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The High Cost of Not Paying Attention
It would be best if we began with something familiar to all of us, money. Everybody has some once in a while. Some of us even sock away a few pennies for our retirement. None of us can do without it. Yet few of us understand how it underpins the very nature of the recovery. And those underpinnings may be coming loose. You have heard numerous sources, me included, cite the housing market as the driving force behind this economic recovery. And sure enough, the low cost of borrowing money to buy a home would find many people leaving their landlords for homeownership. For the most part, that is good news, an American dream story. That same inexpensive money found its way into the hands of people who wanted to refinance their mortgage, an event that is almost expected if the interest rate on your current loan was higher than the current rate. Smart borrowers used the money to lower their interest rates paying less in overall housing costs which increased their spending power. In many sections of the country, housing valuations started taking off. It became harder to purchase a reasonably priced home in many areas as a result. But the people who already had a home, now had a virtual gold mine in their equity. That sudden growth in a person's cash position had consequences that went beyond the average borrower. Everyone understands that banks lend money based on the amount of money they have deposited. It is the money on deposit that keeps the wheels greased with abundant low interest rate loans. It's pretty basic banking. But suppose there were too few deposits. Several forces play against one another and in doing so, generally muck up a good situation. Consider those people who took out all of that equity. Borrowing has slowed down dramatically in the last several months. When that happens, the equity that is usually deposited, even for a short time in banks while it is waiting its final destination, back into the economy via construction, travel, education, or many of the myriad uses cheap money can find, is no longer there. Banks counted on this money to keep loans based on those deposits going out the front door. The Federal Reserve who has set the rate so low just so the economy would use the money for a greater stimulative effect, also counts on the money being in the banks. This lack of came at a cost of course that will take just a while longer to fully appreciate. Those lower interest rates also took the incentive out of saving. And as the cost of servicing all of the frenzied borrowing last summer comes into play, the last and final part of the money equation can be added. Money that was used for lending is not being deposited at a rate high enough to sustain the optimism of joyous economic growth. No money means the low interest rates are a mote point. There will always be borrowers, but those low rates won't hold as long as there is greater demand than supply. So here we have a little problem. The Fed has almost guaranteed that they will not be raising rates until next year sometime late spring, if then. The job recovery is still limping along tentatively with revisions always seeming to err on the upside. This only means that all those jobs that should be providing the economy with real spending money and taxable income hasn't materialized just yet. If consumer equity borrowing is down an estimated 75% and that money has all been spent, then what will be the catalyst that will lift the economy? The tax cuts, money that should have been spent on growth will now go to debt service. Some of the debt service will end up in bankruptcy court as these poor souls find that paying off loans is not as easy as getting them. That money would have probably have been trickling into the economy on a much more steady basis, week after week had the overall debt not increased. Now we all know that money hasn't completely disappeared. Banks still have some and they haven't had to do much to attract deposits. They don't pay interest rates worth the effort, yet they still have enough to stay in business. How can this be? They can thank the failure of the money market account for that. Money market accounts, believe it or not, helped the mutual fund industry get the recognition it deserved and spurred the growth that followed. Interest rates, checking privileges and liquidity made the money market account the go-to place for savers to keep money. People literally turned their backs on banks altogether in spite of the uninsured nature of the holding, parking vast sums in these funds while they sat out stock market woes or simply as a safe retirement account. But things have changed since those blissful days. The companies that manage these funds are finding little reason to continue to service these types of funds largely because they are seeing red ink where there was once black. A money market funds reaches break even when they can pay management to find good, ultra safe short term investments while paying an attractive interest rate to their shareholders. That interest rate attracts deposits. These ultra safe holdings, regulated by the Securities and Exchange Commission usually look to the one year Treasury. But they are yielding about 1.3% last time I checked a couple days ago. So after expenses are paid, there just isn't that much left over to pay those shareholders. This has dramatically altered the playing field. All but the biggest players remain. These funds are large enough that they can manage even lower expenses in relation to management fees. But they aren't they aren't making investing in one very attractive either. Who the biggest players are is not so much the question you should ask but whether your mutual fund company is still running their money market account. Smaller money funds have either closed or allowed themselves to be swallowed up by bigger funds. And what do those big players do with all of these assets. They sweep them into the banks they own, increasing deposits on the short term.
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