Fed Punishing the Prudent

"Neither a borrower nor a lender be," Polonius advises his son Laertes in Act I of Shakespeare's  Hamlet.  "For loan oft loses both itself and friend, / And borrowing dulls the edge of husbandry."

Polonius may be Shakespeare's idea of an old fool, but his advice still rings true.  Most human beings, I believe, have an innate fear of excessive borrowing and a corresponding reluctance to loan money in the absence of solid collateral.  Or they did, before the moral hazard attached to reckless fiscal behavior was removed by governments eager to spur growth at all cost.  Recent actions by the Federal Reserve, in particular, have set this ancient wisdom on its head.

Over the past five and a half years under Ben Bernanke, the Fed has pursued an extreme policy designed to bail out improvident borrowers at the expense of responsible long-term savers.  By lowering interest rates to inflation-adjusted negative rates of return, the Fed has attempted to recapitalize banks and other improvident borrowers while penalizing cautious savers, who now see a loss in the real returns of their accounts.  In effect, the Fed has been transferring billions of dollars from the savings of provident Americans into the accounts of reckless borrowers.

The Fed's policy is beginning to hit pension funds and other retirement savings particularly hard.  Pension funds that rely on intermediate-term Treasury bonds are now receiving interest of less than 1%.  The 2011 inflation rate, which has been running above 3% since March, now stands at 3.8%.  At 3.8% the inflation-adjusted return of retirement savings based on the intermediate Treasury bond is minus 2.8%.  At that rate, compounded over 10 years, savers are guaranteed to lose 30% of their buying power.

A long-term Treasury bond, currently yielding 3.51%, provides a somewhat better return but at much greater risk.  But even that investment currently offers savers a negative inflation-adjusted return of minus 0.29%.  Compounded over 30 years, an investor in long-term bonds would earn a total real return of minus 23%, assuming a constant inflation rate of 3.8%.

Every investor knows the painful truth of these numbers.  Retirees purchasing one-year CDs at their local bank are currently offered the derisory return of something like 0.5%.  With inflation over 3%, they are virtually guaranteed a loss of capital, and this loss can be tied to the Fed's policy of extended low interest rates.  Under that policy, those who have prudently set aside savings are punished.  But those who have engaged in reckless borrowing are bailed out by virtue of these same low rates.

It is not just the Federal Reserve, and it is not just America.  The continuing attempt by the state attorneys general to extort mortgage loan renegotiations from lenders is another attempt to bail out improvident borrowers at the expense of savers.  Having worked out a deal that would reportedly provide $45 billion for borrowers who are unable to pay their mortgages, the AGs now find that arrangement in jeopardy as New York and California demand even more concessions.  The Holy Grail, I suppose, is simply to pay off the mortgages of those who have imprudently taken on more than they could afford or who have borrowed against their homes just as prices peaked.  The politicians are callously oblivious to the fact that bailouts operate at the expense of prudent savers and pension funds, to whom financial institutions can afford to pay scant returns once they've been stung by the demands of state AGs.

One might expect the media to point out the consequences of debt that has been defaulted upon.  Six million homes are currently delinquent or in foreclosure.  Those borrowers are often portrayed as victims of unscrupulous lenders, but the real victims of the mortgage crisis are the lenders.  These include pension funds, bond funds, and individual investors.  For each home that works its way through foreclosure, there are investors, most of them associated in some way with retirement funds, who lose a portion of their investment.  Those who have taken on more than they could afford have done so at the expense of savers.

In truth, there exists a bias throughout the liberal media and political culture on the side of the improvident -- those who are underwater with their mortgages after speculating on rising home prices or taking out home equity lines of credit, those who save nothing throughout their lives and arrive at retirement entirely dependent on the Ponzi scheme known as Social Security, those unionized government workers who suppose that their unfunded retirement benefits can actually be honored while being extended to new hires.  The liberal bias is all on the side of the spendthrift and irresponsible: those who are losing "their" homes (on which they have paid virtually nothing), those who are entirely dependent on government as a result of their own improvidence, those in danger of losing their extravagant retirement benefits but who refuse to negotiate reasonable concessions.

When they must face the consequences of their actions, the improvident respond with the instincts of a mob.  On September 30, 24 persons were arrested at a Boston sit-down protest against Bank of America.  The protest was part of what Bank of America termed a series of "increasingly aggressive PR stunts" designed to pressure the bank to forgive mortgage debt.  Somehow, all of these protests take on the same quality of moral indignation.  They seem outraged that those who have borrowed recklessly are actually expected to pay back what they owe.  As if it were somehow morally offensive to suppose that the debtor must pay his debt.

The same phenomenon is evident overseas, especially in the countries of southern Europe.  And the response to calls for prudent policy is much the same: a mob reaction that threatens violence against society for holding borrowers responsible for their debts.  The young communists in the streets of Athens or Lisbon are operating from the same expectations as America's improvident borrowers.  Their nations teeter on the edge of bankruptcy, but they demand a continuation of the impossible level of government benefits that is responsible for their fiscal woes.  And they are callously oblivious to the fact that someone else, in this case the cautious savers of northern Europe, must be harmed if they are to be bailed out.

The traditional moral hazard associated with excessive levels of debt is under assault, in large part as a result of the actions the Federal Reserve.  With leaders like Bernanke and Obama in charge of our finances, Shakespeare's words seem more relevant than ever.  But with debtors everywhere refusing to pay back what they owe, and with liberals aiding and abetting them at every turn, another maxim comes to mind: "Thou shalt not steal."

Jeffrey Folks is author of many books and articles on American culture and politics.

