Sense on Cents

Why is it that the very people who saved and invested to finance a lot of the growth in our nation are now the very ones being penalized by the exceptionally low interest rate policy of the Federal Reserve? While Ben Bernanke and his Washington cronies maintain that our economy needs these artificially induced government driven interest rates, the very fact is these anemic rates are crushing those citizens in our country who live on fixed incomes and rolled their CDs. While savers are getting waxed on one side of the coin, the banks are sticking it to our brethren who rely on credit lines from their credit cards on the other side. That’s business, you say? No, that is not purely business. In the midst of an economy dominated by the government, our current interest rate and credit card policies are nothing more than invisible taxes on both savers and consumers alike.

There are two sides to this coin and on both sides banks are squeezing American citizens. Savings rates have plummeted while borrowing rates via credit cards move higher. Both these points are highlighted in recent commentaries. 

The New York Times’ Gretchen Morgenson provides riveting insights into the ‘tax’ embedded in our interest rate policy in writing Debt’s Deadly Grip:

…this is what happens after a spectacular asset bubble bursts. Nevertheless, for consumers who are cutting debt and trying to save, it is dispiriting indeed that they generate so little on their money. Those living on fixed incomes are also in a bind.

It is not lost on these consumers that their minuscule returns are a direct result of the Federal Reserve’s attempt to shore up troubled banks’ financial standing. Sharply cutting interest rates vastly increases banks’ profits by widening the spread between what they pay to depositors and what they receive from borrowers. As such, the Fed’s zero-interest-rate policy is yet another government bailout for the very industry that drove the economy to the brink.

Todd E. Petzel, chief investment officer at Offit Capital Advisors, a private wealth management concern, characterizes the Fed’s interest rate policy as an invisible tax that costs savers and investors roughly $350 billion a year. This tax is stifling consumption, Mr. Petzel argues, and is pushing investors to reach for yields in riskier securities that they wouldn’t otherwise go near.

In short, the Fed’s interest rate policy may be causing more economic problems than it’s solving.

Here’s how Mr. Petzel calculated the amount that savers are losing: Some $14 trillion in debt issued by the Treasury, federal agencies and municipalities is held by investors here and overseas. Rates are currently near zero on short-term Treasuries, compared with an average of 3 percent over time. Therefore, Mr. Petzel says, it is reasonable to estimate that rates are too low by 2.5 percentage points. On $14 trillion, that’s $350 billion a year in lost income. (LD’s emphasis)

Yes, we’re talking real money. It’s more than 2 percent of gross domestic product and almost 3 percent of disposable personal income, Mr. Petzel noted.

“If we thought this zero-interest-rate policy was lowering people’s credit card bills it would be one thing but it doesn’t,” he said. Neither does it seem to be resulting in increased lending by the banks. “It’s a policy matter that people are not focusing on,” Mr. Petzel added.

What about those credit card bills? Yes, while the banks get to borrow at virtually zero interest rate, the rates being charged on credit cards are moving ever higher. How so? The Wall Street Journal addressed this ‘invisible tax’ yesterday in reporting, Credit-Card Rates Climb:

In the second quarter, the average interest rate on existing cards reached 14.7%, up from 13.1% a year earlier, according to research firm Synovate, a unit of Aegis Group PLC. That was the highest level since 2001.

Those figures look especially stark when measuring the gap between the prime rate—the benchmark against which card rates are set—and average credit-card rates. The current difference of 11.45 percentage points is the largest in at least 22 years, Synovate estimates.

Add it all up and what does it mean? Americans are redistributing their wealth to financial institutions on both ends of the spectrum. Is it any surprise why Americans are looking for financial solutions elsewhere? Where are they looking? Community banks, credit unions, and elsewhere.

Are these invisible taxes likely to change anytime soon? Nope. Why? The embedded losses in our major financial institutions remain large. They need to continue to build capital cushions to offset them. Borrowing at 0% and lending at 14.7% may work for the banks, but on the street that is called loan sharking or, more politely, usury.

Navigate accordingly.

Larry Doyle

I have no affiliation or business interest with any entity referenced in this commentary. As President of Greenwich Investment Management, an SEC regulated privately held registered investment adviser, I am merely a proponent of real transparency within our markets, including our financial regulators, so that investor confidence and investor protection can be achieved.

Please subscribe to all my work via e-mail, an RSS feed, on Twitter or Facebook.

This entry was posted on Tuesday, August 24th, 2010 at 8:27 AM and is filed under General. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.