Saturday, March 31, 2012

Good article by a local banker

Below I am re-posting an article which originally appears on the website of "State Bank & Trust" here: https://www.statebanks.com/news/the-hidden-costs-of-sustained-low-interest-rates/

The Silver Squirrel makes no claim of authorship or ownership of this work and it is re-posted here for convenience, education, and fair use.  I stumbled across it while looking to see if there were any publicly traded banks based in North Dakota.  If anyone knows of any, please let me know.  The only one I am aware of so far is Dactotah Bank which only trades in the OTC pink sheets.


Mr. Greg Sweeney's article goes well alongside my own article written back in 2010, which also points out some of the negative consequences of artificially low rates: http://thesilversquirrel.blogspot.com/2010/06/critical-role-of-squirrels-in-economy.html
I don't know if he likes precious metals or Austrian economics at all, but at least he is not blinded by Keynesian propagandists like Paul Krugman who see nothing but angels and geniuses running the Fed.



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The Hidden Costs of Sustained Low Interest Rates

By Greg Sweeney, Chief Investment Officer, State Bank & Trust

Reducing interest rates across the spectrum may be backfiring

From a retiree’s point of view, the impact of today’s low interest rates is painfully evident: there is very little interest income to provide for living expenses. The Federal Reserve has made a point of reducing interest rates across the spectrum in an effort to encourage borrowing to stimulate economic growth. It may be backfiring. Consumers are not in the frame of mind to take on more debt, while low rates have made it very difficult for people living on fixed incomes to generate any money to spend.

Hidden challenges of sustained low rates

Behind the scenes, sustained low interest rates are creating other, less visible problems. Corporate and municipality pension plans, also known as defined benefit plans, promise to pay beneficiaries a predetermined amount of money each month during retirement. Each year, these plans are evaluated to determine if the plan sponsor (corporation or municipality) has set aside enough money to meet its promises. As interest rates drop, more money must be set aside to meet obligations, even if there is no change in the money to be paid out to beneficiaries. In the case of a short-term decline in interest rates, accounting rules allow a plan sponsor to spread new cash contributions across several years. As interest rates remain low, they become more permanent, cost more money and can spiral into substantial costs in a short period of time. This will hurt corporate Market Engagement earnings and put pressure on municipalities that already have strained resources.

Insurance companies collect premiums for car, property, health and other types of coverage. They invest these premiums in bonds to earn interest income in an effort to keep insurance rates competitive and to generate income to pay claims. As the insurance companies’ ability to generate income goes down, the pressure to raise premiums goes up, and customers end up with higher premium expenses.

These are just two of the hidden challenges of sustained low rates. The pension situation is particularly concerning because of the scale of expenses that can accrue in the face of lower yields. This is one of the many features we look at when evaluating stocks for consistency, as we create a diversified portfolio across large, medium and small cap stocks, value and growth characteristics and all sectors in both domestic and foreign holdings. For long-term investors, this combination of consistency and diversification provides a more solid foundation than you can build by choosing a particular index or market that ebbs and flows in popularity.

2 comments:

  1. That IS a great article.

    It puts the head to the nail so to speak, thanks for sharing that one.

    Cheers.

    ReplyDelete
  2. The other problem with low interest rates is that if they are held low for a long time, they encourage speculation rather than business creation.

    More here (at the end of the article): http://www.worldcomplex.blogspot.ca/2011/11/inference-of-dynamics-for-complex.html

    ReplyDelete