Thursday, February 18, 2010

What's wrong with this: Associated Press: Record-low borrowing costs near zero are still needed to foster the recovery ???

The answer: it is wrong!

Lower borrowing costs make it cheaper for businesses to take on new debt and/or service their existing debt (assuming they have variable interest loans)... but it isn't going to make much of a difference to the borrower or the economy as a whole if borrowers aren't profitable enough to service the debt (even with the new lower interest rates) and/or optimistic about the future to the point where they are willing to take on new debt to finance growth.

Take, for example, a company with a $1 million outstanding loan. Each percentage point of interest amounts to $10,000 of interest expense. If 'normal' loan rates were, say, 5%, then a 'near zero' rate (which, by the way, borrowers rarely get to pay, but let's use that as an example anyway), saves the borrower $49,000 in interest... not an insignificant amount, but not likely an amount that makes the difference between a business sticking around or failing. The only businesses helped by this are those who can't meet debt service at 5% but can make the payments at close to zero... and since most businesses having trouble meeting debt service do so because they're unprofitable (rather than just not profitable enough), this ought to help very few borrowers.

Or look at a company thinking of borrowing $1 million (for this or that), they would 'save' $50,000 a year in interest, again, not an insignificant amount, but they're not going to go out and borrow money unless they felt pretty comfortable they'd get a decent return on whatever it was they spent the borrowed money on.

As I've said before, the key to the economy is whether consumers and businesses are optimistic or whether they're pessimistic. If they're pessimistic, they're not going to borrow money, they are not only not going to hire staff, they're likely to continue cutting staff, they aren't going to go out and buy new cars and appliances and take vacations.

And keeping interest rates low isn't going to turn a pessimistic business into an optimistic business.