Monday, April 20, 2009

Low interest rates

It seems that a fundamental problem with our economy is the Federal Reserve driving the interest rate environment.

The current interest rate on Bank of America savings accounts is... 0.20%. I just don't get it. If I am a bank, I make fundamentally make money by loaning people money at a rate higher than what I pay other people for giving it to me (and charging a few fees). But who's going to give me their money at 0.2%?

This rate is extraordinarily low, but interest rates have been really low for years now. The fiscal policy behind this was pushed by Greenspan. We know now it had some weird side effects, like most government fiscal policy, that have basically crushed our economy.

On 60 Minutes last night they had a piece about people "losing" half of their 401k balance. This would mean they were 100% in equities, with maybe some in corporate bonds. Why were they 100% in equities? Especially when they were approaching retirement age?

Maybe it had something to do with the low interest rates. Even with a CD yielding 2%, your money is growing slower than the inflation rate. So, people poured their money into equities, creating a bubble. To make it worse, a lot of prominent companies haven't been paying dividends lately, so they weren't even getting any income from these investments. Stock price to earnings ratios still seem high when you look at all of the companies where the investors don't see any of the earnings, and have to speculate by selling the stock to take advantage of the price.

Lower interest rates drove the price of houses up. Government backed loans drove the price of houses up. Since the price of houses were so high, the government started buying risky loans from banks so that people could keep buying houses.

So, low interest rates may help companies grow, but most large companies sell bonds, they don't borrow from banks like I do. Who exactly are these low interest rates helping? Is there someone out there who just loves bubbles?

No comments: