The Fed spends an inordinate amount of time focusing on increasing Lending with the idea that loan growth increases economic activity. Is it possible that the Fed may have it backwards and that it is Interest Income derived from Savings that is more important to economic growth?
Simply put, Banks fundamentally exist to provide two services to society:
1) Lending: a place where borrowers can go to get money to purchase goods or services.
2) Saving: a place where savers can go to put money in return for interest income.
From a societal perspective, which is the more productive service? Historically, Lending & Saving would happily co-exist finding an equilibrium. Since 2009 the Fed has been decidedly in favor of increasing Lending as shown by the following chart.
Federal Funds Effective Rate since 1955:
In the 645 months from January 1955 to September 2008 the Fed Funds rate fell below 1.00% only 4 times – 3 of those during mid-1958. In the 597 months from January 1959 to September 2008 it dropped below 1% only ONE time (December 2003).
In the 69 consecutive sub-1% months since October 2008 the Fed Funds rate has been below 0.20% 63 months. For 13 straight months the rate has been below 0.10%.
Clearly, the Fed is focused solely on Lending growth with this unprecedented approach. So, what has this done to aggregate bank loans?
Federal Funds Effective Rate v. Total Bank Loans & Leases:
The orange line is Total Bank Loans & Leases in Trillions while the purple series is the Fed Funds Effective Rate from the earlier chart. Three things come to mind viewing this chart:
1) In June 2004 the Fed Funds Effective Rate was at 1.03% and the aggregate Loans & Leases stood at $5.79 Trillion. For the next 2+ years (9 quarters) the Fed “tightened” by increasing rates to 5.26% while the Total Loans & Leases rose to $7.29 Trillion. Tightening had virtually zero impact on slowing Lending levels.
In fact, running a correlation function on the Fed Funds Effective Rate and Bank Loans & Leases on the 2004 Q2 through 2007 Q1 time period reveals a 0.99 relationship. An economist might draw the conclusion from this period that raising rates leads to more loans.
The data might support the idea that rising Interest Expense pushes Banks to lend more to increase Interest Income. Lowering rates to 0% encourages Banks to minimize Interest Expense and invest Deposits into lower yielding, but less risky MBS, Munis or Treasuries.
2) Loans climbed another $700 Billion before topping out at $8.01 Trillion when rates were once again dramatically being cut and sitting at 2.00%. From the left hand side of the chart I see nothing that would lead a Central Banker to assume that lowering interest rates increases lending levels.
3) In December 2008 the Fed Funds Effective Rate stood at 0.16% and Total Loans had dipped to $7.89 Trillion. Over the course of the past 5.5 years we have seen the Fed Funds rate stay at nearly zero % while the Total Loans figure has climbed a mere $45.38 Billion to $7.93 Trillion. Once again, from the chart I see little relationship between lower rates and increased lending levels.
5.5 Years of near 0% Fed Funds Rates, what’s the impact been on Savers?
Anyone with a checking account, a savings account and/or CDs knows that the past 5 years have been punishing to say the least. One of my favorite “complete waste of time” analysis I’ve done recently was to determine that it takes holding $50,000 in a Wells Fargo High Yield Checking Account for 1 year to generate the $15 necessary to handle one (1) Incoming Domestic Wire Transfer. Yes, that’s Incoming Wire Transfer – what used to be free at 95% of the banks a decade ago.
Analyzing the hit to savers is complicated and requires a couple of assumptions. First off, let’s review a chart of CD Rates History from Bankrate.com.
The chart details that CDs Rates have been coming down for three decades. What’s most disturbing is that each recent “peak” is lower than the prior cycle’s “trough”. Please take a hard look at the 2006-08 period and note that on this chart the 6 month, 1 year and 5 year data points for that time frame would not be considered high from a historical basis.
There are 4 Call Report categories where we can find Funding Costs associated with Savers:
1) Transaction Accounts: Interest Bearing Demand Deposits, NOW, ATS…
2) Savings Deposits: Savings Accounts including Money Market Accounts
3) Time Deposits > $100,000: jumbo CDs
4) Time Deposits < $100,000: non-jumbo CDs
Funding Costs are what banks pay as an annualized percentage for a particular Funding type – the flip side of this is the Yield to the holder of the account.
Let’s take a look at the Funding Cost % for Time Deposits < $100,000 since 2005:
If we assume that 3.01% is a reasonable blended CD yield for amounts less than $100k we find that holders of these CDs have lost out on $58.64 Billion in cumulative interest income since 2009 Q1. The 3.01% figure is what banks paid out in 2009 Q1 and, as shown on the prior Bankrate.com chart, is not at all out of the realm of reasonable had the Fed not gone to near 0% on the effective rate.
As a reminder, the $58.64 Billion in lost interest income easily exceeds the $45.38 Billion in net additional Loans & Leases since 2008 Q4.
Funding Cost % for Savings Accounts since 2005:
Once again, the 0.60% is a reasonable, conservative estimate of Savings Acounts yields based upon historical data. What we find here is that Savers have lost an additional $87.28 Billion since 2009 Q1.
