0% Financing Doesn't Mean It's Free 21 comments
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Hey! Looks like it’s no-money-down, 0% financing for everyone these days! First we hear that rates paid on Treasury debt have fallen to essentially zero, and then that the Fed has matched suit with their key rate (slashing their target for the federal funds rate to a record low of between 0 and 0.25 percent). From the Bloomberg story on Treasuries (by Matthew Benjamin and Liz Capo McCormick):
Dec. 15 (Bloomberg) — Bill Clinton was forced to abandon spending initiatives to boost the economy at the start of his presidency when advisers warned him that the borrowing needed to fund the programs would push interest rates higher. President- elect Barack Obama may not have the same problem.
While the total amount of U.S. government debt outstanding rose to $10.7 trillion in November from $9.15 trillion a year earlier, the amount of interest paid in the last two months fell by $10 billion, according to the Treasury Department.
Instead of shunning the U.S., where losses on subprime mortgages in 2007 triggered a global seizure in credit markets that led to the downfall of securities firms Bear Stearns Cos. and Lehman Brothers Holdings Inc., investors can’t get enough Treasuries. Even as estimates of Obama’s stimulus package and the budget deficit rise to a record $1 trillion, demand continues to increase as investors flee risky assets around the world and put their cash into U.S. bonds paying, in some cases, nothing in yield just to ensure the return of their principal…
“This is not about return and yield and value; investors are functioning out of raw fear,” said Barr Segal, a managing director at Los Angeles-based TCW Group Inc., which oversees $90 billion in fixed-income assets. At the same time, “this is fabulous for the Treasury because they are borrowing at virtually nothing,” he said…
“It’s good news,” said James Horney, director of federal fiscal policy at the Center on Budget and Policy Priorities in Washington. “Even though we’re borrowing larger amounts of money, the total amount we’re going to pay in interest is going to be somewhat lower.”…
But really, it’s not as good news as some might want to think, because even 0% financing on our private and public borrowing doesn’t mean that borrowed money is “free.” The unfortunate reality beyond the next few months to a year is:
- We still have to pay it back; and
- Interest rates will eventually (and inevitably) come up.
I worry that the downside of currently very-low interest rates is the same kind of downside that led to the subprime mortgage crisis. Rates near zero give individuals, businesses, and government the false sense that borrowing is costless, and that they can afford to take on more debt than they really can.
Interest rates cannot stay near zero for very long, as there are ultimate limits on the worldwide supply of capital that prevent it from keeping up with our insatiable demands. The interest rate paid on Treasury debt is near zero now, not because investors are not worried about the government’s ability to pay down the debt in the future, but because they’re more worried about the current riskiness of other investments.
That dynamic will change over the next few months. And if consumers and businesses begin to see the zero percent Fed rate passed through to much lower interest rates on their own borrowing, they will be encouraged to borrow and consume again–which is what we want to happen with the monetary stimulus–but will they be encouraged to borrow and consume too much, such that when interest rates start to rise again as the economy recovers, they will find themselves (yet again) overextended? Are the now near-zero interest rates like “teaser” rates–the kind of only-temporarily-low rates that encouraged unsustainable debt burdens that got us into this mess in the first place?
My “bottom-line worry” is that the news of these near-zero interest rates will make politicians and the American public believe (falsely) that deficit spending is free. Today’s Washington Post reports on a new poll showing that public support for a massive increase in government spending is strong, but only when people don’t think about the costs:
The poll found that nearly two-thirds of Americans support new federal spending to stimulate the economy, and majorities of both Democrats and Republicans back the idea. Concern about deficit spending, however, mutes enthusiasm for the stimulus plan. When respondents were asked whether they would back the plan if it increased the deficit, support dropped to 47 percent. Overall, nearly nine in 10 said they are worried about the size of the federal budget deficit, including nearly half who are “very concerned.”
So the danger is that in a world of no-money-down, 0% financing, people will start to over-discount the costs of borrowing, start to think (falsely) that money is free, start to think (falsely) that anything with any potentially positive marginal benefit is worth pursuing–regardless of the marginal costs. In other words, people (and the government) will start behaving as if there are no budget constraints and no need to scrutinize and prioritize, when exactly the opposite attitude is needed going forward.
As Alice Rivlin, who is quoted at the end of the Bloomberg article on Treasury rates, says: “We can’t press our luck”… “Eventually, we’ve got to show the world that we are fiscally responsible.”
