The Hidden Costs of Sustained Low Interest Rates

By Greg Sweeney, Chief Investment Officer, Bell 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.

 

If you’d like to talk more about your financial security , call Greg Sweeney to start the conversation.

208-345-1196
800-709-5781

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2 Responses to this post...

  • Bill Sweeney (no relation) on Mar 30, 2012 at 10:52 pm #

    I stumbled upon this while investigating whether there were any publicly traded banks based in the Dakotas (so far only found one and it trades on the pink sheets – any suggestions?). I have to say I agree with these complaints about low interest rates. Interest rates seemingly no longer have any connection to the supply of real savings, which amounts to an abrogation of the free market in a huge sector of the economy.

    I re-posted the article on my blog with full credit to the author and a link – I hope that is OK. I blog about “bullion, bonds, and banknotes”, so interest rates are very relevant. Thanks!

  • jlarson on Apr 2, 2012 at 1:25 pm #

    Bill,

    Feel free to re-post any of our articles!

    Here is the response from Greg Sweeney:
    Pink sheets is the name given to describe the quote system for over the counter stocks (otc stocks) that are not listed by the National Association of Securities Dealers Automated Quotations (NASDAQ) system. The pink sheets (the printed quotes are traditionally on pink paper) does not have any minimum requirements for listing like the major exchanges so there is more discovery work that should be deployed before purchasing a stock listed in the pink sheets. Also, there tends to be a lot less activity (buys/sells) volume in pink sheet stocks which means it may be harder to execute buys and sells or a particular stock may be more sensitive to manipulation.

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