The victims of low-interest locusts
Another financial crisis looms for U.S. taxpayers, a disaster likely to create even worse human misery than the mortgage fiasco that some of us warned about years before the Wall Street meltdown in 2008.
The crisis next time: collapsing investment incomes for older Americans as artificially reduced interest rates force them to use up their savings and drive more pension plans into failure.
Eviscerating the interest income of savers is the undeniable result of a long-running Federal Reserve policy to reduce interest rates, especially since December 2008. The Fed reiterated on Aug. 1 that it plans to keep interest rates low through late 2014. It says this helps to promote stronger economic growth and bring down the jobless rate.
As in the mortgage crisis, you can see this disaster building by examining the official data.
At the broadest level, 53 percent of taxpayers earned interest in 2000. But by 2010 just 39 percent did, my analysis of Internal Revenue Service data shows, while high-interest debt has become ubiquitous.
From 2000 to 2010 total interest earned by savers fell 53 percent in real terms, a decline of $134 billion. Average interest earned per taxpayer, measured in 2010 dollars, plummeted from $1,950 to $825.
A drop of $1,125 per taxpayer may not seem like much, especially since the average income reported on 2010 tax returns was more than $56,000. But look at who relies on interest to make ends meet and the problem comes into focus.
RELIANCE ON INTEREST
Americans overall received just 1.5 percent of their income from interest payments in 2010. But among those with tiny incomes – the 37 million taxpayers making less than $15,000 – interest accounted for 9.3 percent of their money.
More than three-fourths of these low-income Americans reported no interest income. This means that the minority who saved relied heavily on the interest their savings earned. IRS and other government data show that minority consists mostly of older Americans who saved during their working years, prudently spending less than they earned so they could avoid poverty in their golden years.
The low interest rates paid on savings and bonds are not the result of market forces, but official policy. As readers here know, I favor competitive markets to set most prices, including interest rates.
The Fed has been suppressing interest rates for more than a decade – a major factor in the housing bubble that began in the mid-1990s. The bubble was obvious in official data by 2002 as housing prices grew much faster than incomes, a trend that could not be sustained. But those of us who pointed this out were ignored. Alan Greenspan famously claims no one saw it coming, which is true if you suffer willful blindness.
Since December 2008, just three months after the Wall Street meltdown, the Fed has kept the federal funds rate at zero to 0.25 percent. The other interest rate the Fed controls, for money it loans directly to banks, is being maintained at three quarters of one percent. These, in turn, tend to lower other interest rates.
This Fed policy props up the Too Big to Fail Banks, which pay next to nothing to borrow from the Fed and then use that borrowed money to buy federal debt paying 3 percent or so. Any bank with a 3 percent spread should report healthy profits. The built-in mismatch between taxes and spending in Washington guarantees plenty more federal debt, no matter who gets elected to the White House and Congress, for years to come.
Cheap interest also benefits credit-worthy individuals and companies, who can use cheap loans to scoop up assets that collapsed in value after the 2008 Wall Street meltdown. This is a subtle mechanism for concentrating wealth among the best off.
For savers, the reverse alchemy of low interest rates turns gold into dross.
As interest income falls, older savers start cutting into their nest eggs. Millions of older Americans relying on interest income will, thanks to the Fed, run out of savings before they run out of time, a prescription for another taxpayer bailout, though this time one with a stronger moral case than rescuing the fortunes of profligate bankers and those who foolishly invested in the companies they run.
Expect more pension plans to fail, too, because their once robust interest income has shriveled thanks to the Fed’s low-interest policy, a subject I’ll examine in my next column. About 44 million Americans have earned a pension, 1.5 million of them in plans that already have failed, according to the U.S. government’s Pension Benefit Guaranty Corp.
One effect of the Fed’s low-interest policies can be seen in all those mid-day television ads encouraging older Americans to take out reverse mortgages on their homes, as people desperate for enough money to put food on the table consume the equity in their homes. I say desperate because only someone desperate to survive would accept the stiff interest charges and fees in these reverse mortgage deals.
In the next few years expect news reports, like those I read as a boy a half century ago, about old ladies buying cat food not for a pet, but to get a little protein for dinner.
Holding down interest rates to prop up banks and the economy and help the already rich buy assets on the cheap, amounts to an official policy to take from the ants who saved for their old age and give to the Wall Street grasshoppers. Given the economic devastation this causes, it is more accurate to say to give to the financial locusts.