Thursday, November 1, 2012

Who loses from zero interest rate policies

In his Bloomberg column, A. Gary Shilling catalogs who loses from zero interest rate policies.

I know that I have been talking about zero interest rate and quantitative easing policies as creating their own economic headwinds, but Mr. Shilling drives home the point that these policies are like treating the patient in medieval times by bleeding the patient to death.
Yet interest rates close to zero are causing considerable distortions and, for many, outright harm. 
Think about savers who are receiving trivial returns on their bank and money-market accounts. Those returns would be negative if fund managers weren’t waiving fees. 
Furthermore, free checking accounts are disappearing. Banks and thrifts, facing low interest earnings, have increased the size of the required balance on checking accounts that pay no interest to $723, on average, up 23 percent in the last year.....

Will Americans be discouraged by low interest-rate returns and save less, or will they save more to reach lifetime goals? 
I believe the latter, which is one more reason why I expect the household-saving rate to climb back to more than 10 percent. 
At the same time, low interest returns in conjunction with volatile stock and huge losses on owner-occupied houses are forcing many vastly undersaved baby boomers to work well beyond their expected retirements; another distortion. 
Sure, better health care for seniors and increasing life spans are also factors, but the percentages of men and women over 65 and in the labor force are rising rapidly. 
And as senior citizens retain their jobs, there are fewer openings for younger people and less advancement for those in between. 
The Fed intends to keep short-term interest rates close to zero through 2015, and probably longer as deleveraging keeps the economy subdued and unemployment high. So what can savers do? Hope for deflation, which will push real interest rates from negative to positive? 
Banks are also suffering because of close-to-zero interest rates, even though financial institutions are paying next to nothing on deposits, which continue to swell as savers stampede for liquidity and safety.... 
Bank yields on assets are in a distinctly downward trend, which will no doubt persist as the Fed continues to keep short rates at zero. U.S. banks also have considerable exposure to the sovereign-debt troubles in Europe. Of their total foreign exposure, 24 percent is in the euro zone; 44 percent if the U.K. is included. European banks are in considerable danger because of their large holdings of such government debt.

Insurers, too, have been hurt by low interest rates, especially life-insurance companies whose cash-value policy and annuities are basically savings accounts with insurance wrappers. 
Insurers largely invest in bonds, mortgages and related securities, and declining yields on their portfolios are forcing them to cut benefits, design less generous policies and raise prices where competition allows. These conditions will last for years as maturing, higher-yield securities are replaced by lower-earning obligations. 
Pension funds, especially vastly underfunded state and local defined-benefit plans, are probably the most severely hurt by chronic low interest rates. Corporations have been shifting to 401(k) and other defined-contribution plans and away from defined-benefit pensions, but the latter are uncomfortably underfunded, especially with low interest rates and muted investment returns in prospect. One study found that 42 companies in the Standard & Poor’s 500 Index may have to contribute at least $250 million each this year to make up for pension-funding shortfalls. 
Corporate defined-benefit plans estimate their future returns on investments, and the median expected rate of return for S&P 500 company plans has dropped to a still very optimistic 7.8 percent from 9.1 percent a decade ago. Furthermore, factoring in current low interest rates on their bond holdings, their expectations for stock returns are often unrealistic... 
Chronic low interest rates leave defined-benefit pension plans, corporate and public, in the U.S. and elsewhere, with tough choices. They need to reduce asset-return targets and discount rates to more realistic levels, but that means more contributions and/or reduced benefits. Cutting pension benefits is always difficult, especially when employers are restrained by public and private union contracts..... 

Please remind me again, what are the presumed benefits of the Fed's policies?

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