I wrote a column on interest rates sometime back detailing the danger of rates going too high or too low. I stated that money is a commodity really no different from bananas, oil or coffee. Any commodity that drops too low in price risks the danger of negativity.
The price we pay for the commodity of money is interest. Just 18 months ago, any Wall Street financial forecaster of a 1 percent Fed rate would have been let go from that firm; however, the 1 percent Fed rate is a reality. With the present rate just one point shy of zero, real pressure exists for banks and alternative lending institutions in securing profit margins.
After 12 Fed rate declines since 2001, what can the financial loan sector do respective to its earnings? The common corporate trend of cost-cutting by postponing scheduled expenditures, staff reduction and outsourcing is now three years deep, with these avenues of upholding earnings and averting loss having worn out their welcome.
So whats next? The charging and raising of fees for services, which is nothing new. Travel agencies have had to implement such a policy with the past elimination of most airline commissions. Large commercial banks have the lifeboat of credit card income and various security trading.
In this environment, growth of net interest income or interest spreads, which formerly contributed to a savings bank, credit union or lending institution, no longer cuts the pie. Its a water hole that is drying up fast.
With these institutions looking to halt the deterioration of their balance sheets, it is the public that now must beware. Mortgage rates may be at all-time lows, but look for increases in origination among other general fees charged in the closing of mortgage loans.
So hows business for banks, credit unions and savings and lending institutions? No one knows how long mortgage interest rates will remain low, but a crystal ball is not needed to realize that the day will come when they rise again. The sharper lending institutions already will have sold off the low-bearing instruments after already having beefed up their revenue in fee collections.
When those rates begin to rise, the chain reaction will begin in the reduction of volume followed by the decline in the refinancing sector. It will be nothing short of a game of musical chairs. When the music stops and this party ends, the remaining holders of those very low instruments will find themselves in jeopardy.
Joe Palumbo is the fund manager for The Palco Group, Inc. and can be reached at firstname.lastname@example.org or 718-461-8317.
©2003 Community News Group
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