But we Americans are not good at self-discipline. That’s why I worry about the “good news” of near-zero interest rates.
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The irony with the average voter is that they are starting to "get" the deficit because they (themselves) are up to their eyeballs in debt and are wondering how / who is going to pay for it.
They're not sure how it works exactly, interest rates that are determined by the guy with a beard, we've made it till this point without having to know the dollar is just a paper currency (hey, we're americans....we were born better than everyone else, don't you know that?)
and so i think it is ultimately that american attitude eventually dig the hole and kill the dollar and make your predictions on China a certainty.
Hard lessons can not be taught, only learned, and we will be no different.
This game of chicken is getting really really old.
In fact the fed funds rate is somewhat irrelevant at this point as private sector rates are significantly higher (noone really effective borrow/lends out at these low rates). The key is to encourage banks to lend out capital which they clearly are not doing right now and hoarding it instead, making it even more difficult for businesses to function. Ironically, it will likely take the perception of another credit bubble to ensure inflation expectations and capital to flow through the economy once again. To encourage this to happen if what the fed calls "quantitative easing" which is a fancy way of saying printing money and injecting it into the system.
Of course this comes at a great cost, but probably a better alternative than standing idle like the BoJ.
The Fed funds rate is very relevant at this point, because companies that CAN'T sell their debt to the Fed or Treasury via TARP must now pay much higher interest rates to bondholders in the public markets.
Your contention that the BoJ stood idle is ridiculous, because the BoJ in the early 1990s did much of what the Fed is doing today to provide liquidity. Roadstar, it doesn't appear you have a good understanding of what's going on.
On Dec 17 05:45 PM roadstar wrote:
> Despite your credentials, it doesn't appear you have a good understanding
> of whats going on. Deficit spending is obviously not free but completely
> necessary to hopefully avoid a prolonged recession/depression. The
> fear is deflation where expectations of lower future prices encourages
> deferral of spending, which serves to lower prices even more - creating
> an unstable economy.
>
> In fact the fed funds rate is somewhat irrelevant at this point as
> private sector rates are significantly higher (noone really effective
> borrow/lends out at these low rates). The key is to encourage banks
> to lend out capital which they clearly are not doing right now and
> hoarding it instead, making it even more difficult for businesses
> to function. Ironically, it will likely take the perception of another
> credit bubble to ensure inflation expectations and capital to flow
> through the economy once again. To encourage this to happen if what
> the fed calls "quantitative easing" which is a fancy way of saying
> printing money and injecting it into the system.
>
> Of course this comes at a great cost, but probably a better alternative
> than standing idle like the BoJ.
>
1) Clearly the risk if deflation not inflation. It is the hope that quantitative easing can create inflation or at least expectations for it. At this point reflating is a good thing.
"Trying a debt-fueled fiscal stimulus in this environment will require more of the Fed's quantitative easing, and thus more inflation. "
2) That is my point - it is irrelevant to (most) of the private sector that need access to liquidity because their effective rates are much higher. The author talking about 0% financing and no-money down is clearly not the reality right now (look at senior loan officer surveys etc)
"The Fed funds rate is very relevant at this point, because companies that CAN'T sell their debt to the Fed or Treasury via TARP must now pay much higher interest rates to bondholders in the public markets."
3) Standing idle may be too strong of a word, but clearly BoJ's actions were at least delayed. What I'm saying is if the fed didn't do this, things would be a lot worse.
Recent Fed/Treasury actions not withstanding, the end result will be the same. The 70% consumer spending economy of the US is toast. This shell game is over and the Fed is simply attempting to take it to another ridiculously unsustainable level.
--------------------
"3) Standing idle may be too strong of a word, but clearly BoJ's actions were at least delayed. What I'm saying is if the fed didn't do this, things would be a lot worse. "
But we where always told by US that we did not understand big business.
I did a lot of auditing of automotive in US, and any talk about public transport, shared risk of social insurance and far too low taxation for rich was always shrugged of with a little smile.
I simply do not believe absolute any statistic published. The two class society that was anticipated will or has come, and lest hope it will not destabilize the country, this has happens in the past history.
a saying form the bible says: after the seven fat years, came the seven lean years.
further: arrogance comes before the fall
I am neither very religious nor believe too much in general saying, but these do have relevant historical meaning.
