Why Are Interest Rates So Low? What You Need To Know 2
What else is in an interest rate?
We have already seen how the interest rate fallacy plays out when people only see rates as a function of central bank policy, neglecting the fact that borrower’s perceptions matter as well.
But what about how lenders see things?
People too often assume that low rates mean lenders are having trouble making loans.
Again, this stems from having a central bank-centric perspective, where rates are seen as the price of money, set and controlled by the central bank.
From this standpoint, low rates mean a low price, hence if rates are stuck near zero, that means prices aren’t low enough to entice borrowers in.
This, however, is not the case.
Imagine that you are a lender seeing a range of clients from all across the spectrum of creditworthiness. In normal times, you would reject those who simply prove too much of a credit risk, and charge different clients different interest rates for their loans based on their relative creditworthiness.
Now imagine an economic shock so severe that it rattles your confidence in everyone’s ability to repay their loans (a la 2008 and 2020). Everyone, that is, except for those with the easiest access to liquidity and capital.
What you have now is a bifurcated loan market. One where you, as a lender, will only lend to the highest rated credits, and not to anyone else.
As a result, you begin to offer lower interest rates to this particular subset of your clientele in order to entice them to borrow from you.
But they won’t, simply because they already have ample capital, as well as ample access to it, which makes you offer them loans at even lower rates.
All this while, the people who would have to pay higher rates for borrowing simply are not offered any credit, and are locked out of the credit market.
In addition, low rates must also be considered from the perspective of the repo market.
In this case, low and negative rates demonstrate exceedingly high levels of demand for collateral, especially in higher quality issues like AAA corporate bonds and sovereign debt. Naturally, this is caused by the same kind of crises that pushed lenders to only offer credit to the safest counterparties.
Moreover, central banks like the ECB and Fed have been busy removing quality collateral from the market via QE, which only serves to drive prices higher, and yields lower.
This general state of risk aversion on the part of lenders, as well as repo market dealers and participants, can be traced back to the Great Financial Crisis of 2008.
As such, it has been over a decade without any policies to help people regain access to credit, or to address the role and importance of the repo market (and its collateral issues).
Is it any wonder that today’s rates are stuck at historic lows?
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