Monday, September 26, 2011

The Pain of Low Interest Rates

The Fed's announcement of "Operation Twist" has gotten mixed reviews so far.

The Fed is attempting to boost the housing market by selling some of its shorter maturity holdings and buying longer maturity Treasury and mortgage-backed bonds.

The hope is that lower mortgage rates will increase the affordability of housing, as well as allowing more homeowners to refinance their existing mortgages.

Problem is, it not clear that mortgage rates are what ails the housing market, as the Washington Post notes this morning:

...Despite historically low interest rates, the very people most in need of the kind of relief that could come from refinancing their homes have found it difficult to qualify.

Even as the Fed undertook new measures, a study released by the central bank this week found that tight lending standards and the continuing drop in home prices prevented 2.3 million homeowners from refinancing last year. A combination of high unemployment, stricter lending requirements enacted after the financial crisis and the sheer number of borrowers who owe more than their homes are worth continues to thwart many Americans from taking advantage of rock-bottom rates.

Investors, meanwhile, are receiving incredibly paltry returns on their bond portfolios. For the life insurers, for example, this is a very serious problem, as Reuters points out:

The Federal Reserve's latest move to stimulate credit for consumers and businesses, known as Operation Twist, is likely to threaten the earnings of some of the country's largest insurers for years to come...

...The problem is that returns on insurers' investment portfolios can't keep pace with the obligations they have accumulated from torrid sales of annuities and life policies over the past few years...

Insurers were demonstrating sound financial management in purchasing long-term bonds with the premiums they collected to balance their long-term obligations. But if the Fed's Operation Twist is successfully executed it will push long-term rates lower and, according to some experts, force insurers to retrench on product sales.

A long time ago, a very wise investor told me that markets move in the direction that causes the most "pain".

Right now, lower interest rates would be a very painful scenario for most investors, so perhaps that is the direction we're heading.