Low interest rates are hurting the middle class

Editor’s note: This commentary originally appeared in M&T Bank CEO Robert Wilmers’ annual message to shareholders.

With the benefit of hindsight, it appears the economy in recent years has fallen out of balance — overly reliant on monetary policy not accompanied by traditional fiscal stimulus.

Policies designed to benefit the majority have perversely only benefited a few. The impacts of these decisions or nondecisions are real. In particular, the middle class and small businesses are losing ground. So, too, are their communities.

This extended period of ultralow interest rates no longer benefits the average U.S. household. The majority of the wealth of the typical M&T customer, like that of most Americans, takes the form of equity in their homes, retirement savings, bank deposits and, to a lesser extent, stock market investments. Low rates initially provided middle-class households with relief both by lowering monthly mortgage payments and supporting a recovery in home values. However, the investments of these same families have suffered. Indeed, many middle-class families, frightened by the precipitous market decline of 2008, responded by pulling out of the market. Only half of these households today hold any stocks or mutual fund shares; before the crisis, fully 72% did so.

Crucially, without stocks and the growth in value and dividends they can provide, most households must rely on interest from their investments to save for college, a down payment on a home or to prepare for and navigate retirement. It is here that they have felt the sting of near-zero interest rates. Interest income for households has declined sharply in the aggregate. In 2014, it had, compared with 2005, fallen by some $64 billion. This disproportionately affected households with incomes of less than $100,000; their interest income declined by $44 billion, or 68% of the total decrease for all households.

Investments managed on behalf of the typical American family are not immune to these economic trends. At the heart of the issue is the declining rate of return on investments — particularly secure investments like bonds. The practical implications for the alternatives through which typical households preserve and grow wealth, such as insurance, retirement accounts and pensions, are troubling.

Indicative of what has happened in the marketplace, insurers that have traditionally invested premiums in safe, long-term instruments such as government securities and high-quality corporate bonds have come under pressure. The average yield on 10-year U.S. Treasury bonds since 2010 has declined to a level 274 basis points, or 53%, below the 30-year average. Insurers ultimately have limited options to offset sustained low yields on their investments.

Should rates remain low, it will eventually be necessary to raise prices or invest in assets that offer higher returns but also carry higher risk. Neither outcome would benefit middle-class families. Pension plans sponsored by employers, long a pillar of retirement savings for many workers, face similar pressures. Low rates that pension funds earn on investments mean either that businesses and governments must set aside more to ensure future benefits, or put those benefits at risk by underfunding them.

Given these costs and challenges, many businesses have responded by transitioning away from offering pensions altogether, instead sponsoring programs such as 401(k) accounts through which employees largely bear responsibility for determining the amount they save and the manner in which they invest. Workers then confront the same difficult choices as investment managers, weighing the trade-off between accepting low returns and undertaking greater risk with their hard-earned savings.

No wage growth. No investment earnings growth. No wonder families are stretched and stressed. We should hardly be surprised, then, to see a sharply increased rate of savings — 1.5 percentage points higher than that in 2000 to 2004. Accompanied by lower interest income, this has led middle-class families to spend less, dampening economic growth. Simple math suggests that a 1.5- percentage-point increase in the savings rate equated to nearly $200 billion in consumer spending — spending that did not occur as families instead saved more to make up for their lost income.

Monetary policy was intended to act as an accelerant for an economy in recession, and did in fact accomplish that goal early on; however, its benefits have waned, if not reversed, over time.