Hey! Looks like it’s no-money-down, 0% financing for everyone these days! First we hear that rates paid on Treasury debt have fallen to essentially zero, and then that the Fed has followed suit with their key rate (slashing their target for the federal funds rate to a record low of between 0 and 0.25 percent). From the Bloomberg story on Treasuries (by Matthew Benjamin and Liz Capo McCormick):
Dec. 15 (Bloomberg) — Bill Clinton was forced to abandon spending initiatives to boost the economy at the start of his presidency when advisers warned him that the borrowing needed to fund the programs would push interest rates higher. President- elect Barack Obama may not have the same problem.
While the total amount of U.S. government debt outstanding rose to $10.7 trillion in November from $9.15 trillion a year earlier, the amount of interest paid in the last two months fell by $10 billion, according to the Treasury Department.
Instead of shunning the U.S., where losses on subprime mortgages in 2007 triggered a global seizure in credit markets that led to the downfall of securities firms Bear Stearns Cos. and Lehman Brothers Holdings Inc., investors can’t get enough Treasuries. Even as estimates of Obama’s stimulus package and the budget deficit rise to a record $1 trillion, demand continues to increase as investors flee risky assets around the world and put their cash into U.S. bonds paying, in some cases, nothing in yield just to ensure the return of their principal…
“This is not about return and yield and value; investors are functioning out of raw fear,” said Barr Segal, a managing director at Los Angeles-based TCW Group Inc., which oversees $90 billion in fixed-income assets. At the same time, “this is fabulous for the Treasury because they are borrowing at virtually nothing,” he said…
“It’s good news,” said James Horney, director of federal fiscal policy at the Center on Budget and Policy Priorities in Washington. “Even though we’re borrowing larger amounts of money, the total amount we’re going to pay in interest is going to be somewhat lower.”…
But really, it’s not as good news as some might want to think, because even 0% financing on our private and public borrowing doesn’t mean that borrowed money is “free.” The unfortunate reality beyond the next few months to a year is:
- We still have to pay it back; and
- Interest rates will eventually (and inevitably) come up.
I worry that the downside of currently very-low interest rates is the same kind of downside that led to the subprime mortgage crisis. Rates near zero give individuals, businesses, and government the false sense that borrowing is costless, and that they can afford to take on more debt than they really can. Interest rates cannot stay near zero for very long, as there are ultimate limits on the worldwide supply of capital that prevent it from keeping up with our insatiable demands. The interest rate paid on Treasury debt is near zero now, not because investors are not worried about the government’s ability to pay down the debt in the future, but because they’re more worried about the current riskiness of other investments. That dynamic will change over the next few months. And if consumers and businesses begin to see the zero percent Fed rate passed through to much lower interest rates on their own borrowing, they will be encouraged to borrow and consume again–which is what we want to happen with the monetary stimulus–but will they be encouraged to borrow and consume too much, such that when interest rates start to rise again as the economy recovers, they will find themselves (yet again) overextended? Are the now near-zero interest rates like “teaser” rates–the kind of only-temporarily-low rates that encouraged unsustainable debt burdens that got us into this mess in the first place?
My “bottom-line worry” is that the news of these near-zero interest rates will make politicians and the American public believe (falsely) that deficit spending is free. Today’s Washington Post reports on a new poll showing that public support for a massive increase in government spending is strong, but only when people don’t think about the costs:
The poll found that nearly two-thirds of Americans support new federal spending to stimulate the economy, and majorities of both Democrats and Republicans back the idea. Concern about deficit spending, however, mutes enthusiasm for the stimulus plan. When respondents were asked whether they would back the plan if it increased the deficit, support dropped to 47 percent. Overall, nearly nine in 10 said they are worried about the size of the federal budget deficit, including nearly half who are “very concerned.”
So the danger is that in a world of no-money-down, 0% financing, people will start to over-discount the costs of borrowing, start to think (falsely) that money is free, start to think (falsely) that anything with any potentially positive marginal benefit is worth pursuing–regardless of the marginal costs. In other words, people (and the government) will start behaving as if there are no budget constraints and no need to scrutinize and prioritize, when exactly the opposite attitude is needed going forward.
As Alice Rivlin is quoted at the end of the Bloomberg article on Treasury rates: “We can’t press our luck”… “Eventually, we’ve got to show the world that we are fiscally responsible.”
But we Americans are not good at self-discipline. That’s why I worry about the “good news” of near-zero interest rates.