It's a common refrain. Low interest rates may help the young and indebted, but deny interest income to seniors living off savings and social security. And like most untruths, it seems logical on the face of it. Cash balances at banks pay essentially zero, and most one year CDs yield a paltry 100 basis points. During Fed Chairman Yellen's testimony on Tuesday, many Congressman brought up seniors who supposedly have saved their money, done the right thing, and now have been hit hard by low rates. The classic response by the Fed is that while seniors may be deprived of interest income, their children and grandchildren are rewarded with better job prospects and more valuable homes. This may be true, but in reality any senior which really was saving before the financial crisis should have experienced the same windfalls other holders of fixed income assets did as rates fell through the floor.
Bond Price Explosion:
While low interest rates may make it hard for new savers to earn a solid returns if building a fixed income portfolio from scratch, falling interest rates are usually a windfall who those who have existing portfolios I assume this includes all those seniors out there that "did the right thing." A few back of the envelope calculations demonstrate this. Ten year US treasury yields were at five percent in late 2007, and then plunged to two percent in the depths of the financial crisis. The underlying price of these securities therefore increased substantially, that same ten year was worth over twenty percent more in 2009 than in 2007. Yields moved up again in 2010 as some signs of recovery sprung up, only to plunge again as the Fed gobbled up more long debt instruments as part of its so-called quantitative easing program. So again, since the financial crisis risk-free assets have been an excellent opportunity for financial gain. Many say seniors could not part with the liquidity and therefore could not purchase ten year bonds. Well, the equivalent two year notes which also yielded five percent in 2007 and then dropped to 0.3 percent in 2009 saw there values soar roughly 9 percent over the same period. Not a bad return considering that the Dow Jones Industrial Average would lose over fifty percent of its value during the financial crisis.
So far from being a lack of safe investment vehicles for seniors to invest in over the past five years, those who actually did invest in the very same safe securities they claim they want have made out like bandits.
Doing Alright:
Furthermore, compared to other Americans, seniors have fared much better in the financial crisis and the great recession. While poverty rates soared for younger Americans during the Great Recession from nine to fourteen percent, the rate of poverty actually declined for those aged 65 and older from 2008 to 2011. So much for seniors being forced into the poor house because of low interest rates. Other measures of well being also point toward seniors doing okay. As this figure shows, the median net worth of 35 to 44 year olds declined a whopping 58
percent from 2005 to 2010. Seniors on the other hand experienced only a
13 percent decline in median net worth over the same period. Those under thirty five, who have little savings are usually don't own homes, saw median net worth fall by 38 percent, while prime working-aged adults, or 45 to 64, year olds experienced a 25 percent decline. In sum, since, during, and after the Great Recession, seniors have experienced less poverty, and have suffered fewer losses in terms of net wealth than the average American.
Risky Business:
Unfortunately, what I susupect is really going on is that just like everyone else, seniors were heavily exposed to the stock market in 2007, not satisfied the five percent returns offered by government bonds or other safe instruments. When things went south, they followed everyone from the Norges Bank (which oversees Norway's 800 billion dollar sovereign wealth fund) to US hedge funds into government fixed income, but the glut of buyers of these securities drove prices up and yields down. Am I the only one who finds it ironic that seniors, who vote overwhelmingly for Republicans, are damning the very free market forces which have delivered low interest rates while also attending the same Tea Party rallies which deride President Obama as a socialist?
Japan's Savers' Windfall:
Finally, there is a precedent for falling rates actually helping fixed income investors and savers. Two decades of deflation and super easy money in Japan have resulted in an incredible bull run for Japanese Government Bonds precisely because falling rates cause the prices of these bonds to increase. If anything, it has been the overabundance of safe vehicles to invest in which have kept Japan mired in two decades of stagnation. Why invest in plant and equipment, real estate, or stocks, if you know rates will fall thus boosting the values of government securities or other super safe fixed income holdings? Couple this with very low inflation or even deflation as in the case of Japan, and the returns are magnified because as prices for goods fall the real value of the debt owed by the government actually increases rather than being eroded away by inflation. Indeed, Japanese banks, pension funds, and insurance companies have made spectacular returns using this very strategy. According to Warren Mosler, an economist and former hedge fund manager, the depreciation in the Yen last year was mainly do to these same entities buying foreign bonds without hedging the currency risk. While the Bank of Japan's latest round of easing has seemed to cause some Japanese names to seek yield abroad, Mosler believes they could very well revert to their old ways. Indeed, the Japanese have been net sellers of foreign securities so far in 2014.
Wanting the World:
The past five years have been tough financial times for many Americans, but seniors have done just fine. Younger Americans on the other hand face an anemic jobs market, where they are unable to utilize the skills they payed dearly to obtain at college. Meanwhile, those of us who actually work continued to foot the bill for Medicare and Social Security all through the Great Recession. While these entitlements are crucial for the security of many seniors, and thus must be preserved, it is also necessary to thank and acknowledge those who bear the cost of providing them. So I am so sorry that affluent seniors must accept lower coupon rates when they roll over their bond portfolios. But really, with medical technology ever advancing and bonds providing fat returns over the past five years, what more could a retiree ask for?
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