Households and corporations alike are refinancing their loans in droves to take advantage of interest rates that seem impossibly cheap. But those same low rates come with a flip side, driving down the income of retirees and others who live off their savings.
It is a side effect of a government policy meant to push down interest rates to a point that businesses and consumers are compelled to borrow and spend again, and yet it is hurting anyone with a savings account.
With the regulated rate that financial institutions can borrow from one another at almost zero, banks are paying savers next to nothing. The average returns on interest-bearing deposit accounts slipped to 0.99 percent in July, according to Market Rates Insight, which tracks bank rates. It is the first time its measure has dipped below 1 percent since the 1950s, when its data begins.
As a result, the amount of money on deposit at United States bank branches fell during the first half of 2010, Market Rates Insight reported this week. It was the first time that had happened in nearly two decades, indicating that people are dissatisfied with how little interest they are earning from their bank accounts.
Perversely, coming after a devastating financial crisis caused by companies and households that feasted on borrowing, ultralow interest rates are penalizing people who have paid down their debt and are now trying to save. It is also punishing those who rely on the proceeds of their nest eggs to pay the bills.
“It’s the whole point of low rates, to entice borrowing and discourage saving, but it means a massive wealth transfer from savers to borrowers,” said Greg McBride, a senior financial analyst at Bankrate.com. “It is a trend on steroids now because interest rates have been cut to the bone.”
For example, anyone keeping $500,000 in a 12-month certificate of deposit earning a rate of 1.5 percent annually — one of the best savings rates available nationally these days — would earn $7,500 a year, hardly enough to live on. Just three years ago, that same investment would have generated $26,250.
The new low interest rates are having a personal impact. Take William D’Alessandro, 62, an editor of corporate sustainability newsletters in Amherst, N.H. He has moved from job to job and has no pension but planned to live on savings when he retired.
Now, year by year, Mr. D’Alessandro has had to put off his retirement until he can afford to buy, among other things, health insurance for himself and his wife, to supplement Medicare when he gets it.
“It is fearful,” he said. “We have been saving all these years, and now we want to go into retirement we can’t. We have been traveling less. What am I going to do if I live to 82 — or 99 like my grandfather?”
Now, savers are searching desperately for a better return on their money. “All of our clients are struggling with this,” said Cary Carbonaro, a financial planner who works in New York City and Long Island. “It has never been as bad.”
With the jittery stock market posing too much risk for many people, they have rushed to Treasury bonds, which generate higher rates than regular bank accounts or short-term C.D.’s.
But so much money flowing into Treasuries has served only to depress the rate of return on those bonds, to a dismal 2.7 percent a year for a 10-year note; shorter-term bond rates are below 1 percent. Anyone investing $500,000 in 10-year Treasuries at current yields would earn $13,500 a year.
Some savers have begun to pour more of their cash into the corporate bond market, where big companies sell bonds to raise money, usually at a slightly higher return in exchange for modestly higher risk.
As demand for such bonds has soared, it has prompted corporations like PepsiCo and Wal-Mart to issue more bonds at bargain-basement rates of interest. Such companies sold $563.4 billion to United States investors last year, a record, and have sold $238.8 billion more so far in 2010, according to Dealogic, a financial data provider. Yet, economists complain that apart from a few notable corporate acquisitions that were financed largely with pent-up cash, many businesses are sitting on their money rather than spending it. For now, that would seem to undermine the purpose of low interest rates, which is to get companies and consumers spending again.
Nonfinancial corporations were holding about $1.8 trillion in liquid assets in the first quarter of this year, according to the Federal Reserve, a level that has been steadily rising and compares with $1.5 trillion at the start of 2009.
“They don’t need the cash,” said Bernard Baumohl, an economist at the Economic Outlook Group, but they are borrowing anyway because it is so cheap at the moment.
Once again, though, the unusually high demand for blue-chip corporate bonds is driving down the rate of return on those bonds. When I.B.M. sold $1.5 billion of three-year bonds in August, investors received only a 1 percent return.
So some ordinary investors seeking better returns are resorting to lending to companies with shakier credit. The so-called high-yield junk bond market has taken off, with nonfinancial companies issuing $159.6 billion in high-yield bonds to American investors last year, the most since at least 1995. They have borrowed a further $142.4 billion so far this year, according to Dealogic, a financial data provider.
This is giving the ordinary investors a rate of return they used to get from ordinary savings accounts or C.D.’s but with higher risk.
As long as rates stay this low, the plight of the saver will be especially disquieting for those who rely on their savings for a large slice, if not all, of their income. That is a particularly unnerving prospect for pensioners or for people approaching retirement age — who now want to draw on the interest from their savings to support them when they are no longer working.
“You have spent your life being prudent, building a nest egg for your retirement, and now the returns are terrible,” said Todd E. Petzel, chief investment adviser at Offit Capital Advisors, a wealth advisory company in New York. “I am 58 years old. I know lots of my peers who are thinking of retiring, and they are scared to death.”
Among the winners from low interest rates are people taking out new mortgages. The benchmark 30-year fixed-rate mortgage has fallen to 4.53 percent, the lowest in more than half a century, according to Bankrate.com.
At these rates, refinancing is attractive. The Mortgage Bankers Association said last week that 83 percent of pending mortgage applications were for refinancing existing mortgages.
It is good for other kinds of borrowers, too. Marcel Lonneman, a retired AT&Tengineer in Jamestown, R.I., said he would like to borrow more, but his partners in a real estate business he is associated with are reluctant to borrow at current interest rates because they think they may still fall further.
“It is an excellent time to be a borrower,” he said. “I’ve paid as high as 21 percent interest in 1981 for a real estate loan and have refinanced real estate loans several times for lower interest rates,” he added in an e-mail. “Better a borrower than a lender be.”