Sunday, July 24, 2011

How the Federal Reserve Has Crushed Middle Class Savers

Starting in 2008 we had so many posts on what was coming that I ended up boring myself.
Here's one from December of that year:
"Mom, Ben Bernanke Likes Bankers Better than He Likes You"
Savers are getting screwed as banks reliquify their balance sheets.
The ostensible reason short rates are now officially at 0.2% is to encourage banks to lend.
It's not going to happen. The banks are not taking on individual's or commercial's risk. Auto loans for a FICO score of less than 720 aren't being written.
So what are they doing? Carry-trade (say it like "Toga party").
For months, the borrow U.S. short, lend U.S. long has been used to rebuild banks balance sheets, destroyed by their former business practices.

Now with the Fed explicitly committed to lowering long rates (the 30-year trading at 2.63%, the 10-year at 2.144%), even borrowing at 0.2% doesn't give enough spread to run cash flow through the income statement and onto the bank's balance sheets.
What will the banks do? My guess is they will start buying sovereign debt for the yield, maybe even selling it to the Fed so they can take the money and do it all over again.
Right now Australian 15-years are priced at 4.20%.

Today, the American saver gets a pittance in a money market. It's really nothing but a wealth transfer racket.
Mom, we're going to Sydney.
Similar thoughts at "Investment Postcards from Cape Town":
Here's today's story, from Barron's:
The Steep Costs of Easy Money
The Fed's loose monetary policies have delivered a body blow to savers—and to the economy.
Aesop and his ants had it all wrong: The advantage belongs to the grasshoppers.

A new study by two economists at the nonpartisan American Institute for Economic Research concludes that Federal Reserve Board Chairman Ben Bernanke's crisis management has kept interest rates so low for so long that it has deprived savers of hundreds of billions of dollars in interest income. That, in turn, has cost the economy $256 billion to $587 billion in consumption and 2.4 million to 4.6 million jobs, but has shaved between 1.75 and 3.32 percentage points to gross-domestic-product growth.

The beneficiaries of the Fed's policies have been borrowers. In other words, people employing record-inexpensive leverage—the grasshoppers among us—have been thriving, while the fortunes of the prudent, savings-minded ants have been wilting.

Bernanke, defending his policies, has cited a study by the central bank's own economists that concluded the Fed's policy of easy money and huge asset purchases prevented a ruinous bout of deflation, and will have contributed to the addition of three million jobs to the economy by 2012. Minus the Fed's actions, there would have been 1.8 million fewer jobs, the study claims. Bernanke cited the Fed study in a footnote to the semiannual Monetary Policy Report to the Congress, which he delivered July 13 to the House Committee on Financial Services.

Like the American Institute's study, the Fed paper admits that savers paid a price. But if you read between the lines, the Fed paper is arguing that its actions significantly boosted the fortunes of people who own stocks, are inclined to borrow for business, own homes and purchase cars and major appliances—supposedly, most U.S. households. While the Fed study doesn't claim that Bernanke's policies constituted a magic bullet, it argues that any standard macroeconomic model would show that the easy money and the asset purchases created a net positive effect on spending.

"The Fed paper argues that it impacted the economy positively through three main channels," says Polina Vlasenko, who co-authored the American Institute paper with fellow economist William Ford.

First, the Fed notes, it has kept rates low to stimulate borrowing; second, it has created a wealth effect by encouraging savers to move money from certificates of deposit and low-yielding bonds into riskier assets like equities. Third, it depressed the value of the dollar, stimulating export growth. All of these channels worked to some extent, says Vlasenko, who discussed the research with me by phone last week. "What we say is that there is another channel affecting the economy, which is that as you keep rates low for a very long time, you deprive those who save of their interest income."...MORE