If Neville Chamberlain were alive today, he would be an economist instead of a diplomat. He would be creating jobs instead of peace. He would champion the Federal Reserve line that we need low interest rates to stimulate the economy. He would get off the plane with the Beige Book to proclaim: “We have jobs in our time”.
The common economic analysis says that low interest rates spur investment which creates the jobs that are needed to drive the economy. Unfortunately, this economic myopia works only in the world of academia where it is possible to hold the world ceteris paribus and keep the forces of unintended consequences in the footnotes.
The basic flaw in this economic model is that it assumes that all investment is good and that resources put to work were idle. The model works well when an unemployed person borrows to open a business which is profitable enough to repay the loan. The model works less well as the quality of the investment erodes, or the resources employed were drawn away from productive uses. For example, it is possible that lower interest rates will encourage a good baker to become a bad house flipper. Does that help the economy?
What economists need to explain is how the economic transfers actually make the economy better. Lower interest rates transfer economic activity from the future to the present. It transfers wealth from lenders to borrowers. It transfers demand from unleveraged purchases to leveraged purchases. But how does all of this economic activity help the economy?
Interest is the cost of money over time and risk. Lowering the cost of money today means that you will push demand forward, getting people to buy things today that they would have bought in the future. This demand comes from somewhere. It is shifted from other current demand, or it is brought forward from the future to the present. When I buy a $30,000 car today on leverage, it is $30,000 of purchases of other things that I am not making in the future. Debt is not spurring the economy. It is borrowing prosperity from the future.
It is the purchases ‘not made’ that economists never factor into a ceteris paribus model. Economists focus solely on the borrower who invests the money, but they forget that for every dollar of interest saved someone has lost a dollar of payment. The bank is not a lender, but rather a conduit to the lender which may be an 85 year-old retiree. When the Federal Reserve lowers interest rates by 90%, it is effectively cutting the pay of the 85 year-old retiree. It is cutting the pay of businesses which no longer enjoy the patronage of the 85 year-old retiree.
This activity will help the economy only to the extent that the borrower spends the money more wisely than the 85 year-old retiree would. This is a pretty dubious assumption given that the interest rates are a function of risk. So lowering interest rates encourages marginal borrowers to open businesses which would not exist under a normal interest rate structure. In the case where lower interest rates encourage a good baker to become a bad house flipper, the economy is going to be hurt.
One should ask what will happen to these businesses once the interest rate structure normalizes. As the cost of funds rises, will these new businesses survive? Some will not, and you have to ask how does it help the economy to have someone leave a productive job to start an unproductive business that ends in bankruptcy?
It is economically unreasonable, if not counter-intuitive, to suggest that desensitizing the users of capital from the cost will lead to a better economy. To suggest that the lowering the cost of money is good for the economy is no more reasonable than saying that lowering the cost of bread will help the economy. In this case, the buyers of bread win and the bakers of bread lose as people buy more bread. The bakers of muffins lose as more people eat bread than muffins. There are winners and losers, but the problem with the logic isn’t in the winners and losers – it is in the bread crumbs. If you lower the cost of bread people, both consumers and producers, will leave more crumbs.
To illustrate the ‘bread crumbs’ of capital that are lost to lower interest rates, drive to any new housing development. There are 5 or 6 where I live. While these developments serve different markets and different pricing points, they all have one thing in common – no workers and no occupants. If you call the realtors you get the same story – we are waiting for the market to turn. It is only possible to hold these economic assets inactive because of the internal cost of funds at the bank.
The owners of capital have no reason to pick-up the ‘bread-crumbs’ when interest rates are .25%. People will let the penny jar grow. What is the point of putting them in a bank when the rate is .07%?
One of the inescapable ends of lowering interest rates the way is a rising foreclosure rate. Levered assets will flow over time the lowest cost of funds just as water runs down hill. If the marginal homeowner pays 6% and the bank pays .25%, the cost of owning the home by the bank is fractional compared to that of the homeowner. The bank will hold real estate longer, and be less willing to renegotiate existing loans. There is nothing in that outcome that helps the economy.
The whole point of lowering interest rates isn’t to improve the economy. It is to give the voting public a nearterm feel-good number that makes them think that the economy is turning around. The fact is that all of what we are doing is making the crisis worse and last longer than it should.
Saturday, January 16, 2010
Why Should The Elderly Bear The Burden For The Financial Crisis
This is an open letter to the AARP.
AARP
601 E Street N.W.
Washington, DC 20049
Dear AARP,
I would like to know more about your organization, and give you a chance to reply to what in my mind seems like an irreconcilable contradiction between the stated goals of your organization and what appears to be a complete indifference to the welfare of your members.
Your members are largely retired, and in some part dependent upon generating a fixed return from their life’s savings. This income is their paycheck, and provides in many cases necessities of life. That paycheck has been cut by more than 90% by the Federal Reserve which has forced interest rates down to help stabilize the global financial system.
