Lately, I've been hearing more speculation about the impacts of quantitative easing and low interest rates. Unfortunately, the speculation is rarely recognizing the long-term impacts. One theory that seems to be gaining traction is the idea that quantitative easing helps "the rich." Without defining which people will be qualified as "the rich," it is difficult to bring the discussion into the light. To have a meaningful discussion, we need to determine whether "the rich" means the top 10%, top 1%, top 0.1%, or simply people with wealth over a certain dollar amount. For simplicity sake, I'll use the term "the wealthy" to refer to the top .1%.
Income Isn't Equal to Wealth
The first issue that needs to be addressed is that income and wealth are inherently different. However, income is a key component in building wealth over time. If we look only at the top .1% for income, the major driving factor for their income is the income from investments. This comes in the form of interest, dividends, and capital gains. Once we get this far into the top of the income brackets, the people who are selected will usually be those with large amounts of wealth.
Impact of Low Rates for Wealthy People
The decline in interest rates leads to a dramatic increase in the value of bonds. That makes the wealthy portion of the population have more wealth, but it doesn't increase their income. For someone to have more income from a 30-year bond purchased before quantitative easing began, they would need to sell the bond. Their additional income would be the capital gain, but the reinvested proceeds would only be earning interest at the new market rates.
The immediate impact of quantitative easing increases the net worth of individuals with large amounts of bonds. However, it also slashes their income in future years because reinvested capital will earn substantially lower rates of return. If the low rates are successful at decreasing deflation, or creating inflation, then the real return on bonds will be even lower.
To put it simply: It drove up net worth, but drove down future income.
Impact of Low Rates for Middle Class
The Federal Reserve decided to shift from buying treasury securities to buying agency MBS. When they made that shift, it created more downward pressure on the interest rates on mortgages. While someone may be in the top .1% and have a mortgage, the outstanding loan balance is unlikely to be material relative to their wealth. On the other hand, many homeowners who owe a substantial amount of their mortgages were able to refinance into lower rates. The result of the lower rates is less interest expense, and consequently, it increases the portion of their income available for other uses.
For the Middle Class: QE drove down their costs of borrowing, and mortgage debt was often going to exceed the value of their bond portfolio. Net worth was only slightly impacted, as lower rates pushed house prices higher. Future income should barely be impacted, but future costs decreased. The net result is effectively an increase in their purchasing power.
Impact of Low Rates for Lower Class
Those without much income or wealth are much more likely to be renting. The quantitative easing did nothing to reduce the level of rent charged on apartments. From a housing perspective, this is a net loss. For those without wealth, interest income would be a foreign concept.
The impact on wealth should be immaterial.
There would be some small positive impacts from lower costs on loans, but it wouldn't reach the same levels it would for the middle class. Theoretically, lower rates on MBS would mean cheaper financing of apartment buildings, and under most economic theories, the decline in the cost of providing housing would send rent levels lower. That did not happen.
Rent levels increased and the share prices of REITs soared as the savings on the cost of debt turned into stronger dividends. There is no proof that higher rates would have prevented the increase in rental rates, so the only clear impact is a lower interest rate on loans.
The impact of lower rates is most substantial for the middle class due to the benefits of being able to refinance houses at lower rates. The embedded option in the mortgage (the right to prepay) is the most valuable feature in a period of suddenly declining interest rates. For the wealthy to retain the level of interest income they achieved previously, they would need interest rates to go back to prior levels. That would erase the gains to net worth from low rates. On the other hand, if rates moved back to higher levels, the middle class would still have the benefit of cheaper mortgage financing.
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