The hidden dangers of low interest rates
The Fed’s campaign to hold short-term interest rates near zero is a loser for taxpayers. A rise in rates would also burden taxpayers, but it would come with a benefit for those who save.
Low rates keep alive the banks that the government considers too big to fail and reduce the cost of servicing the burgeoning federal debt. Low rates also come at a cost, cutting income to older Americans and to pension funds. This forces retirees to eat into principal, may put more pressure on welfare programs for the elderly, and will probably require the government to spend money to fulfill pension guarantees.
Raising interest rates shifts the costs and benefits, increasing the risks that mismanaged banks will collapse and diverting more taxpayers’ money to service federal debt. On the other hand, higher interest rates mean that savers, both individual and in pension funds, enjoy the fruits of their prudence.
No matter which way interest rates go, taxpayers face dangers. The question is where we want to take our losses. For my money, saving the mismanaged mega-banks should be the last priority and savers the first. Of course breaking up the big banks or letting them fail also imposes costs and low interest rates benefit many Americans, though mostly those with top credit scores, but policy involves choices and rescuing banks from their own mistakes and subtly siphoning wealth from the prudent is corrosive to the ethical and social fabric.
ON THE RISE?
The federal government paid $454 billion in interest on its debt in 2011. That is the equivalent of all the individual income taxes paid last year through the first three weeks of June
If rates return to, say, 6.64 percent, the level they were in 2000, one year’s interest costs would equal the individual income taxes for all of 2011 plus the first few weeks of 2012.
Last week , rates took a step in that direction. The yield on the 10-year bond, a benchmark for other interest rates, jumped to 3.3 percent, from 2.57 percent in early November, raising the government’s cost of borrowing in that sale by one fourth.
The average maturity of federal bills, notes and bonds is just five years, with just 7 percent of debt financed for more than 10 years, the equivalent of an adjustable rate mortgage with no upside limit.
The low interest rates since the financial crisis already have imposed a cost on the prudent people who saved for the future, both those who saved as individuals and those who put their money in pension funds.
Banks are paying less than one percent interest on savings, which means rates are negative in real terms, forcing retirees to dig into their nest eggs or cut spending.
Across the country, some fundraisers have told me of benefactors who called to say that expected bequests would not be forthcoming because they had been forced to dig into their savings.
Tax returns, too, show a disturbing, if logical, trend toward less saving. The share of income from taxable interest fell from 3 percent in 1999 to 2.2 percent in 2009, the latest year for which tax return data are available.
More troubling is that the number of taxpayers grew by more than 13 million over those years, while those reporting any taxable interest fell from 67.2 million to 57.8 million. The share of taxpayers earning interest plummeted from 52.9 percent to 44.1 percent.
RAVAGED PENSION FUNDS
At the same time, low interest rates, on top of weak stock prices, have ravaged pension funds.
Overall, state and local public employee plans lost 22.7 percent of their value in 2009, the Census Bureau reported in October. Their assets fell to $2.5 trillion from more than $3.2 trillion, while annual payments to retirees and survivors rose 6.7 percent to $187 billion.
In 2007 California’s three main funds had from 96.6 percent to 102 percent of the funds needed to pay benefits. As of last June 30, however, two of the funds held less than two-thirds of the assets needed to pay benefits, while the teachers’ fund had just 69.5 percent.
Eventually, inadequate endowments will require taxpayers to pay more so state and local governments can keep their pension promises.
The Pension Benefit Guaranty Corporation, which insures corporate plans, owed $106.7 billion to retirees as of Sept. 30, but had only $80.7 billion of assets, a $26 billion shortfall. Just four years earlier it reported a surplus of nearly $10 billion, or 87 percent.
The guaranty corporation also reported that its “reasonably possible exposure” to plans that may fail increased by a third last year to $227.2 billion. Low interest rates are a key part of that risk.
Low interest rates are good for mismanaged banks and for obscuring the cost of servicing the federal debt. But why do we elevate those issues above the interests of society’s prudent people whose personal and pension fund endowments are being consumed prematurely due to government policy?