Look at what Europe and China are doing, we have a long history (much longer than the states) in treating these kind of problems. We have a saying that Europe is the father, China the mother and US the little naughty child.
I would suggest generate a workable system of shared social security (it is just simply a win-win situation for everybody, you might also be laid of)
Increase your tax cap to 50%
People will start treating money with much more caution, no mater the financing.
This system if for the majority of the people and not for some few wealthy, that need to multiply their millions.
stop worrying about the statistics etc. that already got you screwed, get back to common knowledge.
On Dec 17 03:53 PM Chris B wrote:
> Government spending cuts to balance the budget, as well as protective
> tariffs, are widely seen as the factors that turned what could have
> been a severe recession into the great depression. We've understandably
> moved on to different economic theories since then!
>
> Nonetheless, the time to reduce government debt and balance budgets
> was years ago. Instead we had the Bush administration and Congress
> spending like drunken sailors on stupid, counterproductive wars,
> tax cuts for the rich, election-year "tax rebates", pork, cronyism,
> unaudited "faith-based&q... programs, and silly bureaucracy.
>
>
> Imagine now an alternative history in which the US paid off most
> of the national debt during the past 10 years instead of tripling
> it. There would be no big problem - a minor routine recession perhaps,
> and the spector of dollar devaluation or national default would not
> be present. The status of the dollar as the world's reserve currency
> and the future standard of living in the USA would not be questioned.
> Talk of a new depression would be non-existant. Wouldn't that have
> been nice.
>
> Unfortunately the rest of the Western world followed our self-destructive
> example, which is why China will be the dominant power of the 21st
> century.
Presently, the Federal Funds rate is effectively 0%; these are the funds that have been deposited with the Federal Reserve as reserves which banks lend to one another, usually overnight. This rate is determined by the FOMC and can remain zero until there is a policy change.
Short-term Treasury bills are presently trading at or around zero only because large investors.....in this economic climate.... who park large amounts of capital are more concerned about a return of capital than a return on capital. Until recently, the dollar was seen as a safe haven currency though this is likely to change.
Government bonds, 10 and 30 year, are yielding 2.2% and 2.6%, respectively. These rates are more indicative federal borrowing costs but are likely to increase/
High grade commercial paper is presently yielding approximately 6% while longer-term bonds are yielding approximately 8%. Some commercial borrowers who are less credit worthy must pay 10% or more for short term working capital.
As to your thesis that 0% rate money will lead to irresponsible borrowing and a repeat of what we are presently experiencing, I suspect government officials will take every occasion possible to exploit current borrowing costs, if nothing else to put the deficit in the best possible light. Longer-term, borrowing costs will rise as the dollar depreciates; we will need to offer foreign investors an incentive to hold a deteriorating currency.
Recent Fed action is designed, in part, to lower corporate borrowing costs which are historically as measured by frequently used credit spreads. I think this is salutary.
Whatever the headlines, consumers will not have access to 0% money. Most consumers are in the process of "delevering" as a result of tighter lending standards and lenders pulling-down credit lines. Student loans, auto loans and credit card loans are all being reduced.
I detect a sense of the above statement in the article but it deserves to be clearly stated. Elaborating:
The cost is not free if the debt must be rolled over later and interest rates are then higher than zero.
The cost is not free if the economy is deflating because the repayment dollars are worth more than the borrowed dollars.
I don't think my statements are necessary to improve the understanding of many of the commenters (or the author), but making them may help some readers who have confusion about the subject.
Is a debt-funded spending-spree sustainable indefinitely? FYI, that's a rhetorical question. Of course it's not. At some point we have to stop spending at current levels, and it's going to crush our consumer-funded economy for a while. Like a college student graduating with 100k in credit card debt, we're about to get smacked in the face.
If we're smart (unlikely) the markets/economy will be reborn in a more efficient and risk-averse form, and we'll grow from there. But we have a nasty crash headed our way some time in the near future, and we're just delaying the pain.
Advice for the Fed: "Don't just do something, stand there".
What you do do when there is no yield is that 1-2% of people take out 50-100% of their money and keep it since they don't get any interest putting it at a bank. and 20-30% of the people take out 5-10% of their money and keep it to save them the trouble of going to the bank since they are trying to use cash and use less credit cards. And then the big sucking sound of less money at the bank is heard which causes the money multiplier to shrink more.
