Author Topic: Five Year of the Fed's Zero Interest Rate Policy with Winners and Losers  (Read 5070 times)

SeattleSun

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Let's face it if we could get 5.5% in an FDIC insured account many of us wouldn't be here.  The Fed has Mom and Pop saver force way out on the risk curve and the stretch for yield often ends badly.

Additionally I suspect the Pension Funds and Insurance Companies are the institutional whales moving into P2P as they have been hurt badly by the ZIRP.

SS

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Dec 16, 2008 to Dec 16, 2013 Happy 5th Birthday ZIRP!





The Consequences of the Fed's Zero Interest Rate Ppolicy


1) The large losses from the continued financial repression of interest rates falls on SAVERS and PENSION FUNDS/INSURANCE COMPANIES companies.

Simply put, ultra-low interest rates mean that those who have saved money in whatever form will be getting less return on that money from safe, fixed-income investments. We're talking about rather large sums of money, as we will see. Ironically, this translates into a loss of consumption power when the Federal Reserve is supposedly concerned about consumption and requires increased savings at a time when the Fed is trying to boost demand. This is robbing Peter to favor an already well-off Paul.

A new report from the McKinsey Global Institute examines the distributional effects of these ultra-low rates. It finds that there have been significant effects on different sectors in the economy in terms of income interest and expense. From 2007 to 2012, governments in the Eurozone, the United Kingdom, and the United States collectively benefited by $1.6 trillion, both through reduced debt-service costs and increased profits remitted by central banks (see the chart below). Nonfinancial corporations large borrowers such as governments benefited by $710 billion as the interest rates on debt fell. Although ultra-low interest rates boosted corporate profits in the United Kingdom and the United States by 5% in 2012, this has not translated into higher investment, possibly as a result of uncertainty about the strength of the economic recovery, as well as tighter lending standards. Meanwhile, households in these countries together lost $630 billion in net interest income, although the impact varies across groups. Younger households that are net borrowers have benefited, while older households with significant interest-bearing assets have lost income.

McKinsey estimates that households in the US have lost a cumulative $360 billion. Meanwhile, banks and businesses have done very well.




This loss of household income requires tightened spending by retirees and means that those facing retirement have to spend less and save more in order to make sure they will have enough to live on. It also requires the older generation to work longer, which is demonstrably keeping jobs away from the younger generation, as I've documented clearly in past letters.

ZIRP means that the pension funds and insurance companies responsible for your annuities are making significantly less on their portfolios than they had hoped. There are lots of ways to express this loss, but I will offer three charts that will give us some indication of the magnitude of the loss over a period of 30 years.

Most public pension funds work with some variation of the traditional 60-40 portfolio, that is to say, 60% in equities and 40% in fixed income. They also target anywhere from 7 to 8.5% returns from their portfolios over the next 30 years in order to be able to generate the money they will need to pay retirees. The amount of assets they have today in their accounts is quite small in comparison to future requirements, and thus they are depending upon the magic of compound interest in order to be able to deliver the needed pension funds to their clients.

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« Last Edit: December 25, 2013, 04:10:37 PM by SeattleSun »

Peter

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Re: Five Year of the Fed's Zero Interest Rate Policy with Winners and Losers
« Reply #1 on: December 27, 2013, 06:19:04 PM »
I just read that Bill Gross from PIMCO said today that he doesn't expects rates to rise until at least 2016. By the time this is said and done we will probably have a decade of close to ZIRP. This will continue to make all forms of alternative fixed income very attractive and so LC, Prosper and many others will be making hay for several years to come.
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Rob L

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Re: Five Year of the Fed's Zero Interest Rate Policy with Winners and Losers
« Reply #2 on: December 27, 2013, 06:50:50 PM »
P2P is a rather new "asset class". Only hindsight will tell where it falls on the risk curve.
We have all seen that very clearly ZIRP is moving major capital in its direction and it is rapidly accelerating. My guess is that there's probably more risk than it presently seems since there's no such thing as an easy 8% in the new normal.

rawraw

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Re: Five Year of the Fed's Zero Interest Rate Policy with Winners and Losers
« Reply #3 on: December 28, 2013, 08:12:57 AM »
I just read that Bill Gross from PIMCO said today that he doesn't expects rates to rise until at least 2016. By the time this is said and done we will probably have a decade of close to ZIRP. This will continue to make all forms of alternative fixed income very attractive and so LC, Prosper and many others will be making hay for several years to come.
That's a long time.  But I also don't trust people to predict things like this, as they have a terrible track record.

SeattleSun

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Re: Five Year of the Fed's Zero Interest Rate Policy with Winners and Losers
« Reply #4 on: January 03, 2014, 01:29:05 AM »
I just read that Bill Gross from PIMCO said today that he doesn't expects rates to rise until at least 2016. By the time this is said and done we will probably have a decade of close to ZIRP. This will continue to make all forms of alternative fixed income very attractive and so LC, Prosper and many others will be making hay for several years to come.


