Quantitative Easing

Why the interest rate on your savings is low: banks don’t want your money right now

Interest rates and inflation in the United States are on the rise again, which means Americans can expect to pay higher rates on mortgages, auto loans, and credit cards. But don’t expect this to result in increased interest on your savings account anytime soon.

The banks don’t want your money. This is why they are offering such low rates.

Today, the average American savings account pays 0.06% interest per year. In other words, in one year, a saver will only earn $ 6 in interest on $ 10,000 of deposits. Even many of the best online “high yield savings accounts” in the United States pay a negligible 0.5% interest per annum. And the average one-year certificate of deposit (CD), usually one of the most profitable savings vehicles, pays 0.15%.

While savings accounts and CD yields are at historically low levels, inflation this year is expected to rise at the fastest rate since 1991, eroding consumers’ purchasing power and reducing the value of their dollars. Normally, high inflation results in higher interest rates which translates into higher rates on savings accounts as banks seek deposits. But this is not the case in 2021.

In July, Americans who put their money in savings accounts were hit by the most negative average real savings rate in US history: -5.34%.

At this rate, $ 10,000 deposited into a savings account would only be worth $ 9,460 in equivalent dollars at the end of a one-year period. Essentially, the saver loses $ 540 in purchasing power to earn $ 6 in interest.

Yet Americans are pouring money into savings accounts at an historic rate. The Personal savings rate in the United States in 2020 rose to 13.7%, the highest in the 62-year history of the measure; in 2021, it has so far approached this rate on average.

The accumulation of savings is the by-product of a confluence of events related to the Covid-19 pandemic: reduced ability to spend on purchases related to services such as restaurant meals and travel, support government like stimulus checks and improved unemployment benefits, and fears that the recession from February 2020 to April 2020 would lead to financial instability and large-scale job losses. It was also a call to action for many, as more than half (51%) of Americans have less than three months of emergency savings.

However, financial professionals say the call has now gone too far, especially given the paltry gains for those who save.

“We are seeing clients with too much liquidity in their portfolios, and this could impact their purchasing power,” said Michael Briese, senior vice president and private client advisor at JP Morgan Wealth Management. “Think of it this way: if the economy grows and prices go up but your savings stay the same, what you can buy with that money goes down in the long run. “

Banks have been inundated with consumer deposits since the start of the pandemic. Cash holdings in commercial banks totaled $ 4.7 trillion as of September 15. That’s more than double the $ 1.8 trillion in cash held at these banks as of February 2020.

The trend is the reverse of what was in place from 2014 to 2019 when Americans – seemingly fed up with near-zero returns on their savings accounts – began withdrawing money from commercial banks. Between October 2014 and October 2019, liquidity of commercial banks decreases from just under $ 3 trillion to about $ 1.7 trillion.

“All this money has been deposited, but the banks can’t find good loans to make,” says Gary Zimmerman, founder and CEO of the fintech savings vehicle MaxMyInterest. “There has been a big slowdown in lending, and because the banks have more deposits than they can find, their only option is to try to lower their interest rates to get you out. The major credit institutions actively hope that you will withdraw your money.

Data from the Federal Reserve shows that as deposits have increased, loans have declined, largely because banks are also depleting money in the form of securities guaranteed by the federal government. And while mortgages have largely held up, thanks to the boom in the US real estate market, commercial and industrial loans have been in free fall since May 2020, declining nearly 20%.

The share of total assets devoted to loans at the 25 largest U.S. banks fell to its lowest level in nearly 36 years of history in the Fed’s weekly data this year. The loan-to-deposit ratio at U.S. banks also fell to its lowest level on record in the second quarter, according to the S&P Global Market Intelligence database, which dates back to 2003.

In theory, banks need deposits to be able to make loans, which are their main source of income. But in reality, the Federal Reserve – the all-powerful central bank of the United States – pushed the reserve requirement ratio (RRR) to zero percent in March 2020.

The RRR is the ratio of the actual liquidity that banks must hold and the amount they lend. If the reserve requirement ratio is 10%, banks wishing to lend $ 100,000 must hold $ 10,000 in cash. With a zero ratio, commercial banks have the ability to lend much more money without needing a corresponding increase in deposits.

In addition to bringing the RRR to zero percent, the Fed has also flooded markets with liquidity through its quantitative easing (QE) program since March 2020, pumping $ 120 billion into the economy each month. This gives banks better access to capital and even less of an incentive for consumers to save or make deposits.

Making savings unattractive is a feature, not a bug, of the Fed’s policy. Low interest rates and plentiful capital are meant to push consumers to buy instead of saving or take additional risk and do things like start a business or take out a second mortgage on a house in order to spend more money. ‘money.

The goal is for this money to flow into the economy and encourage companies to hire more workers and pay them more, thus fostering a virtuous circle of spending that benefits everyone.

But some argue that the Fed’s extraordinary support since the start of the pandemic has not helped the economy as much as it has fueled asset bubbles in stocks, real estate and even commodities, because of more and more investors are borrowing money which they use to speculate in these markets.

The effects can be seen in the rise not only of the global stock market and real estate prices, but also in cryptocurrencies (salty as a savings asset that the Fed cannot handle), the frenzy of ” memes’ actions like GameStop and AMC, and in the skyrocketing price of collectible cards, artwork, and things like non-fungible tokens or NFTs.

Investors are largely following the lead of U.S. companies, which borrowed a record $ 1.3 trillion last year and held a total of $ 13.5 trillion in debt for the year. 2020.

Large corporations are able to avoid banks and traditional lending by borrowing money from the public debt markets through bond issues, which means they are taking money out of the public debt markets. investors in the form of loans that are repaid with interest over time.

The Fed is helping here too. By lowering U.S. interest rates and buying U.S. government bonds through QE, the average amount that companies have to pay in interest is nearly the lowest ever. This is especially important for risky businesses with “junk” credit ratings that would otherwise find it very expensive to borrow.

Faced with this new environment, certain wealth managers like Douglas Boneparth, president of Bone Fide Wealth, encourage their clients to adopt a strategy similar to that of companies.

Bonparth, who works primarily with older millennials, typically advises clients to have nine to 12 months of living expenses in cash. But he’s now suggesting that some clients who have equity portfolios or own their home open lines of credit backed by those assets instead of holding all that money.

“What really matters is [that] having too much money in the market is a missed opportunity to increase your wealth, ”says Boneparth.

Because it is so unprofitable to save and so inexpensive to borrow, Bonparth advises some clients to have six months of living expenses in cash and the equivalent amount available through a home equity line of credit or mortgage. margin loan from a brokerage firm.

“You play the rates to your advantage. The rates are low, the money is super cheap right now, ”he says. “[However], the advice is not to get into debt or to get into debt. If you are disciplined enough to use credit responsibly, here is one way it can prove to be very powerful.

More and more customers are looking to take advantage of such opportunities, says Bonparth.

This is not surprising for Zimmerman, who created MaxMyInterest in response to the anemic returns offered on the savings accounts of the big banks. The company aims to help consumers with large amounts of cash automatically find the best interest rate available.

The combination of the Fed’s massive intervention in the markets and the government’s heavy spending on stimulus and stimulus bills “put so much artificial money into the banks,” Zimmerman says.

“People take more risk because they say, ‘If the bank doesn’t want my money, I have to find another place to put it.

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