Opinion

David Cay Johnston

The victims of low-interest locusts

By David Cay Johnston
August 10, 2012

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.

CONCENTRATING WEALTH

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.

Comments
22 comments so far | RSS Comments RSS

Low interests benefit most the US Govt that can finance his debt at very very low cost.

If interests were back to 6-7% on T-Bills we would face the same problems that some Euro countries r facing now.

Indeed the retired working ants r the most suffering.

The solution would be to stimulate internal economy growth beyond consumer spending. How long before it will happen?

Posted by robb1 | Report as abusive
 

Usually I like David Cay Johnson’s writing, but this column is seriously oversimplified. There are many investments suitable for modest-income pensioners that have much better returns than interest-bearing savings accounts. Two examples among many: Fidelity Inflation-Protected Bond Fund FINPX, average annual return 6.52% 10 years, 9.88% 3 years, 9.28% 1 year; and PIMCO Total Return Fund Class D PTTDX, 6.77% 10 years, 8.19% 3 years, 7.15% 1 year. Investing some retirement assets in stocks, such a low-cost S&P 500 index fund, would offer comparable overall returns with lower overall portfolio volatility.

The real issue is that many people correctly feel too inexperienced to take on the risks of market investing. The correct solution, however, is not to shun the markets, but to find trusted experts to invest on one’s behalf. Many state employee retirement funds actually manage their investments reasonably well; their greatest problems come from unreasonable requirements imposed on them politically. Although politics again would no doubt interfere, finding a way for non-governmental retirees to benefit from similar investment expertise would go far to address the problem Johnson has raised.

Posted by azbill | Report as abusive
 

Progressives just can’t help raising the class warfare flag. It’s been documented time and again that the well off have suffered the most in terms of wealth destruction, a trend that will almost certainly continue. Yes, the middle class is shrinking, but not because we’re being exploited by the wealthy. A bigger problem than low interest rates is the increased risk in both bonds and equities that have driven many (most?) retail investors to the sidelines. It’s bad enough to get a lousy return, but the hits to principal ala 2008 are far worse. We are in the early stages of economic decline. The prognosis for the near and mid term is not encouraging. If you haven’t already, now is the time to devote a portion of your portfolio to hard assets.

Posted by gordo53 | Report as abusive
 

That people on fixed incomes must spend their savings is nuanced inflation. It affects persons no longer creating value, and is a perverse outcome of the Fed’s dual mandate to create growth while limiting inflation. Given the choice of draining this group’s assets or stepping up the basis for everyone I would choose the one time loss. The Fed certainly has.

Posted by JimTheDiver | Report as abusive
 

“Progressives just can’t help raising the class warfare flag. It’s been documented time and again that the well off have suffered the most in terms of wealth destruction, a trend that will almost certainly continue.”

The well off have suffered the most! Everyone get that?

Everyone should be raising the class warfare flag because the wealthiest have been waging it for decades. It’s hilarious that the moneyed class is the one that cries class warfare. You are living in an age of vast income inequality.

But you want to share how the well of have suffered the most? As opposed to the millions more who are suffering and will continue to suffer?

Laughable.

Posted by TheUSofA | Report as abusive
 

Whisper that the top 1 percent pay the lowest tax rate in 80 years and you’re trafficking in class resentment. Help the working and middle classes get health care and you’re a socialist.

In the United States, from 1980 to 2005 more than 80 percent of the total increase in income went to the top 1 percent of the population. The gap there between the superrich and everybody else is now greater than at any time since before the Depression of the 1930s.

The wealthy have never had it easier. If you’re talking about class warfare, the well off have already won.

Posted by TheUSofA | Report as abusive
 

Thanks to God David Johnston for you writing this article, it’s so long overdue that we start talking about this. I’ve been noticing this too, esp. since 2003. The big impacts:

1) reduced interest income for retired
2) reduced investment income for retired, as other security returns follow the trend down
3) working person’s 401Ks showing smaller returns
4) churches, lodges, many charitable institutions and non-profit institutions are being devastated by rapidly falling investment income. The balances they have used to generate enough money to barely keep them in the black, many are in the red and closing now.
5) Eventual transfer of said institutions to the government, and also don’t forget, to foreign investors who are sniping the good assets for fire-sale prices.

Somehow, some way, let’s keep these articles coming and in the public eye MORE!!!

Posted by equ32 | Report as abusive
 

When interest rates decline, the value of long term bonds rises. Hence, a person or pension fund holding long term bonds prior to the financial crisis could have sold their bonds at a profit when interest rates declined, and reinvested the money in a basket of stocks with a high dividend yield.

