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Interest Rates

from Peter Radford

The Fed’s decision last week not to raise interest rates has produced a predictable burst of apoplexy in the banking industry.

So what?

Banks would be more profitable if rates were higher. These low rates have squeezed their net interest margins and banker are prone to bleat very loudly if their bonus opportunities are damaged slightly.

So what?

I was asked over the weekend whether this prolonged period of low interest rates was politically rather than economically driven. I am not quite sure what my questioner had in mind about the political motivation. It was probably some deep Obama plot to deprive retirees of their interest income. I tried to present the basic argument explaining low rates and their persistence. I don’t think I made much impression.

It seems that the bankers and their friends in the right wing media have managed to bludgeon their message into the public’s minds. Plenty of people who normally ignore economics are suddenly experts on Wicksell. Or so it seems.

I keep trying to suggest that monetary policy remains stuck in a more extreme state, and a largely ineffective one at that, due to our extraordinarily counter-productive fiscal policy. If my retiree questioner want interest rates to shift upward to provide a more comfortable income for him and his wife, then he needs to call for a shift in fiscal policy. Perhaps we ned a higher rate of inflation too.

When I ask him about this, he looks at me as if I am mad. The government, he is certain, needs to balance its books. Then we need zero interest rates I respond.

And the conversation ends abruptly.

The bankers really have won the public relations game.

I just file this away in my plutocracy drawer. The long war continues. Those of defending democracy have a long road ahead of us.

  1. September 27, 2015 at 10:09 am

    I dont understand this post — I thought that Banks borrow from the Fed and love low interest rates. Indeed their continued survival has been due to the zero interest regime following the GFC. That easy money has been a boon for financiers and banks, and the threat of raised interest rates was enough to drive the markets crazy. See for example, Mike Whitney: Markets Gone Mad. http://www.counterpunch.org/2015/09/25/markets-gone-mad/

  2. September 27, 2015 at 3:28 pm

    “Banks would be more profitable if rates were higher. These low rates have squeezed their net interest margins and banker are prone to bleat very loudly if their bonus opportunities are damaged slightly.”
    You got that right but you fail to mention the increase in risk.
    Also you fail to mention (or know) that the Fed is taking care of their bosses (The Banks)
    by increasing the rate of interest PAID to them for not lending the money they hold at these low rates which I believe you would agree that is a higher return with a lowest of possible risk.
    http://www.nytimes.com/2015/09/13/business/economy/the-feds-policy-mechanics-retool-for-a-rise

    The markets are soooo trustworthy, why not allow them to set rates for the central banks. If understood they will now be asked “what interest to charge their DEPOSITORS?”

  3. September 27, 2015 at 10:54 pm

    If, as I understand it, banks make money on the difference between their borrowing costs and their lending rates, they don’t care at all about whether both rates go up or both go down. What they should want is an increased margin. Since the basic business of banking is borrowing short and lending long, what they most need is a steeper yield curve. What’s dissatisfying to them is that, while they can borrow at near 0%, lending rates are also low. It’s really hard for them to get a 3% point spread with strong borrowers and they would like a larger spread. Conventionally, the Fed controls the short term rate, but larger market forces control medium and long-term rates. So, if the market is holding the 10-year bond yield at just above 2%, and will continue to hold it there if the Fed raises the short term rate to say 0.5% or 1.0%, isn’t an increase in short-term rates the opposite of good for banks?

    I must be missing something important because Paul Krugman and others have been making this same argument about what’s good for banks and why they are manipulating the Fed in the background to raise rates. What am I not understanding?

    • October 5, 2015 at 8:24 pm

      Roger Chittu, ” What’s dissatisfying to them is that, while they can borrow at near 0%, lending rates are also low. It’s really hard for them to get a 3% point spread with strong borrowers and they would like a larger spread. ”
      How would you like to borrow $1 trillion dollars at a one time cost of $2.5 billion, put it in deposit of your bank-hold it there for the Feds- have no real risk of loss, and earn
      $7.5 billion as NET INCOME PROFIT.
      The Fed wants to try a new program;i.e., raise the lending rate at least a percentage point higher for “risk” lending.
      http://www.nytimes.com/2015/09/13/business/economy/the-feds-policy-mechanics-retool-for-a-rise

      • October 5, 2015 at 9:06 pm

        Link is incomplete. Try this: http://www.nytimes.com/2015/09/13/business/economy/the-feds-policy-mechanics-retool-for-a-rise-in-interest-rates.html

        Still not clear to me why banks want short term rates to go up when there is a serious risk that longterm rates will not move or will move less–squeezing margins. Is it because at the margins banks aren’t lending long anyway? Is the marginal borrower a hedge fund or the bank’s own trading desk at overnight rates? If that’s true of Wall Street, I bet it isn’t true of local and regional banks, who would potentially be squeezed by a flatter yield curve.

  4. luis
    September 28, 2015 at 2:05 pm

    Yes, I´m with you in this analize….the very big & big banks only are accumulate (atesorando in spanish), keep money with them instead of put in fianancial circuits, to citizens or firms. The high financial class, and their wife & families (jajaj) , want more benefits, …more & more. We all have long road ahead us (sic).

