The shark swimming underneath us? That's the end of artificially low interest rates
The shark in the water swimming underneath us all
On Wednesday, in a news cycle that focused largely on Donald Trump's latest travel ban, the health care act now unravelling before the U.S. Congress and, yes, the Canadian prime minister speaking to a Broadway audience seeing a musical about tolerance (while Trump's daughter sat a few metres away), something interesting happened.
Interest rates went up a smidge.
The Federal Reserve raised its benchmark overnight interest rate by a quarter of a percentage point, which means that the folks who borrow from the Fed (which is kind of like the Bank of Canada, and whose customers are other lenders) will now pay in a range from 0.75 per cent to 1 per cent.
Up until Wednesday, the range was as low as 0.5 per cent.
A quarter of a percentage point? Doesn't sound like much, so no wonder the announcement got overwhelmed by everything else.
Consider this: the Fed's rate is now double what it is in Canada. It's very difficult to believe that the decision there will not have a ripple effect that will eventually hit Canadian mortgages and lending rates — and along with them, people who've never lived and owed when rates suddenly jack up.
But let's think about the decision, which is only — believe it or not — the third time that the Fed has ever raised a rate since the financial crisis that engulfed the world in 2008. (It is, on the other hand, the second hike in three months.)
On the upside, the hike is generally perceived to be an indication of growing strength and optimism in the American marketplace.
"The simple message," said Fed chair Janet Yellen, who is expected to step down within a year, "is the economy is doing well."
But what many people in the finance world are expecting is more of the same; that is, more hikes. Another is expected in June, and the Washington Post used the words "more frequent" to describe what the Fed's hikes will be like from now on.
The purpose of a rate hike, especially while rates have been (when you think about it) remarkably tiny is to keep inflation in check.
But the other side of that coin is what higher rates can do to ordinary consumers, including those on this side of the border.
Rates are a fraction of what they once were
This is where my head has been lately.
It seems to be we've had a full generation of consumers that don't know the piercing agony that comes when interest rates are high, or who might be inclined to believe that what they're paying now on, say, their credit card bill is high enough.
Moreover, these consumers may not appreciate to what extent that lending rates have, for almost a decade, have been artificially low. (I'm tempted to call them politically low, too, in light of the 2008 crisis.)
Now, some history, both provincial and personal: In the early Eighties, interest rates were not just in the double digits, they were above 20 per cent. The recession that came with it was harsh, deep and sweeping in its destruction.
The local impact was crushing, perhaps because there was an ebullient feeling in the wake of the 1979 Hibernia discovery. In 1988, a few years before he died, St. John's businessman Andrew Crosbie reflected on the wicked boom and bust of the early Eighties.
"We certainly got caught — but I don't know if it was in the oil euphoria rather than the interest rate euphoria" that caused so much damage to businesses like his own.
In the late Eighties, my wife and I bought a small home in a subdivision on the outskirts of the city. To drum up business, the lending company offered a limited-time introductory low rate of interest, which I recall being around 6.5 per cent.
When the two years was up, we were all exposed to market rates, and we were suddenly stuck with an open rate of 14 per cent — the highest I've ever had to accept. Soon — but not nearly soon enough, believe me — we locked in for a year at 11 per cent.
And gradually, every year thereafter, our rates got increasingly reasonable.
At the outset, though, it was harsh. Several owners in our neighbourhood walked away from their mortgages and just turned over the keys to their homes.
A sharp, pointed lesson
That period was also a sobering lesson. Thereafter, we made a financial plan that emphasized slaying our debt, and never being beholden to another spike that could threaten us.
It seems so long ago, because it was, in a way, so long ago. Indeed, that was a period that many current homeowners never encountered — and I would not wish it upon them.
A more significant factor in the local economy has been the surge in the housing market. Even though things have substantially softened in the current downturn, homes are priced two, three or even four times what they were a generation ago.
Affordability has already become a crisis for many ordinary people, who struggle to even get into the marketplace. A downpayment is formidable, and the monthly payments on that mountain of debt are considerable.
Which is why I get nervous when I hear that interest rate hikes are going to become more frequent.
Do the math, for your own good
I think about younger friends of mine who've made their way into home ownership, or other friends who traded up for the place they dreamed of.
What happens if rates go up several percentage points in the course of a few years? To my mind, housing prices have exploded in part because the cost of borrowing was so incredibly low.
Interest rates are currently a fraction of what they were 25 years ago.
A hike of a quarter point may not make much of a difference, but a "more rapid" series definitely would, or should.
I invite younger adults with homes to sit down, look at the principal of your debt, and start running scenarios through an online mortgage calculator … including the double-digit rates of just a generation ago. (If you drink, you may want to make a double.)
I'm not trying to be an alarmist. I just think people should think ahead, plan ahead, and assume that some bad things could indeed happen.
After all, we had a government that evidently thought that oil prices would dance for years around the $100 US mark. And look how that turned out.