Posted by DifferentOne | Report as abusive
 

Mr Johnson: you mention the reverse mortgage business as recent activity but this had been going on for at least a decade prior to the collapse of the housing bubble.

I recall some senior citizens communities that were financed with large up front payments that guaranteed the residents life-time accommodation. They must be in trouble too because of low interest rates.

Is it fair to assume that most of them are underwater as well? I suppose the facilities have lost value too? The income stream may be the same but the so costs have risen. I suppose the seniors are in no position to care if the value of the entire community may have dropped. But long term care costs didn’t drop either. The entire economy and almost everything in it has been fueled by speculative mania for almost 30 years. It could be fair to say that they aren’t as lucrative as they used to be.

What do the wealthy expect to do with a nation of impoverished people? I think there are many investors who think we are sheep ready to be slaughtered. Maybe they are right. I was raised in a generation that did not believe in constant warfare. We were comfortable and relatively affluent and it was not encouraged. We were very controlled and encouraged to be passive. The wealthy were no different in their social attitudes and were in fact the leaders of the pact during the 60s and 70s. They were not selling the ideas or a militant society fueled by military spending and global conquest.

But their kids and even grandchildren have different attitudes. And the new wealthy class may have very different social values then their parents and grandparents. Maybe they really would think they deserve to survive and thrive at all costs and the rest be dammed. But where they are going to bury the losers is a question?

Cremation? It doesn’t take up much space? Most won’t be able to afford burial plots if they don’t have them already. We could be living in the era of the nice nazis: the very subtle nazis. The could be polite fascists with velvet gloves and charming media messages but just as ruthless and selfish. They know people around the world who may believe that they are the only people that matter and most are too stupid to live. It may not make any difference to them that the only difference between the qualifications of the upper and the bottom is the amount of money in their bank accounts.

The ruthless may have set up a very easy conquest as the country ages and the old can no longer fight. However, the self-named Greatest Generation may find they are robbed blind by the later generations and they may be doing it unconsciously or not so unconsciously? It’s a sickening thought.

Posted by paintcan | Report as abusive
 

My head spins. Don’t I recall Alan Greenspan getting the blame for creating the bubble by leaving the interest rates too low for too long? Bernanke is doing same. I seem to recall that I was taught in school that interest represents risk and therefore high risk= high interest, low risk= low interest………… In all this uncertainty, no direction, no plan, no effective law, no financial rules, well, the bankers make the laws……… is this low risk?

There seems to be no connection between big money, that the hedge funds and banks bet, and the small money that working people exchange. A Tobin tax might make them connect, but man, what to do, now that the banks own the laws. Nothing is illegal when you write the laws. But it is sure making us all broke.

Meanwhile the contenders for the bubble at the head of the ‘free world’ are debating gay marriage, but in apparent agreement about drones(fine), financial oversight (none), climate change (none), ongoing wars, and ‘growth’; while unaware of the productivity multiplication of robots, computers, and the internet. What the Hoot does interest represent? The risk of creating money from nothing?

“If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.”

– Thomas Jefferson, Letter to Treasury Secretary Albert Gallatin (1802)

Posted by TheOldSodbuster | Report as abusive
 

We are approaching the end of a world wide sovereign debt bubble. Soon the bubble will burst and the world’s fiat currencies will lose much of their value, including the dollar. This is the price you pay for over 30 years of fiscal mismanagement by nearly every government in the “developed” world. No matter who is in control of government and the prevailing political philosophy, we are in for a very bad time in the not too distant future. Central banks are keeping interest rates low in hopes of delaying the inevitable world wide economic contraction.

Posted by gordo53 | Report as abusive
 

I agree with all the above comment.

Where is Thomas Jefferson, When we need him the most!

As a citizen, The whom loves country of ours,
what keep me wake at night,
These peoples, whom, call them selves as Leader!

Posted by fixthedebtnow | Report as abusive
 

Time for a regime change at the rogue Fed. Destruction of the life style of a broad set of citizens is not part of their mandate. The sooner Bernanke and Company are replaced the better. No republic in history had an fiscal and monetary policy like the U.S. currently has and done well economically. It doesn’t take a genius to understand that.

Posted by Boat52 | Report as abusive
 

The federal reserve basically has only 2 tools to govern the economy with: the money supply and interest rates. When the interest rate goes to zero, and the economy no longer responds, that is a condition known as the “Liquidity Trap”. We are now in the Liquidity Trap, and the Fed is basically in a position where it no longer stimulate the depressed economy. At this point, the government is supposed to step in and start building roads and infrastructure, but they don’t because present day Calvin-Coolidge/Herbert-Hoover’s (like Paul Ryan) have the idea that we should pay off the debt in the middle of a depression. That’ll surely fix the economy – NOT. And it didn’t fix it in the Coolidge/Hoover days either.