"Neither a borrower nor a lender be," Polonius advises his son Laertes in Act I of Shakespeare's  Hamlet.  "For loan oft loses both itself and friend, / And borrowing dulls the edge of husbandry."

Polonius may be Shakespeare's idea of an old fool, but his advice still rings true.  Most human beings, I believe, have an innate fear of excessive borrowing and a corresponding reluctance to loan money in the absence of solid collateral.  Or they did, before the moral hazard attached to reckless fiscal behavior was removed by governments eager to spur growth at all cost.  Recent actions by the Federal Reserve, in particular, have set this ancient wisdom on its head.

Over the past five and a half years under Ben Bernanke, the Fed has pursued an extreme policy designed to bail out improvident borrowers at the expense of responsible long-term savers.  By lowering interest rates to inflation-adjusted negative rates of return, the Fed has attempted to recapitalize banks and other improvident borrowers while penalizing cautious savers, who now see a loss in the real returns of their accounts.  In effect, the Fed has been transferring billions of dollars from the savings of provident Americans into the accounts of reckless borrowers.

The Fed's policy is beginning to hit pension funds and other retirement savings particularly hard.  Pension funds that rely on intermediate-term Treasury bonds are now receiving interest of less than 1%.  The 2011 inflation rate, which has been running above 3% since March, now stands at 3.8%.  At 3.8% the inflation-adjusted return of retirement savings based on the intermediate Treasury bond is minus 2.8%.  At that rate, compounded over 10 years, savers are guaranteed to lose 30% of their buying power.

A long-term Treasury bond, currently yielding 3.51%, provides a somewhat better return but at much greater risk.  But even that investment currently offers savers a negative inflation-adjusted return of minus 0.29%.  Compounded over 30 years, an investor in long-term bonds would earn a total real return of minus 23%, assuming a constant inflation rate of 3.8%.

Every investor knows the painful truth of these numbers.  Retirees purchasing one-year CDs at their local bank are currently offered the derisory return of something like 0.5%.  With inflation over 3%, they are virtually guaranteed a loss of capital, and this loss can be tied to the Fed's policy of extended low interest rates.  Under that policy, those who have prudently set aside savings are punished.  But those who have engaged in reckless borrowing are bailed out by virtue of these same low rates.

It is not just the Federal Reserve, and it is not just America.  The continuing attempt by the state attorneys general to extort mortgage loan renegotiations from lenders is another attempt to bail out improvident borrowers at the expense of savers.  Having worked out a deal that would reportedly provide $45 billion for borrowers who are unable to pay their mortgages, the AGs now find that arrangement in jeopardy as New York and California demand even more concessions.  The Holy Grail, I suppose, is simply to pay off the mortgages of those who have imprudently taken on more than they could afford or who have borrowed against their homes just as prices peaked.  The politicians are callously oblivious to the fact that bailouts operate at the expense of prudent savers and pension funds, to whom financial institutions can afford to pay scant returns once they've been stung by the demands of state AGs.

One might expect the media to point out the consequences of debt that has been defaulted upon.  Six million homes are currently delinquent or in foreclosure.  Those borrowers are often portrayed as victims of unscrupulous lenders, but the real victims of the mortgage crisis are the lenders.  These include pension funds, bond funds, and individual investors.  For each home that works its way through foreclosure, there are investors, most of them associated in some way with retirement funds, who lose a portion of their investment.  Those who have taken on more than they could afford have done so at the expense of savers.

In truth, there exists a bias throughout the liberal media and political culture on the side of the improvident -- those who are underwater with their mortgages after speculating on rising home prices or taking out home equity lines of credit, those who save nothing throughout their lives and arrive at retirement entirely dependent on the Ponzi scheme known as Social Security, those unionized government workers who suppose that their unfunded retirement benefits can actually be honored while being extended to new hires.  The liberal bias is all on the side of the spendthrift and irresponsible: those who are losing "their" homes (on which they have paid virtually nothing), those who are entirely dependent on government as a result of their own improvidence, those in danger of losing their extravagant retirement benefits but who refuse to negotiate reasonable concessions.

When they must face the consequences of their actions, the improvident respond with the instincts of a mob.  On September 30, 24 persons were arrested at a Boston sit-down protest against Bank of America.  The protest was part of what Bank of America termed a series of "increasingly aggressive PR stunts" designed to pressure the bank to forgive mortgage debt.  Somehow, all of these protests take on the same quality of moral indignation.  They seem outraged that those who have borrowed recklessly are actually expected to pay back what they owe.  As if it were somehow morally offensive to suppose that the debtor must pay his debt.

The same phenomenon is evident overseas, especially in the countries of southern Europe.  And the response to calls for prudent policy is much the same: a mob reaction that threatens violence against society for holding borrowers responsible for their debts.  The young communists in the streets of Athens or Lisbon are operating from the same expectations as America's improvident borrowers.  Their nations teeter on the edge of bankruptcy, but they demand a continuation of the impossible level of government benefits that is responsible for their fiscal woes.  And they are callously oblivious to the fact that someone else, in this case the cautious savers of northern Europe, must be harmed if they are to be bailed out.

The traditional moral hazard associated with excessive levels of debt is under assault, in large part as a result of the actions the Federal Reserve.  With leaders like Bernanke and Obama in charge of our finances, Shakespeare's words seem more relevant than ever.  But with debtors everywhere refusing to pay back what they owe, and with liberals aiding and abetting them at every turn, another maxim comes to mind: "Thou shalt not steal."

Jeffrey Folks is author of many books and articles on American culture and politics.