Special Report: NIRP and You: What to Expect

"We're taking a look at them... I wouldn't take those off the table.”

Those are the words Fed Chair Janet Yellen used in a congressional hearing a couple months ago regarding one of the most bizarre and possibly most damaging economic aberrations of our lifetimes.

As the Great Recession wore on, we had to grapple with the consequences of zero interest rate policies. Now we're facing the prospect of ZIRP becoming NIRP — negative interest rate policies.

Japan and a lot of Europe have already crossed over into this uncharted territory. The Eurozone recently delved even deeper into negative rates, and now we know the U.S. may as well.

Now is the time for us to get used to what this means for us, both for the NIRP in place in international markets and for if and when the Fed plunges us into the same mess.

Even Worse Lending

First and foremost, ultra-low interest rates are already changing how banks work. An equity market that has been rocky but ultimately flat for a year and a half is only adding fuel to the fire.

Using ZIRP following the credit crunch that drove the Great Recession already hurt lending operations.

Though banks were particularly risk averse and were only lending to those with the highest credit scores, reducing headline interest rates only made things worse by narrowing the spread between what banks can charge and what they can pull in as profits.

NIRP makes that even worse by driving down yields even further, though personal loans are never going to go negative themselves.

Consider home and auto loans as the major types of credit we'll personally utilize. Back in the ’90s, when the Fed Funds Rate hovered around 5%, home loans were around 8% and new car loans were around 10%.

Now, both are a bit above 5%. That is a 60% hit to interest collected from home lending and 50% from new car lending.

The all-important spread, the difference between what the bank pays the Fed and what the bank makes for itself, has tightened as a result as well.

With NIRP, the spread will only get worse. Banks will be losing more money because of a limited capacity to force negative interest rate costs on consumers (more on that shortly), while the interest rates they can charge will keep dropping.

No wonder banks aren't too keen on ramping up lending, though ZIRP and NIRP proponents have been scratching their heads for years, as if it was some unsolvable paradox.

The answer is simple — banks have less incentive to work on creating lending risks with lackluster rewards. NIRP only makes it worse.

Fees Explosion

Instead, the focus has gone to more profitable ventures. One way to keep the coffers filling is to jack up fees. Both banks and brokerages are doing it, and NIRP makes it worse.

Loan closing fees are up, fees for just about any depositor service are up, and new fees are being added to everything from savings and checking accounts to IRAs and 401(k)s.

One particular group, bank depositors, is going to be hit hard during the transition from ZIRP to NIRP with little capacity to opt out. We're already starting to see that in Europe.

Banks are reluctant to pass on NIRP costs for obvious reasons. The first banks to do it face outrage and the potential for mass withdrawals; however, not too many people manually calculate how their fees are increasing or can get a straight answer as to why.

Non-sufficient funds fees and ATM fees are constantly hitting new highs. Here in Baltimore, according to BankRate.com, the average NSF fee is now $34.55, the average ATM fee is $2.75, and using another bank's ATM will add an average $1.93.

Then there are the monthly maintenance fees. You'll pay $14 to Bank of America if you don't keep your checking account balance over $1,500 or your savings balance over $2,000.

Not hard to do for many, but considering well over half of Americans report living paycheck to paycheck, that means a whole lot of people are paying a hefty fee burden now with ZIRP.

NIRP, where banks are paying central banks, makes it that much worse.

European banks have started passing on the costs, especially with the European Central Bank moving its funds rate from -0.35% to -0.5%. Banks in Denmark, Finland, Switzerland, and Germany are grappling with how and when to roll out what are effectively penalties for savers.

Until now, fees have been sufficient in Europe to cover the costs of negative rates, but large consumer and business accounts are being selectively lowered into negative rates, while maintaining the fees, to cover the cost.

This will spread to every account if and when rates go deeper or NIRPs persist over a long time.

And with the level of global integration today, especially in finance, it is already indirectly bleeding over into the U.S. The Wall Street Journal recently reported that J.P. Morgan Chase is preparing to charge large institutional customers for some deposits in an effort to drive down total deposits.

Long-Term Economic Damage

These are the two main ways we'll personally be affected by NIRP, but there is a whole lot that is going to go down that isn't going to be pretty and that will bleed into our lives.

The skewed and mispriced risk equations for investors will only get worse. ZIRP already messed up the bond market by reducing the reward for risky debt as investors, both large and small, tried to maintain account growth.

Just look at the domestic oil situation. With government and investment-grade bonds paying less than inflation, real returns could only be gained from junk-grade bonds.

Those in the oil sector often paid the best, but the amount of investor interest allowed the companies to take on debt burdens that were too large without being priced out of the market by interest rates they couldn't pay.

Now, bonds that pay interest rates are the same as what was offered by governments, and the best companies a decade ago are becoming worthless as these companies fall into bankruptcy.

Fitch Ratings estimates that $40 billion in defaults will happen this year, and it raised its 2016 forecast for U.S. high-yield bond defaults to 6%. That is the highest default rate it has ever forecast during a non-recessionary period.

Money and credit volume is going to be a risk as well. The economy needs a certain amount of churn to keep everything working, but NIRP hurts both.

Credit loses its incentive to create, depositors would rather hoard cash if they can than watch it get siphoned away in an account, and businesses will start behaving in ways we can't imagine.

Let's say a business normally gives a 30- or 60-day period for someone to pay a bill, something very common from your utility bills to big-ticket business to business deals. Will people start paying immediately to avoid losing money while it sits in an account instead of holding it for as long as possible like they do now?

Or what happens if businesses refuse to accept payment for as long as possible to avoid the negative interest rate?

Are we going to end up with corporate balance sheets full of IOUs that have their own risk? Will it reduce liquidity and cash flow in companies if it gets big enough? Will this become a new form of shadow banking?

Would prepaying for years of cable bills, pumping as much as you can into your mortgage and shrinking your rainy-day fund, or a big push into illiquid alternative assets that might appreciate in value, like art or wine, be money-saving ideas?

Will people be able to create an arbitrage play with cash-storing services, tucking away $100 bills by the pallet, at less of a cost than adding the money to a bank account? If so, will that create an accelerating deposit outflow?

Finance is ultimately about borrowing from future taxes, wages, or productivity. The loan taken today is depending on what employees produce or citizens pay down the line to pay it back.

What are the implications of inverting the basis of modern financial institutions and banks in playing a role in this process?

The questions are too bizarre to even have answers, and that creates uncertainties that are the last things economies and everyday people need right now.

If monetary velocity starts slipping, growth goes with it, and NIRP incentivizes a lot of small behaviors that add up to a large headwind to exactly what NIRP intends to promote.

And finally, there are the negative aspects of just about the only thing NIRP seems to accomplish: driving currency values down.

Exporters love it, and domestic corporations have laid some of their blame for shrinking revenues and sales on the recently strong U.S. dollar, but widespread NIRP equals widespread currency wars.

At least two-dozen countries cut interest rates last year, with currency values sliding with them. Expect more this year, along with all the classic effects of currency wars: currency volatility, wealth destruction via devaluation, “beggar thy neighbor” trade policies, and lower productivity in the long term.

So, needless to say after all that, let's hope NIRP won't be hanging around for long.

The Outsider Club staff will continue to watch this very closely, and our editors have already covered how this NIRP is affecting the market, from top-down analysis, to individual sectors, to bottom-up company profiles.

Stay tuned for more information through our daily newsletter.

The Outsider Club Research Team


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