armored vehicles and massacring civilians, American savers are feeling the financial equivalent of fighting a desperate and so far losing battle against the might of the U.S. central bank. Indeed, until two weeks ago, U.S. savers were being massacred by a zero-rate policy intended to last until the middle of 2013, so the most recent Fed announcement must have seemed like a body blow to this beleaguered group.

As in all other cases of repression, the violence is aimed at protecting the interests of some favored group–the Assad regime and its ethnic Alawite supporters in Syria or in the case of the U.S., the borrowing class.

Why should the U.S. favor borrowers? Economists and bankers offer all sorts of reasons, and usually focus on the need to revive the battered financial and housing sectors, which triggered our economic crisis. With zero rate returns, the thinking goes, those with capital will be forced to enter risk markets, thereby spurring investment and creating a wealth effect while consumers will flock to homeownership since the cost of financing a purchase is so low.

Cynics will argue that the real reason for low rates is that the government itself has assumed the interests of borrowers because, like Assad’s Alawites, they come from the same group. The U.S. after all is the world’s biggest borrower and is running trillion-dollar annual deficits. U.S. debt-service costs would balloon if interest rates were at normal levels. According to this thinking, the Fed is playing for time with the hope that the economy will be growing again and debt trending downward when it once again imposes costs on credit.

In what must seem to some savers as a coordinated attack, the Securities and Exchange Commission this week revealed proposed regulatory changes on money market funds that would have the effect of lowering rates. For those not hip to money funds these days, the current average seven-day yield on a taxable money market fund is 0.02%, which may not sound like much, but is double the 0.01% rate on a comparable tax-free fund.

If the SEC’s proposals were all adopted, it is highly likely that savers would have to pay fund companies to hold their money. And if that sounds far-fetched, the Bank of New York Mellon Corp. made headlines last summer when it announced it would be charging institutional clients 0.13% on deposits of more than $50 million.

The SEC has legitimate concerns about the need to prevent a bank-run style run on funds–as occurred in the wake of the Lehman crisis leading to the Reserve Fund’s breaking the buck. Reasonable people can differ on the propriety of such changes, but the fact remains that savers remain a repressed political class today with few options.

Headline inflation is 3% today, so arguably the U.S. government is offering investors in its bonds the same kind of deal BNY Mellon is offering its customers. For the cost of a 10-year bond, which currently yields 1.97%, U.S. investors get to pay Uncle Sam over 1% a year to hold their money.

Across the board, savings rates are low and declining. The current savings rate average is 0.266% nationally and five-year bank CDs are paying 1.687%, according to depositaccounts.com, which expects rates to continue to fall in the wake of the Fed’s extended zero-rate plans. Savers can of course protect themselves from inflation by purchasing Treasury Inflation Protected Securities. But TIPS are currently paying a negative interest rate of -1.15%. Inflation-protected savings bonds (I Bonds) may be the only bargain around. They pay a flat zero percent!

Savers have been struggling to find ways to preserve their income in the past several years’ low environment. A recent analysis by the free-market-oriented Cato Institute has quantified this problem, revealing that “since 2008, household interest income has fallen by about $400 billion annually. That’s $400 billion each year that families have not had to spend.” (Of course, these same numbers also quantifty the huge gains eligible borrowers have reaped in cheap financing of homes, for instance – another win for the ruling borrower class.)

There is a paucity of alternatives for outgunned savers in the current financial repression. But for beleaguered savers with their fistful of dollars clamoring for the scintillating zero-percent rate on I Bonds, a warning: the government allows a maximum purchase of just $10,000 a year, down from $30,000 annual limit available back in the good old days of 2007.

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