Low Interest Rates Are Hurting The Economy?

Includes: KBE
by: Robert Wagner

Every once in awhile you stumble upon a headline that just begs to be analyzed. "Low Interest Rates are Hurting, Not Helping, The Economy," is just one of those headlines. The premise is just as it states, low interest rates are hurting the economy. To me, that is like saying low prices hurt the consumer.

Here are the problems with this theory:

1) The video provides evidence of a "refi party." Party isn't the type of term you often associate with a hurting economy. Clearly the lower interest rates have gotten people to refinance their homes, which in turn puts more disposable income in their pockets. That isn't a bad thing for the economy. Without the low interest rates there would never have been the party.

2) Arguing that we need banks to start lending again, especially to less credit-worthy applicants is like jumping off a cliff and barely surviving, and hopping back up and doing it all over again. Also, higher interest rates would discourage small business borrowing, so it is unlikely to accomplish the goal anyway. Banks can make higher interest rate loans now if they wanted to, only problem is, the loans would go to less credit-worthy borrowers. In this video, the counter argument is made against repeating the mistakes of prior to 2008. In my opinion it is the better argument. If more lending leads to a repeat of 2008, that won't be helping the economy.

3) Another problem is that the Federal Reserve tracks comercial and industrial loans. According to the data, we are almost back to the 2008 peak level of lending. Banks are clearly willing to lend, the problem is more on the demand side of loans, not the supply side. During a slow growth economy, and the tremendous level of uncertainty being generate by Washington, businesses are unwilling to take on more debt and expand until the economic recovery justifies it. Demand for products will drive the need for more loans, and right now there isn't the demand. With so much excess capacity in the economy as evidenced by the capacity utilization rate being below 80%, why would businesses want to expand when they aren't using what they already have? In fact, businesses and individuals have been de-leveraging, making the fact that we are back near the 2008 peak even more remarkable. If the gap between 2008 and today is due to the fact that banks aren't making irresponsible loans anymore, than that is good for the economy. Closing that gap may lead to a repeat of 2008 if it is done by pressuring banks to make bad loans.

4) Bank lending isn't necessarily needed for a recovery. Most large corporations and many small ones raise capital through the bond market. They do it by issuing bonds, not by taking out bank loans. There is no problem with liquidity in the bond market. The near record low interest rates, even for junk bonds, prove that.

5) Another issue is that banks don't always hold the loans on their books and assume the duration risk. They often simply write the loan and then sell it. In fact, that is the whole purpose of Fannie and Freddie. The markets have also recently introduced new ways making it even easier for banks to securitize their loans, bank loan ETFs.

5) According to the Federal Reserve the average size loan being made today is substantially smaller than back in 2008. I would imagine smaller businesses take out smaller loans. The key is, banks are being more cautious to make sure what loans they do make are credit worthy.

Applicants not creditworthy: Banks also have been saying that lending to Main Street has been down because the small businesses applying for loans aren't creditworthy.

And indeed, the report from the New York Fed backs that up, finding "evidence of comparatively strong demand but weakened applicant quality and continued perceptions of restricted credit availability."

6) The argument is also like getting the carriage in front of the horse. The problem isn't small business lending, it is credit-worthy small business borrowing, demand, not supply. The argument seems to be that by increasing the interest rates small businesses will be more eager to borrow. That is literally like flipping the law of supply and demand on its head. Does anyone else seriously think that by jacking up interest rates small business will borrow and the economy will recover? That simply defies logic and common sense.

In conclusion, arguing that higher interest rates will help the struggling economy is like arguing that leaches will cure anemia, or eating will lead to weight loss. The argument simply makes no sense, and would require repealing the most basic laws of economics, the law of supply and demand. The demand curve slopes down, not up. How is this relevant to investors? If the people arguing that higher interest rates will be good for the economy during a period of recovery ever win the argument, the probability of a recession will increase dramatically. There will eventually come a time when the Fed should increase interest rates, but it won't be to stimulate the economy, it will be to slow it to battle inflation. Increasing interest rates during a time of near double-digit unemployment, sub-par growth and near-deflation prices would likely trigger a recession, and ironically drive interest rates even lower. One thing is almost certain, it won't stimulate the economy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: This article is not an investment recommendation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.

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