In the last two years your members have watched their money market rates drop from over 5% to .07%. The percentages don’t tell the story of your members, though. The 85 year-old retiree who saved $30,000 through hard work has watched his paycheck drop from $1,500 to $21 by government fiat. Every year this person gets to loses $1,479 of things that they don't eat, children they don't see, and basics that they don't have. And for what: so that bankers can take millions in bonuses to their homes in the Hamptons.
Your organization seems OK with this pay cut to help the country. So I have to ask whether you took a 90% pay cut to help the country? Ben Bernanke didn’t take a pay cut, and neither did Geithner. But you are letting the government force a 90% pay cut on your members, who are now forced to rethink the basic needs of life. Frankly I have a difficult time reconciling the amount you are paid with the nothing that you are doing.
While every American is ready to do his part to fix our country, I am pretty sure that asking $1,479 per year from someone bordering on the poverty level is more than his fair share. Fairness is of course always debatable. Maybe you think that is fair. Is it fair to ask the elderly to bear the brunt of the burden for solving this crisis? Is it fair to ask why AARP hasn’t asked this question? I will tell you that it is fair to ask why AARP has been completely silent on the issue.
What isn’t debatable is the fact that the members of AARP had statistically the least to do with the causes of the crisis. Statistically, AARP members own their homes with no ARM leverage. They don’t flip homes. They didn’t originate, package, rate, or sell toxic assets to institutional investors. Punishing the elderly for the casino lifestyle led by others is no more sensible than kicking the dog when your kid brings home bad grades.
Your silence on the Bernanke policies is shameful and reprehensible. What should bother you most is that he is not even an elected official. He is a bureaucrat who has decided one group of people should benefit at the expense of the dues paying members of the AARP. And your organization does nothing to protect those who pay dues to you.
I am writing you so that I can be wrong. I would welcome hearing that you have engaged your lobbying team to protect your members. I would welcome hearing that you took a pay cut so that you could share in the pain of your community. I want to be wrong, and look forward to getting a letter from you explaining how I am wrong. Here is where I am not wrong - what our country is doing to people living on a fixed income is wrong, and no one seems to be doing anything about it.
AARP
601 E Street N.W.
Washington, DC 20049
Dear AARP,
I would like to know more about your organization, and give you a chance to reply to what in my mind seems like an irreconcilable contradiction between the stated goals of your organization and what appears to be a complete indifference to the welfare of your members.
Your members are largely retired, and in some part dependent upon generating a fixed return from their life’s savings. This income is their paycheck, and provides in many cases necessities of life. That paycheck has been cut by more than 90% by the Federal Reserve which has forced interest rates down to help stabilize the global financial system.
In the last two years your members have watched their money market rates drop from over 5% to .07%. The percentages don’t tell the story of your members, though. The 85 year-old retiree who saved $30,000 through hard work has watched his paycheck drop from $1,500 to $21 by government fiat. Every year this person gets to loses $1,479 of things that they don't eat, children they don't see, and basics that they don't have. And for what: so that bankers can take millions in bonuses to their homes in the Hamptons.
Your organization seems OK with this pay cut to help the country. So I have to ask whether you took a 90% pay cut to help the country? Ben Bernanke didn’t take a pay cut, and neither did Geithner. But you are letting the government force a 90% pay cut on your members, who are now forced to rethink the basic needs of life. Frankly I have a difficult time reconciling the amount you are paid with the nothing that you are doing.
While every American is ready to do his part to fix our country, I am pretty sure that asking $1,479 per year from someone bordering on the poverty level is more than his fair share. Fairness is of course always debatable. Maybe you think that is fair. Is it fair to ask the elderly to bear the brunt of the burden for solving this crisis? Is it fair to ask why AARP hasn’t asked this question? I will tell you that it is fair to ask why AARP has been completely silent on the issue.
What isn’t debatable is the fact that the members of AARP had statistically the least to do with the causes of the crisis. Statistically, AARP members own their homes with no ARM leverage. They don’t flip homes. They didn’t originate, package, rate, or sell toxic assets to institutional investors. Punishing the elderly for the casino lifestyle led by others is no more sensible than kicking the dog when your kid brings home bad grades.
Your silence on the Bernanke policies is shameful and reprehensible. What should bother you most is that he is not even an elected official. He is a bureaucrat who has decided one group of people should benefit at the expense of the dues paying members of the AARP. And your organization does nothing to protect those who pay dues to you.
I am writing you so that I can be wrong. I would welcome hearing that you have engaged your lobbying team to protect your members. I would welcome hearing that you took a pay cut so that you could share in the pain of your community. I want to be wrong, and look forward to getting a letter from you explaining how I am wrong. Here is where I am not wrong - what our country is doing to people living on a fixed income is wrong, and no one seems to be doing anything about it.
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