The last time we were at the "zero bound" i.e. ZIRP was Sept 1932 and the next peak in the "policy rate" or what we now call the Fed Funds Rate was 21 years later in August of 1953 at 2.1%.  That would be a very long "extend period of time".  lol

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Rob L

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Re: Five Year of the Fed's Zero Interest Rate Policy with Winners and Losers
« Reply #5 on: January 03, 2014, 08:50:37 AM »
Very interesting data; thanks for posting!

investforfreedom

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Re: Five Year of the Fed's Zero Interest Rate Policy with Winners and Losers
« Reply #6 on: January 06, 2014, 12:35:21 PM »

Although ultra-low interest rates boosted corporate profits in the United Kingdom and the United States by 5% in 2012, this has not translated into higher investment, possibly as a result of uncertainty about the strength of the economic recovery, as well as tighter lending standards.

Thanks to the information and internet revolution in the past couple of decades, labor productivity has risen to unprecedented levels. (http://data.bls.gov/pdq/SurveyOutputServlet?request_action=wh&graph_name=PR_lprbrief) Companies can now do much more with fewer hands and in fact are making more money than ever.  Look at the surge in corporate profits in the 90s, especially around the turn of the century. (http://research.stlouisfed.org/fred2/series/CP)

What incentive do companies have to reinvest if they are already making so much money while keeping the costs down?  Unemployment will stay at elevated levels and the Fed will continue with ZIRP or near ZIPR policies for years to come. 

In fact, it is probably not too farfetched to say that corporations have now taken on the role of the government to pay "fixed" income in the form of dividends, now that they are awash with cash to the tune of $2.4 trillion. (http://research.stlouisfed.org/fred2/series/CNCF) This is why dividend stocks have been outperforming the market for the past 5 years in the wake of the market's hunger for yields.  (http://stockcharts.com/freecharts/perf.php?dvy%2Cspy)

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« Last Edit: January 06, 2014, 12:43:06 PM by investforfreedom »

SeattleSun

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Re: Five Year of the Fed's Zero Interest Rate Policy with Winners and Losers
« Reply #7 on: January 11, 2014, 04:55:58 PM »
Here is a nicer graph than the hand made one I posted on Jan 3rd but there are two difference to note:

1) it's the 10 year not the FFR I used and
2) they cut off the 21 year period of ZIRP from 1932 to 1953

But the long term shape are the point I was trying to make.

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« Last Edit: January 11, 2014, 04:58:02 PM by SeattleSun »

SeattleSun

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Re: Five Year of the Fed's Zero Interest Rate Policy with Winners and Losers
« Reply #8 on: January 11, 2014, 05:03:18 PM »

What incentive do companies have to reinvest if they are already making so much money while keeping the costs down?  Unemployment will stay at elevated levels and the Fed will continue with ZIRP or near ZIPR policies for years to come. 


Very nice post and don't you just love the FRED web site!

Unemployment fell from 7.0% to 6.7% in just the last month (tung in cheek)

investforfreedom

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Re: Five Year of the Fed's Zero Interest Rate Policy with Winners and Losers
« Reply #9 on: January 12, 2014, 01:15:23 AM »

What incentive do companies have to reinvest if they are already making so much money while keeping the costs down?  Unemployment will stay at elevated levels and the Fed will continue with ZIRP or near ZIPR policies for years to come. 


Very nice post and don't you just love the FRED web site!

Unemployment fell from 7.0% to 6.7% in just the last month (tung in cheek)



FRED is a gold mine for amateur economists like myself.  It is arguably just as valuable for professionals. 

6.7% unemployment but labor force participation is at a 35-year low (http://research.stlouisfed.org/fred2/series/CIVPART?cid=32443) and there are twice as many people working part-time for economic reasons as there were before the financial meltdown in 2008 (http://research.stlouisfed.org/fred2/series/LNS12032197).  It is a certainly a recovery for corporations but a job-less one for wage earners.  Here is a different look:(http://research.stlouisfed.org/fred2/series/LNU02032196).

« Last Edit: January 12, 2014, 01:23:06 AM by investforfreedom »

Rob L

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Re: Five Year of the Fed's Zero Interest Rate Policy with Winners and Losers
« Reply #10 on: January 12, 2014, 04:45:01 AM »
I totally lost my economic bearings in '08 am still adrift in the new normal sea without a compass (and no, I didn't take a hit in the stock market crash, I had moved to TIPS before). Early on the immediate measures taken (TARP, etc.) kept us all from falling into a deep dark abyss with possibly unimaginable consequences. That action was unavoidable. Since then the actions of the government have been shocking and even surreal to me. Things were done I never imagined possible with the government intervening so deeply into the private sector. There are no more boundaries. But here we are.  Feels like we've painted ourselves into a corner and I really hope there's a door behind us.