So, whatever happened to that interest rate hike? It was supposed to happen all spring, then all summer, and now we’re supposed to be fully confident that the Federal Reserve is going to raise interest rates by the end of 2015. But so far, it hasn’t. On one hand, that’s great news: You still have time to lock in a fixed-rate mortgage or take out a low, fixed-rate home equity loan to pay off those credit cards before the rates go up. By the way, if you’re interested, that’s only a click away.
On the other hand, it’s a little worrisome. Raising the prime interest rate is how the Fed tells us that the economy is doing well and it’s time to save money. So, why haven’t we seen an interest rate hike? The answer is more interesting than you might think, because it involves a multinational chain of events and a $3 trillion gamble with your tax dollars on an interesting new idea. It’s an idea that falls somewhere between efficiently practical and boringly immoral, just as many decisions often are when they’re made by folks who have spent too much time staring at spreadsheets and not enough time breathing fresh air.
To explain what’s going on, we need to flash back six years. At the height of the financial crisis, the two biggest concerns for the long-term future of the American economy were the resiliency of the big banks and the incredible number of home foreclosures. If the banks couldn’t get their balance sheets straight, they couldn’t loan money, which would mean that anyone who wanted to buy a home, start a business, or go to college would suddenly find themselves without a loan to do so. Meanwhile, those on the brink of foreclosure, trying to keep their businesses afloat or finishing their education might lose everything they’d worked to acquire. Of particular concern to the government were American homes, because our homes represent the largest part of our wealth, are essential to our well-being and buoy our retirement accounts. Unfortunately, investment products built on inadvisable home loans were the centerpiece of the financial crisis, making the protection of our mortgages a difficult task.
The government’s solution was to bail out the banks, but to do so in a way that we hadn’t tried before. Normally, the Fed puts money into the economy by buying government bonds from banks by using money it creates on a computer in its offices. Fed managers tap on their keyboards, change a few spreadsheets, and poof, money is created. In the aftermath of the financial crisis, however, they decided to create money by buying mortgage bonds, which made it easier for government money to flow to beleaguered homeowners, thereby protecting Wall Street and Main Street at the same time.
However, the Fed can’t just create money without enduring some repercussions. Usually, it has to either remove the money from the economy over time, which can slow down an economic recovery, or watch as inflation eats away at the value of the dollar, causing people to dip into their savings and work harder for less actual pay. Neither option is fantastic.
This time, the repercussions could be even worse. Because the Fed has tied the $3 trillion it created over the last six years to mortgage bonds, removing the money could cause a spike in mortgage rates. After all, that $3 trillion has been paying part of your mortgage for the last six years; that’s a profit for your lender that’s been passed on to you. If the Fed chose to remove the $3 trillion and raise interest rates, we could see a spike in mortgage rates that all but guarantees young people will rent their homes for their whole lives. If you were planning on selling your house in time for retirement, it could cripple the value of your home, because the same buyer who had $250,000 wouldn’t have more money, but they would have to pay more to their lender. Not fantastic.
All year, the Fed has been staring down this crisis, warning us that it would have to raise rates, all the time hoping that doing so wouldn’t kill the housing market. Then, a really odd set of circumstances kept it from having to do so. Twin financial crises in Europe and China drove international investors to the dollar. As they sought to sell other currencies, they propped up the value of the dollar, delaying the effects of inflation and buying the Fed more time.
Now, a new plan has emerged, which is where a really interesting idea comes into play. What if the Fed didn’t take the money out? Instead, it’s started paying the banks to keep savings with Washington, just like your savings account (except thousands of times larger). The idea is that, as long as inflation is being kept under control through foreign investment, our central bank can pay about $30 billion a year in interest for financial institutions to store money. That money makes the banks want to save, which takes money out of the economy, which they pass on to some customers in the form of higher savings rates and making them want to save as well. Suddenly, the money has come out of the economy, inflation isn’t a risk, and everyone along the way is getting paid for doing so, especially big banks and their shareholders.
Reminder: that’s your $30 billion per year. Another reminder: $30 billion was the budget request to keep Pell grants in line with inflation … over the next 10 years. You’re paying the mega-banks 10 times what you’re paying to keep college funding from shrinking.
It’s a short-term solution, obviously. Voters don’t love their tax dollars being spent to reward the same banks that caused the financial crisis, and those banks, by definition, are the ones being let off the hook. Europe and China won’t buy dollars forever, particularly if it doesn’t look like the Fed is raising rates (which would help foreign investors who are saving their greenbacks). At some point, the money is coming out of the economy. Ten years from now, the Fed says, it will all be gone. The only question is, how fast it will come out, which means we’re still waiting to hear when the prime interest rate is going up.
And that brings us back to today. We’ve been told to expect a rate hike by the end of the year, and when it comes, it’ll cost you more to pay off your credit cards. If you’re in a variable rate mortgage, your monthly payment will eventually go up. The best move today is the simplest one, which is transferring over to fixed-rate loans. Do it today, so you can save thousands of dollars. Then, once you’ve locked in your rate, let your congressperson know that you don’t love your tax dollars continuing to bail out the mega-banks six years later.