Banks are already on to this game and are hoarding money as the wallets of all Americans are being drained. That in essence means they are playing a game of how much of the US can they own vs. the rest of the population and they are winning thanks to your money in the form of Fed inflating their balance sheet to dump into the banks (deflating your money), and the $700 billion taxpayer money. They are essentially laughing all the way to their bank.
When the banks and the Tresaury and Fed say hoarding money is bad, it is funny since they are doing exactly that. That's because they are protecting their ass at the cost of yours.
So, back to the 0% interest thing. The hoarding has begun. Now you have 2 choices at 0%. One, a multi year deflation spiral with deleveraging malaise. Or two, your government is dumb and inflates to the point of instead of hoarding money the money becomes worth less and less and then they start hoarding gold, food, and other assorted goods when producers have cut back supply. That is a recipe for a disaster movie.
Deflation is better than disaster last time I checked.
They're already overextended. Are we SURE that we want them to continue to borrow?
[The poll found that nearly two-thirds of Americans support new federal spending to stimulate the economy, and majorities of both Democrats and Republicans back the idea. .... When respondents were asked whether they would back the plan if it increased the deficit, support dropped to 47 percent.]
So, 19 percent of the respondents were mentally handicapped?
The Fed and the Government have the conceit (they would would use the archaic definition and some others would use the modern definition of conceit) that they can make monetary and fiscal adjustments to rein in the consequences of policy over-shoots.
A note from history: It is my opinion that Alan Greenspan had the same belief.
Will the new geniuses be smarter than the old?
Foreign trade accounted for only about 5% of the economy in 1930 so the Smoot-Hawley Tariff Act didn't have that much effect -- even though most economists agree that it was not a good move.
Hoover RAISED government spending from 1930 to 1932 (remember Boulder Dam!) but Roosevelt, ironically, campaigned on the promise to BALANCE the budget if elected and Hoover felt that the only way he could be elected was to balance the budget himself, which he tried to do, briefly. Roosevelt, when elected, promptly broke his campaign promise to balance the budget and immediately increased spending by 60%.
Anna Schwartz and Milton Friedman wrote a highly influential history of monetary policy in the United States www.amazon.com/Monetar... which blamed the depression on a contraction of the money supply and most economists seem to accept that cause as one of the major causes of the depression.
They blame high interest rates also, caused by the gold standard which forced countries to raise their interest rates to attract gold. Interest rates in the early 1930s in America were as high as 4% but with 6% deflation, that amounted to real interest rates of 10% which caused borrowing to slow down dramatically. More than forty countries were on the gold standard in 1930 but by 1935 there were fewer than 7. The countries such as Britain and France who got off the gold standard first did much better during the 1930s than countries that were slow to change. This was the beginning of the realization by economists that the gold standard was counter productive but many people today, whose fathers and grandfathers were alive in those days still believe in it.
The consensus, (not necessarily my opinion) is that high real interest rates and contraction of the money supply caused the depression.
Even the collapse in the stock market is seen by most economic historians (including Bernanke who is a student of the Great Depression himself) as not being a big factor because only about 6% of Americans owned stock and the great majority of stocks were held by small minority among the 6%.
Again, the above are not necessarily my opinions but are the opinions of most economics professors.
On Dec 17 03:53 PM Chris B wrote:
> Government spending cuts to balance the budget, as well as protective
> tariffs, are widely seen as the factors that turned what could have
> been a severe recession into the great depression. We've understandably
> moved on to different economic theories since then!
>
> Nonetheless, the time to reduce government debt and balance budgets
> was years ago. Instead we had the Bush administration and Congress
> spending like drunken sailors on stupid, counterproductive wars,
> tax cuts for the rich, election-year "tax rebates", pork, cronyism,
> unaudited "faith-based&q... programs, and silly bureaucracy.
>
>
> Imagine now an alternative history in which the US paid off most
> of the national debt during the past 10 years instead of tripling
> it. There would be no big problem - a minor routine recession perhaps,
> and the spector of dollar devaluation or national default would not
> be present. The status of the dollar as the world's reserve currency
> and the future standard of living in the USA would not be questioned.
> Talk of a new depression would be non-existant. Wouldn't that have
> been nice.
>
> Unfortunately the rest of the Western world followed our self-destructive
> example, which is why China will be the dominant power of the 21st
> century.
France was intelligent enough to break the rules to make gold stay in France. This allowed France to weather the Great Depression better than other countries, notably the United States.
www.econlib.org/librar...