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Tea Leaf: Low interest rates are a two-sided coin

Published: Tuesday, Aug. 30 2011 5:31 p.m. MDT

A home for sale is posted at a reduced price in Palo Alto, Calif., Thursday, June 24, 2010.

Associated Press

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Last week's column discussed the fact that long-term interest rates were the lowest in nearly 50 years, providing great opportunities to refinance a home or to purchase a new or foreclosed property at near record-low mortgage rates.

The column also discussed the reality that anxious stock market investors around the U.S. and around the globe have been pulling billions of dollars from stock markets and reinvesting into U.S. Treasury securities (bills, notes and bonds), still viewed as the most risk-free and marketable securities in the world … regardless of what Standard & Poor's thinks.

We have noted previously that the Federal Reserve (this nation's central bank) has set its most important interest rate — the federal funds rate — at a record low target level of 0 percent to -0.25 percent since December 2008, a period now reaching 32 months.

Equally important, the Fed's monetary policy arm — the Federal Open Market Committee (FOMC) — noted a few weeks ago that it would maintain this rate at the current record low "at least through mid-2013" — unlike any statement the Fed has ever made. A Federal Reserve that has traditionally found value in keeping financial market players guessing as to impending monetary policy changes, for the moment, abandoned such policy in a major way.

Good intentions

The intent of incredibly low longer-term interest rates is clearly to provide greater incentive for consumers and businesses to borrow for various reasons, and for homeowners to take advantage of very attractive refinance or home purchase opportunities. Unfortunately, the combination of weak U.S. economic growth, high unemployment, anxiety about Europe, enormous and destructive budget deficits and a general mistrust in the political direction of this nation have largely kept consumer and business borrowers on the sidelines.

One might logically assume that incredibly low mortgage interest rates of recent weeks and attractive home prices would lead mortgage applications to jump sharply. One would be incorrect. In fact, as reported last week, applications for new mortgages hit a 15-year low! Refinance applications dropped as well.

Why aren't more homeowners and would-be homeowners taking advantage of such low interest rates? The Mortgage Bankers Association in a statement blamed the fall on "volatile markets and rampant uncertainty," which kept home purchasers on the sidelines. Today's reported plunge in consumer confidence only supports that view!

Fewer mortgage lenders and more complex and onerous lending documents compliments of Uncle Sam have only added to the weakness. Businesses have kept new borrowing under wraps and limited hiring for the same general reasons, including major anxiety about the damage being done by politicians in Washington, D.C.

Flip side of the coin

Even as the low interest rate game has largely failed to ignite the housing and business sectors, another major victim of the extremely low interest rate policy exists. It is the millions of older and retired people who have seen their interest income drop like a rock.

The old adage of investing in stocks during one's primary working years and then shifting from stocks to "fixed-income" investments for greater "safety" has been a disaster in recent years. It will get worse over the next 2-3 years.

Tens of millions of retirees would argue they did everything right. They shifted from volatile stocks to bonds and certificates of deposit (CDs) and money market funds and saving accounts, seeking to sleep better at night with the 3 percent or 4 percent or 5 percent or 6 percent or 7 percent annual returns provided by these fixed-income investments over the past 20 years.

Then the bottom fell out.

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