The Stressed Citizens’ Guide To Fedspeak- Part 2 (Cui Bono?

In Part 1 of our Citizens’ Guide we took a brief look at how the Federal Reserve affects the level of interest rates through monetary policy.  Here we will survey the terrain in the wake of Quantitative Easing and identify winners and losers.  This is not a deep structure analysis that is tailored to the mores of the academy.  The voting public, the true sovereign of the American system of government, must pass judgment on the outcome of policies urged by credentialed experts.  So the reader should interpret this post in that light.

Winners- The One Per Cent!

Stock prices and interest rates are highly correlated.  And the equity markets have been reborn in the wake of the various phases of Quantitative Easing.  The major indices have regained most of the losses incurred during the 2008-2009 meltdown, and the technology-laden NASDAQ Composite has reached new heights.  So if you belong to the infamous “One Per Cent”, or at least to, say, the top 2/5 of households in terms of wealth, there is very little to complain about regarding QE: 

Losers- Retirees and Other Savers

For people on fixed incomes,  QE has meant a tremendous drop in disposable income and living standards.  They tend to be risk adverse investors, concentrating their assets in vehicles with low default rates.  Alas, these are closely tied to short-term treasury securities, so they are getting almost a zero return on their investment, and possibly a negative one after inflation.  Take a look at the ongoing drop in one year CD rates, a popular investment choice for seniors.

Let’s try some numbers to complete drawing this picture.  Assume a senior retired at the start of 2007, and receives $15,000 per year from Social Security.  He or she also sold a home and was able to put $250,000 into CD’s, with a conservative tenor of one year or less.  (If you go longer, you get higher yield but face a penalty on early withdrawal.)  In 2006 the 3.25% rate on the CD’s would produce about $8,125 in interest income, for a total income of $23,125.  In 2012, the .25% rate on similar CD’s would produce $625 in interest income.  Assuming modest increases in Social Security checks, that still leaves our hypothetical senior with a 20% drop in income, before taking inflation into account.   Seniors in this situation must either reduce consumption, start spending their capital or move into riskier investments that yield more income.

Winner – the Banks (Sort of)

At first glance banks and other financial institutions would appear to be big winners in the QE sweepstakes.  Banks fund themselves through their depositor base or short-term credit instruments such as commercial paper.   By pushing short rates down sharply, the monetary authorities have restored financial industry profit margins, which were under great pressure during the meltdown.  The chart below shows the restoration of the 300 basis point pre-recession spread between CP rates and prime, the rate banks charge to their best customers.  When you consider the astronomical rates banks still charge for consumer debt, especially credit card debt, you get an idea of the money machine QE can be.

This was part of the plan, of course.   The financial sector needs to recapitalize after the beating it took in the 2008-9 meltdown.  I have no problem with that.  But the manipulation of the short end of the yield curve may prove to have been excessive,  damaging savers more than it is helping bankers.  The sector remains plagued by asset quality and regulatory issues, and these are factors in our lackluster “recovery”.  In the third part of this series, we will take a look at that.