If you’re a home owner, business owner or anyone who is exposed to borrowed money, then you should be concerned about interest rates. A rate increase or decrease will determine what decision you make.
But… if you’re just an average person with a bank account, you should also care. Because whatever money you have in the bank will grow or shrink depending on what happens to rates.
Of course, I have no crystal ball and cannot forecast any future interest rate direction, but here is what seems to be the most likely circumstance…
The worst thing that can happen to interest rates is probably going to happen.
What’s the worst thing?
Interest rates will remain the same or very close to what they are now.
While there are many reasons why this will happen, here are the top three:
1. The Fed has backed itself into a corner than it can’t get out of.
The other day, Yellen made the same speech that she has always given; and that is, we have no idea what she said. Like Bernanke, and especially Greenspan, she has the ability to talk at length about nothing. (This video about “Fedspeak” or “Greenspeak” is a shocker, if you’re not familiar with the goals of the Fed Chairman.)
If the fed raises rates significantly, to where they should be in a free market, the US government will not be able to pay its debts. Instead, debt payments will go straight to the interest and not pay off any of the principal.
The Fed should have raised rates a while ago, when our economy was stronger. However, now that we are in the later stages of an incredible bull market, any rate increase would/could be disastrous.
2. Peer to peer lending.
P2P is becoming more and more mainstream. Companies like Lending Club and Prosper are the most popular and well known, but there are many other up and coming companies as well.
P2P lending will allow home borrowers to circumvent the entire banking industry all together and go straight to direct lenders (i.e. you and me) to receive money at true free market rates.
With this ability to borrow money freely, rates will balance out to what the market will support. Or in other words, rates will be determined by what people are willing to make off of loaning money.
No one will loan money for what central banks are currently loaning money for, which is a negative rate in some cases. On the flip side, no one will borrow money from someone who is charging an absorbent rate. This will result in a balancing, or free market method, of fees.
3. Emerging markets will develop a more sophisticated debt/lending market.
If you go to most other countries in the world, money is lent out at much higher rates. 10% or even 15% are not uncommon at all. This is mostly due to an immature lending market. The reason why the US and other first world countries can have low rates is because the loans are collateralized by real assets, like a house. Now, if someone defaults on their loan, the bank can come take that house.
In many other less developed nations, that process of repossessing assets is inefficient or even non existent. That means that loans need to be at much higher rates because the lender is risking much more – they may be unable to collateralize the loan with substantial guarantees if the loan goes bad.
Furthermore, these less developed economies only loan at 50% loan-to-value ratio, which further protects the lender from default. That is why housing prices are so low in other countries, because less money can be borrowed to by a house.
That’s also why housing prices are so high in The States, because borrowers have the ability to borrow lots of money.
As these developing nations mature, rates will continue to fall, as there will be less risk for the lenders.
To sum it all up, there are variety of factors that will lead to rates staying close to where they are for a while. Any large change in rates by the Fed or any other central authority will cause major repercussions across the world economy – something that no one really wants to risk.
So, as a regular consumer and/or investor, why should you care?
One of the biggest reasons why someone does or doesn’t act upon an idea or desire is because of uncertainty of the future.
If we know that rates will be the same for a while we can assume:
1. Any money that you have will not yield high returns through simple investments (savings/deposit accounts).
2. Asset prices of many things that can be financed will continue to be high, because money can be borrowed cheaply.
3. As is usually the case, in order to make real returns, investors must take active control to ensure profitable returns, as opposed to taking a back seat and allowing saved money to yield healthy returns. This means actually doing work with your money.
