Foreign Perspectives

Archive for the ‘Interest Rates’ Category

The current economic difficulties are pretty unusual in their severity and therefore what “we” should do is not necessarily the same as what we’d ordinarily do by ourselves.

Typically, it’s prudent to build up some reserves in the bank to tide oneself over the hard times. However, if we all do that in the moment then chances are that the downturn will go on for a great deal longer than it needs to. What’s needed is for each of us to act as though the downturn didn’t exist as much as possible.

So, for instance, the banks have basically been told to return to normal lending practices “or else”. In fact, they need to do that for their own sake as tightening up on the lending criteria as many had been doing was simply acting to stagnate the economy which is good for nobody, including the banks.

From the rest of us what’s required is that we don’t simply bank any savings that we’re making but rather that we spend them and thereby do our bit to restart the economy.

Whilst your instinct might be to increase the size of any savings reserve as much as you are able, it’s the worst thing that we could do collectively.

That’s basically what governments around the world are doing right now when they’re supporting the banking system.

For normal people, borrowing even more to get yourself out of a hole can only be a short term solution and even then it only works if you have something else up your sleeve. Bridging loans are typically successful in this area because you’ve a house for sale on the market and will repay the loan when it’s sold.

It’s also only a short term solution for governments too, albeit the term over which they can get away with it is somewhat longer: typically several years or perhaps a decade. That “something up the sleeve” is mainly tax rises to pay interest on the loans that they’re getting and to start repaying them as well so we can all look forward to significant rises in taxes in the next term of our governments (perhaps even in the current Obama term as he won at a very unfortunate time). Other possibilities are asset sales of course so we can look forward to privatisations on a grand scale in a few years time although the unwinding of the various nationalisations of various banks will also need thought.

The other downer for governments is that borrowing more basically means printing more money which in turn reduces the value of that money which is why exchange rates are all over the place at the moment.

Of course, all this work is dependent on the banks returning to normal loan criteria and everyone spending money to get the economies going again…. not an easy thing to do when things look this bleak.

Not so long ago I was joking that either Citibank or HSBC going bankrupt would be a really spectacular event as both are based in one country yet have the bulk of their interests overseas, so who would support them?

Well, it’s happened to Citibank now and it turns out that the American government figured that if they were allowed to go to the wall it would be just that little bit too spectacular to happen so they’ve bailed them out. One wonders how long it can be before we see if the UK government have a similar view of HSBC although that might be quite a while from now as HSBC management dumped the problem HFC quite some time ago and that’s where a lot of their high risk loans lay.

But when you’ve the situation of the largest banks in the world at risk like this it sounds to me that it’ll be quite some time before we get ourselves out of this particular financial mess.

Whilst you might think that all interest rates are going down at the moment, don’t just assume that your bank/credit company will be dropping their rates by the headline amount or even at all.

In fact, although the various governments would like the banks to drop rates across the board to get us out of the current mess, many quite simply can’t. Why? Well, regardless of the headline rate, they still need to get money in the door before they can lend it. In some cases, that means offering quite high rates to depositors and therefore those banking organisations dependant on retail deposits (ie the building societies) may find that they can’t drop their lending rates by as much as they might like to.

As always, don’t assume anything and in particular if you’re one of the many people who have both savings and borrowings, check out the best rates for both as it’s very rare to find that the same organisation is offering both the lowest lending rates and the highest deposit rates.

Interest rate changes by central banks are peculiar affairs.

For one thing, the banks aren’t actually obliged to respond by lowering interest rates although, usually, they do so by a similar amount. It’s usually a similar amount rather than exactly the same amount though which affects people differently: it’s common for banks to drop interest rates on savings accounts by a little more than the cut the central bank announces and loan rates by no more than is announced.

That sounds like they’re ripping you off, and to some extent they are, but what kicks in is the effect of their own administration on the processing of the loans and savings. Even if the central bank cut rates to zero, there would still be a charge for loans as that represents a risk to the bank, and savings rates would drop to zero or possibly a little below that as obviously there is a cost to processing savings too (they’d probably introduce charges rather than negative interest rates).

High interest products tend to represent higher risks so the rates on those aren’t always cut at all following a rate cut announcement.

And, of course, if you’ve a fixed rate loan then the payments on that will stay the same.