Low Interest Rate Long Term Effect

Inflation erodes the purchasing power of a bond 's future cash flows. A rise in inflation will cause investors to demand higher yields to compensate for inflation rate risk. Also, prices will tend to drop because the bond will be paying interest with less purchasing power.

In Chapter 6, I learned that there’s an inverse relationship between interest rate and bond prices. What does this mean? This means when interest rates go down bond prices go up, and as interest rates go up bond prices go down. In accordance with Wright and Quadrini (2009) “When general business conditions were favorable, demand for bonds increased pushing prices higher and yields lower…When general business conditions were unfavorable, profit opportunities for businesses dried up, shifting the supply curve of bonds left, further increasing bond prices and depressing yields” (p. 116). Why is this?

The Federal Reserve had began lowering interest rates from 6.5% in the late 2000, all the way down to 1% in November of 2003 and kept it there until June of 2004. These artificially low interest rates encouraged consumers to buy houses and builders to produce more houses. However, the low interest rate was not an accurate reflection of the true demand for houses in the marketplace. At the same time, Congress amended the Community Reinvestment Act, encouraging banks to offer mortgages to lower income borrowers who would ordinarily not qualify for a loan. In addition, the Federal Government required Fannie Mae and Freddie Mac, the now two infamous government sponsored lenders, to provide over half their mortgages to low-income buyers, also known as subprime mortgages. Essentially, this meant that banks and other mortgages lenders were told to relax their lending standards, and provide mortgages to people who

The gap that banks maintained between the interest they brought in on loans they paid out on deposits were narrow significantly in recent years as The Bank of Canada cut interest rates by a quarter of a percentage point twice in 2015 to help the economy deal with a plunge in oil prices. This led the banks to try harder to steal business from each other. The sandwich effect was being driven primarily by increased competition for mortgages and credit lines, as consumers scale back their borrowing. But the phenomenon was happening on many levels, from lenders offering up lower rates on commercial loans to an intensifying fight among the big banks to build up their deposit base. (Ratner,

Low interest rates and the ease of borrowing money are two primary causes of the current recession. In 2007, 37% of the total home mortgage loans were considered a “liar loan” because the mortgage lender did not evaluate income or assests (Russo, Mitschow, & Schinski, 2015). The Federal Government sought to encourage home loaners to loan to risky homebuyers and they kept low interest rates for far too long. During this time mortgage brokers began selling home mortgage loans rather than a commercial banking system. They were not subject to the scrutinized federal regulations, and lent money to many individuals who were unable to afford the homes that they were buying. Many people overestimate their ability to pay debt, resulting in them buying expensive homes because they were approved regardless of their credit or income. The crisis occurred when homes values dropped due to the ability for individuals to buy expensive homes, which resulted in people owing more on their homes than the value of the house. It was nearly impossible for people to make a profit when selling their homes, so many homeowner’s felt that it would be best to default on their loans as they were losing money paying for a home with less value than the actual loan. The more foreclosures there was, the more home values diminished and causing more and more

After the bursting of the United States housing bubble, many homeowners found themselves in a dire situation. Following the dot-com bubble burst, the Federal Reserve slashed interest rates, meaning credit was cheap. Lower lending standards also meant that consumers with not-so-great credit were suddenly able to attain adjustable rate mortgages with a minimum of money down and easy initial terms. In 2004, approaching the pinnacle of the housing market’s climb, former Federal Reserve Chairman, Alan Greenspan, actually encouraged Americans to take out adjustable rate mortgages. Then, as 2006 came, Americans saw the housing market reach its peak and subsequently plummet downward. As a result, it became difficult to impossible forthe borrowers

In 2010, the American economy was struggling to bounce back from a devastating collapse in 2007. The housing market had collapsed and economists were baffled. The stock market did not entirely crash, yet the economy still could not be stimulated. For the most part, much of the financial industry was left unregulated, allowing banks to loan money to people trying to buy houses, with no guarantee of the money being returned. With a low interest rate of 1.24 percent, people were looking towards the housing markets as an investment. The low interest rate sparked a demand for both mortgages and housing, expecting the prices of houses to rise. However, in 2004, the rates began to rise. By the end of 2004, the interest rate was 2.25 percent.

Concerning increased cost, this adversely affects profitability. Pure play investment banks are facing a reduced demand

Interest rates affect everything in the business world, including the amount of money you must pay on your loans and the ease of obtaining those loans, credit card rates and even the stock market. This is because high interest rates reduce corporate earnings by slowing business and making it more expensive to do business, so the prices of a company’s stock will very likely decline as its earnings declines.

In the US, the measure above, along with a lack of demand for credit which was a result of the recession, contributed to a fast slide in real and nominal interest rates to a extreme-low level, a movement from 5.25 to merely 0.25 in less than three months (Exhibit 3.3). The super low interest rate had since stayed for almost seven years.

The years preceding the market melt down, homeownerships were painted as an American dream in a hyped fashion instead of a responsible investment. The demand for homeownership and immediate profit drove up prices in an unhealthy rate, and fueled a competition among buyers to use real estate as a vehicle to make quick money. That silently destroyed the American dream of homeownership. The competition spread to financial institutions to creatively fit unqualified borrowers into homes and finance over leveraged investors. The biggest debt an individual ever taken on their life time came with the least amount of information, if any. The entire real estate became a pure transaction number, from how much will the buyer able to sell the home they have yet to purchase to how much can real estate professionals make on the deal, to how quickly it can be closed. We saw an enormous amount of buyers not knowing what type of loan programs they just obtained and how it’ll play out through the life of the loan. We heard buyers fascinated in how easy it is to obtain a mortgage loan and the expectation that no one should be denied. The other interesting component is the lack of qualified professional involved in the

Interest rates are a fraction of money that when you loan money from a bank, is a percent of that money that you additionally pay. It may seem like a small amount of money, but over years, it adds

In 2005, the sub-prime mortgages were promising unbelievable interest rates for homeowners – with ballooned mortgages – with the help of home appraisers who may have fudged numbers to help fuel this industry, millions of people fell trap to it, including me.

In 2003, in order to help stimulate the U.S economy, Alan Greenspan, the Federal Reserve Board Chairman suggested, “that homebuyers were wasting money buying fixed rate mortgages instead of adjustable rate mortgages”(Baker, 2009). Fixed rate mortgages did seem attractive at the time as mortgage rates had reached 50 year lows. Most homebuyers could have afforded the ARM during this period; however, most homebuyers did

If the rate of interest began to rise above the equilibrium level there would be an excess supply of money. This excess supply could be used to invest and buy bonds as people have more money balances than they need. This will in turn push up bond prices and interest rates will begin to fall due to the inverse relationship. Low interest rates encourage people to spend more. The opportunity cost of spending is saving, if interest rates are lower, people will receive less interest on their savings so there will now be a lower opportunity cost of spending. This spending will increase demand to the point where it is back at equilibrium.