Lars Svensson, deputy governor of Sweden's central bank recently urged the Federal Reserve to find ways to push borrowing costs lower — this even though we already have the lowest nominal interest rates in modern history.
Really?! Would lowering mortgage rates another 20 basis points suddenly trigger more demand for mortgages to buy a house? Get small business owners to rush out and buy equipment or expand their businesses?
Real interest rates are already negative in many instances. Dennis Lockhart, President of the Federal Reserve Bank of Atlanta, recently observed, "
This is a clear-eyed assessment of the Fed's ability (or inability) to affect real economic activity on Main Street. Programs like "Operation Twist" or more purchases of mortgage backed securities may create activity on Wall Street, but the Fed is out of bullets when it comes to reducing the unemployment rate and inducing job creation.
The National Federation of Independent Business has surveyed its member firms since 1980 about
This has occurred in spite of massive Fed intervention in the form of liquidity-providing purchases of assets (mostly Treasuries and mortgage-backed securities). Although the banking system is awash in liquidity, the spread between the one-year Treasury yield and reported rates paid by business owners has rarely been as large as it has been since 2008 and never for as prolonged a period of time.
With the Fed maintaining a rate target of zero, it is hard to see how the Fed could drive borrowing rates for small firms any lower. This is in part because the cost of funds for community banks is not driven by just the Federal Funds rate.
The community bank business model is built around "relationship" lending and is based on information and factors that are not contained in a Dunn & Bradstreet or credit report, such as the quality of the borrower's management team and prospects for growth in the particular industry segment or geographic area. Small business lending is a labor intensive and capital-intensive operation — one that provides a service that is valued by borrowers and apparently is not available from many of the larger financial institutions.
Most, if not all, community and regional banks have put floors on the rates they will offer on business loans and equity lines of credit that reflect these cost differences and significant economic uncertainty. When market rates are at historic lows, it is risky for small banks to make longer term loans at fixed rates.
When rates rise, as they must, the value of low rate loans on the banks' books will decline and earnings will be impaired. So floor rates are in place and it will be difficult if not impossible for Fed policy to push longer term loan rates below those floors.
That said, loan rates are historically low and the cost of funds is not preventing firms from borrowing. Rather, it is the lack of good uses for borrowed funds that is depressing loan demand. Loans must be repaid and so must be used in ways that at least return the principal amount of the loan with a reasonable profit. Those opportunities are few in this economy.
Most firms see little or no improvement in the economy in the coming year, so they have no need or desire to borrow to invest or hire. It will take time and an election to change these dynamics.
William Dunkelberg is a professor of economics at Temple University and the chief economist of the National Federation of Independent Business. William M. Isaac, former chairman of the Federal Deposit Insurance Corporation, is senior managing director and global head of financial institutions at FTI Consulting, chairman of Fifth Third Bancorporation, and author of "Senseless Panic: How Washington Failed America." The views expressed are their own.
