Pella Chronicle


July 15, 2011

Where is the economy headed next?

Pella — The Wall Street Journal had a recent article titled “Debt Hamstrings Recovery” that noted that consumers have more mortgage and credit card debt than they did five years ago.

After the Wall Street bailouts, the debt of the United States seems off the charts, although the United States debt situation looks great compared to Greece and some other countries in Europe.

The Wall Street Journal quotes economist Carmen Reinhart in asserting that it takes seven years, on average, to unwind debt. Reinhart said, “The issue with debt is that you can’t get rid of it quickly and can’t rid of it nicely.”

I recently had a conversation with Pete Mauhrin, the Bowling Green, Ky., stockbroker, banker and financial guru. I asked him if interest rates were going to spike upward soon.

He reminded me that interest rates dropped during the Great Depression and stayed that way for 20 years.

The Wall Street Journal article backs up Pete’s observation. They quote former World Bank official, Liequest Ahamed, who said that the Federal Reserve cut the discount rate below 2 percent in 1934 and it held at those levels until the mid 1950s.

Even more relevant, Ahamed notes that rates in Japan dropped to near zero in 1995 and have stayed that way ever since.

Mahurin had other thoughts on interest rates. He said, “Generals are often accused of fighting the last war instead of the one in front of them.” Mahurin said that the baby boom generation grew up in a unique, high interest rate period of the 1970s, when inflation was insane and mortgages were near 20 percent interest rates.

You didn’t see that spike before or after that post-Vietnam, post-Great Society, post-Watergate period.

I’m like the rest of the baby boomers. I’ve been waiting since 1981 for the rates to go back to 20 percent again.

Now I am starting to wonder if they won’t come back up.

Mahurin told me that he grew up around people who had lived through the Great Depression. Many lived their lives waiting for deflation to return and were burned by the high inflation in the 1970s.

We have to look at all possibilities.

I started in the structured settlement annuity business in late 1982, when the rate of return on annuities was about 17 percent.

For all of my 29 years in business, I have met people who won’t commit to an annuity because they are “waiting for interest rates to go back up.”

I can understand some hesitancy. Immediate annuities are designed for the long-term and, usually, to last for a person’s lifetime.

Dr. Richard Thaler, a professor of Economics and Behavioral Science at the University of Chicago, wrote an excellent New York Times piece titled, “The Annuity Puzzle for Retirement Investing.”

Thaler said that given a choice of taking a lifetime annuity for retirement or trying to invest a lump sum, most would be better off with an annuity but most take the lump sum.

Dr. Thaler calls this “The Annuity Puzzle.” He gives a lot of explanations based on behavioral science, but one is obvious: Retirees don’t want to commit to long-term annuities. They think interest rates are going to go up.

People have been betting on higher interest rates for over 25 years. And for over 25 years, they have been wrong.

Could they be wrong again?

In the 1980s, I had a client who purchased large blocks of annuities to fund insurance claims. He was getting ready to purchase a million dollar block when interest rates went from 10 percent to 9.9 percent. He stopped buying, saying he would wait “until interest rates got back to 10 percent again.”

He’s been waiting over 20 years. Interest rates have not been back to 10 percent since that day. He finally made his move when they got to about 8 percent. He missed the chance at 9.9 percent, but locking in at 8 percent has worked out well compared to other alternatives.

In a few years, will people be saying the same thing about locking in at 4 percent?

Ahamed had an interesting perspective in the Wall Street Journal piece: “History shows that when people have borrowed too much, they stop borrowing and interest rates stay very low for a very long time.”

The common assumption is that interest rates are going to higher.

Just like the common assumption for many years that you couldn’t lose in the real estate market.

Sometimes we have to consider the un-considerable.

Like the possibility of lower interest rates.

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