You probably know what the Federal Reserve Bank decided at its June meeting. Despite being billed as a month of possible interest-rate hikes, we head into the true summer months without said hikes.
Some welcome this news. If you’re in the market for a home and were worried about getting a mortgage at near-rock bottom rates, you’re probably relieved. Though rates have been inching up, there’s no fell swoop by the Fed that’s going to alter any trends.
But aside from being able to stop worrying whether the payment on your new house is going to go up by $30 a month or so, have you given much thought to the Fed’s move (or, actually, lack thereof)?
I can’t see how everyone could possibly see it as all good. I’m no economist, so take this all with a grain of salt, but all would not appear well.
First, it shows that the Fed is at least a little bit concerned about the health of the economy. If it were growing at pace they were comfortable with, rates would rise. It really is that simple. The decision to keep the Federal Funds rate unchanged is a signal that the economy is not growing as they think it should be. And that, given the fairly recent recession from which we’re still recovering, should be at least a little concerning.
More concerning, however was the timing of the non-move. It came right on the heels of a jobs report that was disappointing. As in, 100,00 fewer people were in jobs than had been anticipated. This might sound like a near-miss of a projection, but the fact is that the economy hums along best when people are working. If you’re in the business of judging an economy’s health, and not as many people are working as you thought there’d be, it’s a bit worrisome.
But there lies more beyond just the somewhat troubling reasons for why rates aren’t rising. There should be concern for what it means when they don’t.
I’ve said it before, and I will say it over and over again: Banks lend money when it is profitable for them to lend money. Everybody moans and groans over “tight” lending or whatever else you want to call it, but do they realize that at least some of that can be attributed to the lack of profitability the lending game is currently affording banks? The whole risk-reward equation is well-known. Do we expect banks to take risks when there is little reward?
On top of the lack of opportunity for banks to make money on the money they lend, there’s also the problem of cash reserves. They are required to have a certain amount of cash on hand, yet low interest rates provide no incentive – and maybe even a disincentive – for depositors to keep money in banks. When you’re earning about a penny a month on every $200 you keep in the bank, you’re going to start looking elsewhere. There are plenty of low-risk investment options that will fetch 10 times what banks pay in interest.
Which means that banks are likely not getting the types of deposits they are accustomed to. If there are other alternatives, why let your money sit at your local bank for half-a-percent of interest? Despite this presumed drop in deposits, banks still must have X amount of cash on hand.
And if banks have to have X amount of money on hand, and they can make very little money when they lend that money, what are they going to do?
Think of it this way: You have 10 bucks in your pocket, which your mom gave you for an emergency but might want back. She says you must keep at least nine of it in your pocket at all times. Someone, a total stranger, wants to borrow one dollar. For loaning him that dollar, he will pay you back $1.04. Do you risk flirting with that nine-dollar minimum your mom has instituted for the gain of a mere four pennies? This is the question every bank faces, thousands of time a day, every day.
I get that the Fed is worried about lowering consumer spending and therefore slowing the economic growth. But meaningful consumer spending is still, for better or for worse, still largely based on available credit. And if the banks aren’t making any money on money they make available as credit, then there simply isn’t as much money available as credit.
For sure, the low-interest rate climate was necessary to keep the economy afloat. To grow it, however, there comes a point when this ultra-cheap money flow has to ebb.
That we can’t clearly see an end it sight should worry us.