We’re now up to $145.92 Billion in lost interest income to Savers from just Savings Accounts & CDs < $100k. Add in Transaction Accounts ($3.57 Billion in lost Interest Income) and Time Deposits > $100k ($46.91 Billion) and we’re up to $196.39 Billion in lost Interest Income since 2009 Q1.
Well, not really, the more likely number is near $305 Billion in cumulative lost Interest Income to Savers since 2009 Q1. The reason for this is that Savers’ behavior changes as a result of rates.
U.S. Banks’ Deposit Mix by Savings Type:
In 2009 Q1 63.50% of Deposits were in either Savings or Transaction Accounts meaning 36.50% were in CDs. The 3.04% for Time Deposits < $100k and 2.52% for Time Deposits > $100k represent the blended Yield being paid in the 2009 Q1 quarter. As the CDs aged and came up for renewal fewer and fewer people re-invested in CDs and instead moved the money to Savings & Transaction Accounts.
In 2014 Q1 83.73% of Deposits were in Savings & Transaction Accounts meaning the CD percentage fell to 16.27%. For the 4 largest banks the CD percentage has fallen to just 9.14%. As rates paid out on CDs has fallen dramatically Savers have opted to keep the money in Transaction and Savings accounts. For example, here’s what I can get from Wells Fargo in Dallas:
Gotta love the fact that Wells is pushing a 6 month CD as an initial 9 month CD with a 6 month renewal. A 58 month CD at 0.50%? With these terms and yields Savers are pretty much being pushed out of the CD market. I’d also put forth that with these rates the large banks are no longer what we’d traditionally define as a “Bank” since there really is no “Saving” component to their business model.
You can see from our Asset Size analyses section of each metric (Savings, Time Dep > $100k and Time Dep < $100k) that most banks below $50 Billion in assets (to their profit disadvantage) are attempting to keep rates higher.
How did I get to the $305 Billion in lost Interest Income since 2009 Q1?
I calculated the weighted average percentage by Savings Deposit Type from 2003 Q1 through 2008 Q4. This represents what the deposit mix might have been had CD rates stayed the same from 2009 Q1 onward. From the earlier Bankrate.com chart we know that this period corresponded to the lowest (till then) CD rates on record.
For each quarter since 2009 Q1 I then multiplied the most likely Deposit type levels (Mix %) by the rates paid out in 2009 Q1. Here are the rates and Interest Income figures by type:
For Savings Deposits banks actually paid out a cumulative $69.516 Billion from 2009 Q1 thru 2014 Q1. Had the rate been 0.60% (instead of the actual 0.26% – and 0.14% for 2014 Q1) and had the Deposit Mix % (from 2003 – 2008) stayed the same 52.06% then the total interest paid out would have been $130.912 Billion. The $61.395 Billion difference for Savings Deposits and $304.635 in aggregate represents what Savers lost out on in Interest Income.
Banks as Investors in Securities are hurt as well.
Up to now I’ve focused solely on lost Interest Income for those with Deposit savings. At $9.9 Trillion for 2014 Q1 Deposit Savings is actually just a fraction of the MBS and Treasury markets. The next chart details interest rate yields from Bank MBS Holdings and what the extra Interest Income would have been since 2010 Q2.
Yield for U.S. Banks’ Mortgage Backed Securities:
Assuming a normal interest rate market (and no QE) it’s not unreasonable to say that MBS rates might have averaged 3.95% for the past few years. In that world, banks would have generated an additional $69.23 Billion in additional Interest Income.
Treasuries (at 2.43%) would have generated another $14.51 Billion while Other Securities (at 3.68%) would have generated another $26.17 Billion. In total, U.S. Banks have likely lost out on over $109 Billion in Interest Income since 2010 due to the Federal Reserve’s focus on driving rates down to generate more lending.
The $109 Billion is just a fraction of the total since the vast majority of Securities are not held by banks, but rather Life Insurance Companies, Pension Funds, Mutual Funds, University Endowments… Combining Savers and Bond Investors we’re most likely well past $1 Trillion in lost Interest Income due to the Fed’s actions. For what? another $45.38 Billion in net additional loans and a bunch of refinanced mortgages? Well, cheaper government financing and “lower” budget deficits is one upshot.
Tax Receipts are negatively impacted from lower rates.
If the IRS had a seat at the Fed table I suspect they would vote for keeping a healthy interest rate environment. Interest Income generates tax receipts at the State and Federal level. If we’re truly looking at $1 Trillion plus lost Interest Income in the past 5.5 years then the IRS has most likely lost out on $200+ Billion in lost taxes.
Every student in an MBA program since the early 80s has been taught “corporate debt is good, corporate debt is good” because the tax code allows corporations to deduct interest payments from income before taxation. To prove the point, Commercial & Industrial lending on Bank books has grown $437 Billion in the past 4 years. During that time all other lending types have shrunk $9.4 Billion.
BankRegData.com | July 10, 2014
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