Thursday, December 9, 2010

Households will benefit if interest rates keep rising

Based on the household balance sheet data released today by the Fed (see my prior post for more details), I have estimated how the data could be disaggregated for the above chart. The picture hasn't changed much over time, but the message is still meaningful: rising interest rates on balance are good for the household sector. If the economy continues to recover, regardless of whether the Fed discontinues QE2 or not, interest rates should rise and that should be a net benefit to consumers.

Households have significantly more exposure to floating rate assets (e.g., time deposits, CDs, money market funds) than to floating rate debt (e.g., adjustable rate mortgages). That means that falling interest rates really cut into the income of retired folks, but rising interest rates are a direct benefit to households since that increases household income. As interest rates rise, the increase in interest income received greatly exceeds the increase in interest paid out.

As for exposure to fixed rates, households suffer somewhat from higher interest rates, since they have about 20% more exposure to fixed rate assets (mainly in the form of bonds whose price would decline as prices rise), than they do to fixed rate debt (mainly in the form of fixed rate mortgages that are immune to higher interest rates). However, this loss would be only on a mark-to-market basis, since cash flows would be largely unaffected.


W.E. Heasley said...

Mr. Grannis:

Although interest rates are historically low, few qualify for loans. Plenty of factors at work regarding “qualify”.

When interest rates rise the spread for the private lending institution should grow. Higher interest rates would seemingly create more credit access at the margin. That “margin” will not likely act in a historic manner due to the recent financial crisis. However, more access seems likely.

Benjamin Cole said...

I don't understand this, and I don't mean that contentiously, I mean it earnestly.

I thought most households were net borrowers (home mortgage, consumer debt).

Would not a rise in interest rates hurt most households, income-wise?

In any event, I predict soft interest rates for a very long horizon. The world is awash in capital, and it seems to get wetter every year.

McKibbinUSA said...

Increasing interest rates would be good for households, I agree. Higher interest rates hurt the government (which borrows too much regardless)...

brodero said...

Scott...don't tell the mark to make
believe followers...they think cash flow doesn't matter and all loans should be marketed to collateral. A huge misconception
borne of the financial crisis. William Isaac's book " Sudden Panic" details this misconception.

The Lantern said...

It's an interesting point and certainly some households will benefit. I think an issue is that a big chuck of the assets are owned by a few households, but the liabilities are a little more spread around. You're more likely to find a guy with $1 billion in assets and no liabilities than a guy with no assets and $1 billion in liabilities (I would think).

Scott Grannis said...

I don't think the super-rich are distorting this picture. The $10 trillion in floating rate assets are all of the type that are held by the great middle class, especially retired folks: money market funds, bank CDs, savings accounts, etc. In contrast, the super-rich keep almost all of their money in real estate and equities. You don't get super-rich by holding lots of cash or cash-like things.

Steve Fulton said...

It would be fun to have some fun with this. There's gotta be 100,000 households with over 100,000,000 in net worth. The democrats are always crowing about tax breaks for millionaires and billionaires (as if some poor orthodontist making 300K a year with 150K in college tuition debt is rich--puh-lease). How about we propose that everyone with a net worth over 50 Million be subject to a 50% millionaires asset tax. We could close the budget deficit in a snap. Of course it's a ridiculous idea but at least it might get blowhard idiots like Buffet to shut their pie holes.