Who Loves Low Interest Rates?

October 25, 1994|By ROBERT L. TAYLOR

The stock market is often said to reflect the general health of the American economy. Oh, yeah?

On June 4, 1993, in response to a strong employment report, declining stocks on the Big Board outnumbered gainers by 2-1. Why? Stock-market operators, those ghouls, were appalled to hear that more people had jobs, and money, and hope, thus presaging an improved economy, because -- oh, horrors! -- interest rates might rise a trifle as a result.

Conversely, on April 5, 1994, when the index of leading indicators declined for the first time in nine months, the market staged a badly-need rally, in hopes of flattened interest rates.

On these occasions, and on countless others, the market has risen on bad economic news and fallen on good, purely and simply because of the expected effect on rates. What reliance can we, or should we, place on the economic recommendations of people who gleefully root for the economy to turn disastrously down, so that they can finance their overblown security positions with money made artificially cheap because the Federal Reserve has been intimidated?

The draconian lowering of rates that we have lived through during the past two or three years has certainly taken a long, long time to produce even the moderate recovery that we were promised. But why should it have? The standard justification for rate-lowering is that we will thereby stimulate sales of automobiles, expensive appliances and homes.

But the question that a person buying a car or any other big-ticket item on time asks is not, ''What will the interest rate be?'' but rather, ''What will my monthly payment be?'' A disconcertingly large part of that monthly payment is not interest at all, but repayment of principal.

Several years ago, inspired by a ringing depiction of the benefits that would surely follow from cheaper new-car loans, a consumer-loan accountant whom I consulted reported that a 2 percent cut would reduce the monthly payment on an average car loan from $321 to $313 and a 4 percent cut to $305. Big deal! A $16 reduction is going to zing the car market? Get real!

Most of the people who dream these pipe dreams have gone through to a Ph.D. at Harvard or Stanford or whatever by the age of 28 or even younger, which either costs a fortune or is achieved by a stunning array of grants and such. People with that background do not buy used Toyotas with 48-month consumer loans and they have little or no understanding of the kind of people who do.

Those who attribute non-existent virtues to low interest rates are far from disinterested; they have an entirely selfish ax to grind.

Leading economists, the influential, telegenic, stridently vocal ones, wind up in a dismaying number of instances in either (A) an investment-banking house; (B) a governmental body; or (C) a university. Every one of these has an absolutely rapacious stake in lower rates.

The vision of noisy economists in investment-banking houses is clouded, in comprehending the relatively small impact of interest rates on the economy as a whole, by the fact that they are dealing with debt that never gets repaid. It is not necessary for them, as it is for people who buy cars, cottages and college, to factor in a component for reduction of principal.

Far from retiring the debt with which they are financing their positions, bond and stock houses are increasing it. In 1992 short-term debt at Salomon Brothers rose from $40 billion to $88 billion. Short-term repos and commercial paper at Merrill Lynch rose from $32 billion to $42 billion. Is it any wonder that firms like that see virtues in low interest rates that do not exist for those less fortunately placed? One percent a year on $88 billion is $880 million. What an earnings jolt that would give to a company that is using 4 percent money to position 8 percent bonds. You get richer with every day that passes, even if you never sell a bond. Especially if you never sell a bond.

Small wonder that on April 10, 1993, the Wall Street Journal reported that net interest income, the differential between the artificially depressed interest paid on short-term borrowing and the far higher interest accruing on the investments positioned therewith, at six large brokerage houses amounted to a stunning 76 percent of the firms' total profits. And small wonder that these ghouls jump with glee when other people's employment drops sharply.

It is entirely understandable, if not especially admirable, that highly placed staff of such firms, doubtless with incentive bonus plans, look so favorably on low rates. Not very long ago, when bonds with 11 percent coupons were carried with 17 percent funds, investment bankers had to position bonds shrewdly and cautiously. Now, however, when they successfully bully the Fed into lower rates, the livin' is easy and the bonuses high.

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