Negative Interest Rates and Why Banks Want Fannie and Freddie

Here are some cutting edge discussions about negative interest rates (NIRP) that are worth your attention. Some of the discussions speak to profound insights gained, and others speak to tweaks needed to fully embrace the negative rate regimes. Others discuss the success or failure of such regimes. Why banks may want to replace Fannie and Freddie so badly is discussed.

Bookmark this page as a reference to these ongoing discussions.

This article was published by me on Talkmarkets:

The assumption of those seeking negative rates is that they will serve as a stimulant to economic growth and a stimulant to mild inflation that would stimulate growth. So far there is little evidence that these measures are working, but the experimentation is far from over. Here then are some of the cutting edge discussions, including some chilling realizations:

Tyler Durden on Talkmarkets shows how demand for bonds is picking up even as the ECB and BOJ go negative. The question then becomes how low the central banks will go in pursuit of stimulus using NIRP. Declining bond yields, of course, means demand for bonds is picking up.

The Econometer Panel has said don't worry about negative interest rates coming to the USA (except for Kelly Cunningham who says otherwise), but hedge those comments with an implied application of them in any serious downturn. The Fed is watching how negative interest rates work in Japan and in the ECB before taking any action.

Jeff Cox at CNBC says that the Fed could reverse payment on interest on reserves (IOER) and force the banks to pay the Fed or lend the money out into the economy. Reversing payment on reserves is a market monetarist position, however, that economic school usually does not seek negative rates.

Stephen Williamson has written extensively about negative interest rates with many fascinating articles from his blog. In particular, he has posted an interesting article showing that in figure 3, the Riksbank was talking up negative rates as a solution to the lack of inflation in the Swedish economy. It turns out that figure 3 was from 2 years ago, and Williams points out the talk failed and that the Swedes are still talking up inflation with no victories at all for the negative rate regime. Similar failures exist in the ECB and in Japan.

I wrote about Summers and Roubini and others accepting the concept of negative interest rates, and even some accepting cashlessness. Most of these guys are New Keynesians (NK), but Summers may embrace certain market monetarist positions.

J.P. Konig discusses the technical difficulties of plunging into negative interest rates. He says that monetary policy for the Fed is very ineffective with negative rates, since negative interest rates on IOR would mean the banks would have to pay the Fed for all those reserves. And because other institutions other than banks, including the GSE's would not have to pay negative rates to the Fed because they don't get IOR now anyway, the Fed Funds Rate would not follow the IOR rate down. Konig speaks of Nick Rowe introducing the concept of the sticky ceiling to the Fed Funds Rate.

In my view, as an observer and not an economist, it would be a good thing that the Fed Funds Rate not go negative if IOER (interest on excess reserves) was reversed to the negative. After all, what interbank lending that there is should not be negative.

But now, thanks to Konig, we may know why the banks want to replace Fannie and Freddie.
In a negative interest rate environment, the GSE's could eat the lunch of the big banks as they will have to pay no interest and will have a competitive advantage. After all, the GSE's are capable of originating loans, not just guaranteeing them. They could offer lower interest rates than the banks if they were excluded from paying negative interest on reserves.

Of course, the big banks want the mortgage guarantee business as well, because it is profitable and would establish a favorable conflict of interest, and I wrote about why that would be a bad idea here at Talkmarkets. 

So, how do market monetarists weigh in on negative interest rates. First of all, they do not believe interest rates should be the main determining factor in monetary policy. They reject the NK's on that issue. They prefer nominal income targeting instead.

However, some market monetarists, like Woolsey, believe in experimenting with negative interest rates on the retail level:
 Some market monetarists like Bill Woolsey have suggested that "The Fed could impose a fee on bank reserves, leaving banks to impose a negative interest rate on their customers’ deposits. That might simply serve to fill up sock-drawers as people took the money out of their accounts. But eventually, instead of hoarding currency, they would spend and invest it, bidding up prices and, with luck, boosting production."[7]
But what if people decide to hoard more currency to make up for the losses on their deposits? Based on the Tyler Durden article at the beginning of this post, that could very well happen. Or, people could just pile into bonds, avoiding the negative tax on their deposits anyway, as bond prices going up would offset rate declines. That would not happen in a regular retail bank account.

And we know that there is a massive demand for bonds already, and negative rates could increase that demand to maddening levels.

We can see that consumer prices are flagging, especially for energy and food. Deflationary pressures are creeping in. Of course, the alternative, high food and energy cost, was a tax on American consumers.  However, banks bet risk on in oil and in food, markets they could control.


World deflationary pressures are worse than in the US at this point. But, while the Riksbank laments inflation below two percent, so does the Fed. 

World population growth has slowed, from 1.24 percent 10 years ago to 1.18 percent today. That is potentially deflationary. The rate of population growth is in serious decline according to that UN pdf. link.

Many government employees experienced no cost of living increase (COLA) this year, and social security recipients were denied a cost of living increase as well. That is quite deflationary and is also evidence of deflation in the economy.

Boomers are getting older and more cautious, and millennials are cautious as well. Keeping rates positive is like swimming upstream. Hopefully the currents will not be stronger than the efforts to push rates up. But since rates are predisposed to be lower, as I wrote here, it is almost insincere of the Fed to be speaking of and seeking significant rate increases.

With the Fed, it has become a question of trust. This we do know, the Federal Reserve is not the friend of main street. Even Konig hints at this when he addresses the issue of bank arbitrage through the use of GSE funds in the positive rate environment we cling to (Konig link above). And the author of this Fed article advocates paying interest on reserves to the GSE's to level the playing field, since depository institutions (big banks) receive that interest.

Of course, in the negative rate regime that is relentlessly coming, that would give the GSE's a massive disadvantage. Yes, this is all about trust, or the lack of it, and whether the Fed is thinking two steps ahead while telling us about the one step ahead.

The ECB was at least honest with regard to the negative consequences of negative interest rates:
A negative deposit rate can, however, also have adverse consequences. For a start, it imposes a cost on banks with excess reserves and could therefore reduce their profitability. Note, however, that this applies to any reduction of the deposit rate and not just to those that make the rate negative. For sure, lower bank profitability could hamper economic recovery, especially in times when banks have to deleverage owning to stricter regulation and enhanced market scrutiny...

...In order to avoid the cost of excess reserves, banks may also, decide to borrow less from the ECB. This would reduce excess liquidity in the banking system and put upward pressure on interest rates in the interbank and bond market, which could counteract the reduction of policy rates. But this is not what we have seen so far. 
 Indeed, as of now, the market monetarist wish for the US Fed, to charge interest on excess reserves, rather than pay it out, would likely not push interest rates in the interbank lending market up as hoped.
Therefore, if the banks need negative rates in the future, and maybe even cashlessness, it is possible that that banks will get their way even if it seriously harms main street. That was the case in the Great Recession and could be the case going forward although we hope real American patriots will prevail.


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