  5. Piya Mahtaney
    October 2, 2015 at 7:53 pm

    The stimulus package an integral constituent of which was the veritably zero interest rate regime has been a stabilization package but the stimulus to the global economy has yet to happen. The crux of stimulus is investment revival and this is yet to happen because creating productive and relatively safe new investment opportunities has yet to happen. The story so far has been bail out packages, real estate bubbles and the slowdown continues. What is needed is a stimulus towards structural reform

  6. October 6, 2015 at 6:26 pm

    Objective determinants of profit and interest
    Comment on ‘Interest Rates’

    You write ‘Banks would be more profitable if rates were higher.’ This is not correct. The profitability of a single bank depends on the spread between the rate it receives on the asset side and the interest it pays on the liability side (plus nonmonetary profit/loss from changes of value). In principle, the absolute height of the interest rate as set by the central bank is not decisive. The spread is decisive.

    Secondly, if the spread (times volume) covers exactly the costs the profit of the bank is zero. Therefore, there is no direct relationship between the absolute height of the rate of interest and the profitability of a bank.

    In addition, it is the term structure of assets and liabilities that influences the spread. Example: if a bank makes a loan with a fixed interest rate for ten years and refinances this loan with a bond of ten years it secures a fixed spread for ten years. However, if the bank refinances the loan with a bond with a fixed interest for five years it can increase the spread and by consequence profit for the first five years.

    The crucial point is that, in the given example, the bank deliberately produces risk. Because, if the rate of interest is higher after five years the spread is reduced. It may even happen that the bank makes a loss or goes bankrupt in the worst case. On the other hand, if the market rate after five years is lower than in the initial period the spread widens. In other words, by setting the actual rate to zero the central bank immediately helps all banks with an incongruent term structure.

    Strictly speaking, the term structure of both sides of a bank’s balance sheet should be identical. In this case there is no risk other than normal credit risk which is covered by the spread. A well organized banking system is defined by a legal framework that secures a congruent term structure. The first thing to notice is that the monetary system of the U.S. is not well-organized. The banks increase their spread on a regular basis by taking in ‘cheap’ short term liabilities and giving out ‘dear’ long term loans. This worked fine in the last decades with a continuously falling interest rate. Now, if the market rate increases the banking system automatically faces troubles which are ultimately due to a poor institutional design.

    The institutional setup of the U.S. monetary system is a historical accident. Theoretical economics, though, is concerned with the essentials of the monetary order in general. Therefore, the first task is to clarify the interrelationship between profit and interest for the monetary economy as a whole (2011a).

    Economic theory does not consists in second guessing bankers or the FMOC (greedy, bonus oriented, corrupt, stupid, etc). Folk psychology, moralizing, or reading the FED chair’s mind does not tell us whether the rate of interest is ‘too low’ or ‘too high’.

    The first mistake of monetary theory is to start with a single bank and then to generalize. This is the fallacy of composition. Theoretical economics has to start with the economic system as a whole and the creation/destruction of money by the consolidated banking sector (central bank plus all other types of banks) (2011b; 2011c). The development of the respective stocks of credit/debt crucially depends on saving/dissaving of private/public households.

    Loosely speaking, the nominal rate of loan interest depends in the most elementary zero-profit case on the (average) wage rate and the productivity of the banking sector. In this benchmark case the interest on deposits is zero. The money of savers is — in a well-organized economy with a money/credit creating banking sector — not needed to finance investment.

    In sum, because profit theory is false interest theory, too, is false. This holds for Orthodoxy but, unfortunately, also for traditional Heterodoxy.

    Egmont Kakarot-Handtke

    References
    Kakarot-Handtke, E. (2011a). The Emergence of Profit and Interest in the Monetary
    Circuit. SSRN Working Paper Series, 1973952: 1–22. URL http://ssrn.com/abstract=1973952
    Kakarot-Handtke, E. (2011b). Reconstructing the Quantity Theory (I). SSRN Working Paper Series, 1895268: 1–28. URL http://ssrn.com/abstract=1895268.
    Kakarot-Handtke, E. (2011c). Reconstructing the Quantity Theory (II). SSRN Working Paper Series, 1903663: 1–20. URL http://ssrn.com/abstract=1903663.

  7. October 7, 2015 at 10:36 pm

    http://www.axec.org/, “The profitability of a single bank depends on the spread between the rate it receives on the asset side and the interest it pays on the liability side (plus nonmonetary profit/loss from changes of value). In principle, the absolute height of the interest rate as set by the central bank is not decisive. The spread is decisive.”
    Thank you, a simple and exact explanation. ‘What is so rare…?
    Kudos.
    Thank you for explaining how the Fed is now benefiting the Private For Profit Banks,
    in easy to understand ‘economics language.’
    The Feds are now guaranteeing the banks an absolute triple Interest income profit
    (allowing borrowing at .25% & lower and keeping that borrowed money on their balance sheets by paying them 1%). Also they are instructed that they could raise interest rates
    to widen that spread should they make loans to any one else because of ‘risk’.
    This will buy the Feds time for the banks to start to convert already existing ‘low’ rate loans to be transfered to the newer higher rate.
    http://www.nytimes.com/2015/09/13/business/economy/the-feds-policy-mechanics-retool-for-a-rise-in-interest-rates.html

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