We’ve all seen the headlines—weak economic growth, high unemployment, declining consumer confidence, etc. These concerns preoccupy most of our thoughts—our nation’s leaders included. The Federal Open Market Committee, a branch of the Federal Reserve that makes monetary policy decisions, released its decision to extend Operation Twist by $267 billion from the original $400 billion in bond buying that began in September 2011. Under Operation Twist, the Fed “twists” down long-term interest rates by selling short-term securities to buy long-term securities. The demand for long-term bonds created by the Fed pushes down interest rates.
The Fed has already kept short-term interest rates cloze to zero, so the next best step is to tackle long-term rates. By decreasing long-term interest rates, the Fed makes borrowing cheaper. The idea is that Americans will recognize that credit is cheaper and start buying and refinancing homes, purchasing cars and other goods, and increasing business investment in hiring. All of this consumer and business activity would then spur economic growth as a result of greater access to credit.
The Credit Divide
With the Fed now estimating lower than expected economic growth for 2012 and higher than expected unemployment, this would seem to be a helpful program. In reality, Operation Twist is limited in its impact. Decreased interest rates have decreased borrowing costs, but not all Americans are able to borrow. Banks spooked by the number of defaulted loans during the recession are reluctant to lend to Americans with lower incomes or blemished credit histories.
The only households receiving the benefits of decreased borrowing costs are those with good credit. The rest of Americans face difficulty and higher costs in comparison to their good credit neighbors when trying to refinance mortgages or purchase new homes. According to Moody’s and Equifax, “Last year, nearly 90% of all new mortgages originated went to households with high credit scores; before the financial crisis, it was about half.” In an April Fed survey, “83% of banks were less likely to approve a new mortgage for a household with a low credit score of 620 and a 10% home down payment than they were in 2006, even a loan guaranteed by Fannie or Freddie.”
Additionally, if those savings in interest payments are invested instead of spent on the economy, the impact is lessened. Unfortunately, consumer spending is weak, meaning one less catalyst to heat up the economic engine.
Lawmakers are too busy avoiding the looming fiscal cliff and adding to the painful uncertainty that prevents Americans from improving their financial situation. Federal Reserve President Ben Bernanke has called on Congress numerous times to take up their share of responsibility in improving the nation’s economy. The costs of failing to address the mounting national debt could significantly damage the economy. Adequate fiscal policy is the only answer. So, Congress—are you in, or are you out?