And that would mean everything we thought we knew about borrowing money may be about to go into reverse…
Usually when you borrow money, you have to pay it back with interest. But what if someone was willing to pay you to take out the loan, so when you pay it back, you’re actually required to pay less than you borrowed?
Sound like a ridiculous fantasy that completely defies logic? It may be about to happen.
In light of the many and sudden economic problems caused by the Coronavirus pandemic, the Federal Reserve has already dropped interest rates to zero, and made it clear that it’s willing to give U.S. banks access to an unlimited amount of money. “The amounts needed” is how the Fed puts it.
But even with access to “free” money, banks aren’t lending, because they have zero visibility about the future of the economy. And even if it costs them nothing to borrow the cash they could use as principal for loans, they need to be pretty sure they’d get that principal paid back. And they don’t know that right now; they can’t know that. Even with their best customers.
For example, we spoke to a friend today in Northern California, which up to a couple of weeks ago was one of the hottest real estate markets in the country. She has a mortgage and a second mortgage, and has never missed a payment on either. She wants to combine the two loans and refinance. She can’t. Everything’s frozen up.
So if offering an unlimited supply of cash to banks at zero interest isn’t succeeding in opening up flows of capital to consumers, where can the Fed go from here?
Negative interest rates.
Meaning if a big bank borrows money and puts it out into the world by lending it to a customer to buy real estate for instance, they’ll be rewarded by having to actually pay back less than they borrowed from the Fed to make that loan. The point—the only point: to put money into action. Now.
This is something Trump has touted for years. But he wanted to do it when the economy was going gangbusters. And thank goodness the Fed didn’t oblige him despite his incessant bullying on it. Because then they wouldn’t have that option open to them now.
On the consumer level, banks and mortgage lenders, etc., always charge more for money than what it costs them to get that money, so even with negative interest rates, most consumers will probably still have to pay some small interest on a mortgage, for instance. But it would probably be a record low percentage, and might even be pretty close to zero. The most likely place for the average consumer to directly access negative interest rates would be in car financing.
And if the Fed does go ahead with it, what that would mean is to your savings account? Instead of being “rewarded” with interest payments, which is the usual way, you’ll now be penalized in some way. Would the you now have to actually pay interest to your bank for hanging on to your money? Probably not. That’s because of competition: if a bank did that, you could just move your money to another bank that didn’t. But retail banks would almost certainly see their profits go down, so it’s very likely you’d see things like higher monthly charges and ATM fees. (And we’ve long argued that the U.S. already has negative interest rates for many poor and middle-income people in the form of the fees they’re already paying on non-interest bearing accounts, but that’s a story for another day.) Even if banks do start charging customers to hold their money, some people may still choose to pay a premium to keep their money in federally insured bank accounts or Treasury securities, just for the relative safety of it.
While negative interest rates may sound magical to borrowers, (not so much for savers) they do not really seem to be a good thing for anybody. Which may be why they’re something the Fed’s been pretty obviously trying to avoid by trying to do absolutely everything else in its power first. Mostly because negative interest rates are often tantamount to an admission no one has any notion where the economy is headed at all. And so you’re trying to urge banks and other borrowers to overlook this and go blindly down a path. Essentially, by making them an offer they can’t refuse.
It also helps contribute to the threat of deflation, which also sounds great—everything’s cheaper!–but isn’t. We’ve explained before why the Fed sometimes tries to work to boost inflation as long as it seems to be under control. Here’s a link to our story about that. Because in a healthy economy, prices should keep going up a little. Negative interest rates tend to work against that. If things can be produced or procured at an ever-cheaper rate, it’s hard to keep prices up. Unless there’s also a shortage of goods. But in the current crisis, except for a few items that are being hoarded and masks, ventilators and other medical equipment, it’s a severe sudden shortage of cashflow, not a shortage of goods that’s the problem.
And once you go down the path of negative interest rates it’s very hard to reverse it. Countries that have tried it in the past to jump start their economies have often become mired in economic malaise for years.
It’s also kind of un-American. Most people in this country were brought up thinking savings is a good thing, and borrowing is bad. Hanging on to cash; having a decent size nest egg was always something to aspire to.
“Neither a borrower nor a lender be,
For loan oft loses both itself and friend.” (Shakespeare. Hamlet. Act 1)
Now that could be completely turned on its head. But then, many things we’ve taken for granted are abruptly changing these days.
“Only be a borrower or a lender,
Forget about your friends; gotta get the economy “open” again!”