Conventional wisdom has it that lower interest rates equal good news for borrowers — but that might not be the case in today’s economy.
As the US interest rate falls, banks are ginning up policies that could pull the plug on American prosperity and possibly plunge the economy into a deep recession, according to some financial analysts.
In July, the Fed cut its key rate by a quarter-point, to a range of 2.0 percent to 2.25 percent — the first drop since the depths of the Great Recession. And, egged on by President Trump, Federal Reserve Chairman Jerome Powell seems poised to further lower the rates this week.
Greg McBride, chief financial analyst at Bankrate.com, said falling interest rates will undoubtedly squeeze interest margins, reflecting concerns among other analysts that banks may start restricting lending — and precipitate a recession — as their focus turns to riskier activities and consumer account charges.
President Trump last week in a tweet called for the Fed “boneheads” to cut rates to zero or below.
But analysts issued a health warning instead.
“Lower rates, and especially a flat yield curve — short-term rates similar to long-term rates — are very tough for banks because they cannot make that interest rate spread on mortgages,” said Raul Elizalde, chief investment officer and president at Path Financial. “Riskier loans may or may not be a source of alternative profits.”
Dick Bove, chief strategist at Odeon Group, said banks could take the “easy road” by restricting lending as margins are squeezed, a policy that could indirectly push the US into a “significant recession.”
Some could even follow the lead of JPMorgan, which is now selling loans at a profit instead of lending, he said.
“The Fed will have no power to stimulate growth in this instance,” Bove said. “It can cut rates all it chooses, but if the banks simply refuse to lend, the rate cuts will only further stimulate the banks’ unwillingness to lend and the desire to sell loans.”
Bove further warned: “At present, the pressure to take this path is rising.”
In the year through August, JP Morgan slashed its loan portfolio by $27.7 billion.
And US bank loans, overall, in the 12 months ending June 2019, have risen by just under 5 percent, which is indicative of a lending slowdown, said analysts.
“Another interest rate cut in the US, coupled with very low and in some cases negative rates in Europe will adversely impact US banks,” said Mayra Rodriguez Valladares at MRV Associates. “They will soon face a wave of mortgage borrowers who will want to refinance to lower-rate mortgages,” she added. “Also, any new mortgages and other types of loans will be at lower rates, compressing banks’ net interest margins.”
Bankrate.com’s McBride said another wrinkle is how careful banks — and all lenders — were with decisions on credit risk during the flush times, and how many loans go toxic when the economy slumps. “Those decisions will dictate which lenders survive and which do not,” he said.
Source: Read Full Article