Posted by possibilianP | Report as abusive
 

The federal reserve basically has only 2 tools to govern the economy with: the money supply and interest rates. When the interest rate goes to zero, and the economy no longer responds, that is a condition known as the “Liquidity Trap”. We are now in the Liquidity Trap, and the Fed is basically in a position where it no longer stimulate the depressed economy. At this point, the government is supposed to step in and start building roads and infrastructure, but they don’t because present day Calvin-Coolidge/Herbert-Hoover’s (like Paul Ryan) have the idea that we should pay off the debt in the middle of a depression. That’ll surely fix the economy – NOT. And it didn’t fix it in the Coolidge/Hoover days either.

Posted by possibilianP | Report as abusive
 

The federal reserve basically has only 2 tools to govern the economy with: the money supply and interest rates. When the interest rate goes to zero, and the economy no longer responds, that is a condition known as the “Liquidity Trap”. We are now in the Liquidity Trap, and the Fed is basically in a position where it no longer stimulate the depressed economy. At this point, the government is supposed to step in and start building roads and infrastructure, but they don’t because present day Calvin-Coolidge/Herbert-Hoover’s (like Paul Ryan) have the idea that we should pay off the debt in the middle of a depression. That’ll surely fix the economy – NOT. And it didn’t fix it in the Coolidge/Hoover days either.

Posted by possibilianP | Report as abusive
 

@TheUSofA – Well said.
@TheOldSodbuster – Well said.

Posted by AdamSmith | Report as abusive
 

@TheUSofA – Well said.
@TheOldSodbuster – Well said.

Posted by AdamSmith | Report as abusive
 

@TheUSofA – Well said.
@TheOldSodbuster – Well said.

Posted by AdamSmith | Report as abusive
 

The full impact of low interest rates on savings still has not occured yet. I was fortunate enough to purchase 5 year CDs with my savings during the past few years. I even have one CD that I am still getting near 6% on through the middle of 2014, but more recently I have had to renew the others at far lower rates. The question for myself is what to do with CDs that continue to come due. Stocks? Gold? Real Estate? My feeling is that stocks will stay about the same, maybe increase slightly, but is the risk worth it? My feeling is No. How about gold? It would not surprise me to see gold fall to $800 or so. Real Estate? In the long run it may be the best investment, but it bothers me that real estate prices are being held artificially high by low interest rates. There is no question that savers are being punished.

Posted by 123456951 | Report as abusive
 

The full impact of low interest rates on savings still has not occured yet. I was fortunate enough to purchase 5 year CDs with my savings during the past few years. I even have one CD that I am still getting near 6% on through the middle of 2014, but more recently I have had to renew the others at far lower rates. The question for myself is what to do with CDs that continue to come due. Stocks? Gold? Real Estate? My feeling is that stocks will stay about the same, maybe increase slightly, but is the risk worth it? My feeling is No. How about gold? It would not surprise me to see gold fall to $800 or so. Real Estate? In the long run it may be the best investment, but it bothers me that real estate prices are being held artificially high by low interest rates. There is no question that savers are being punished.

Posted by 123456951 | Report as abusive
 

Ours is a market economy polluted by communistic and socialistic ideals. Greenspan said he believed market forces correct market imbalances, and then went on to counteract market forces concerning interest rates. This is because the institution he headed gave his bloated ego the power to ignore market forces and corrupt them instead.

Talk of political neutrality concerning the Fed is a farce. It is an institution created to manipulate market forces; run by people who at all times react to their mandates created by politicians. The political aims of these mandates are to pacify the population and business community at large concerning “action” on an economy not behaving as desired. Our society has gotten what it deserves in the way of an economy in collapse with those in the Fed playing the same tricks that got us here.

Social Security, another political creation, has also given us what we deserve – social insecurity. Where is a sense of personal responsibility? The mass of people want their politicians, whether scum of the earth dictators in China or idiots in Europe or America, to give them what they want or it’s off with their heads.

The difference in America is the individual has an opportunity to defend against “the many” and the “leaders” through his or her own actions. The mechanisms of that defense, free markets and the legal system, have been attacked by socialist/communist dogma and the political lackeys of that dogma. It would be nice to see the American Dream of free markets and the legal system survive that attack.

We in America have freedom and are able to defend it through a system of laws where the people do have a say in their creation and a potential for self-defense. China instead has a weak political system, afraid of freedom, made up of weak political leaders who hide their lust for illegitimate power and its exercise behind the skirts of social stability – how incredibly self-serving and pathetic.

Posted by keebo | Report as abusive
 

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