Tuesday, January 10, 2012

"The hidden dangers of low interest rates"

As I said in last October's "America is General Electric's Tax Haven (GE)":
The writer won the 2001 Pulitzer Prize for his reporting on the U.S. Tax Code.
I'm pretty sure he is the only reporter to have ever done so with that subject matter.
From Reuters:
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.

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....MORE
We've touched on the problems associated with racking up debt in a low interest rate environment a few times. In "Betting the Farm: Debt Brings Risk of Losing it All" we led with:
The risk for farmers is the same as that faced by the U.S. government.
It's not the debt per se, it is the cost of servicing it. Low interest rates seduce borrowers into taking on more debt than they should because the current interest cost is manageable. Should rates increase the proportion of cash flow that must go to debt service can crowd out any other use.

I touched on this problem during the run-up to the 2010 mid-term elections in "
For My Republican/Conservative/Tea Party Friends: "Here is where all that Government Spending is Really Going". In a November post, "U.S. Government Debt Service to Surpass Military Outlays by 2016" we had a chart showing Federal interest payments rising from a bit over $200 billion/year to $800 billion, $600 bil. that could go toward productive purposes but instead would be used to keep the collection agency from calling....