Homebuyers, entrepreneurs, and public servants are facing a new reality. If you want to hold off on making big purchases or investments until borrowing costs are lower, you'll probably have to wait a long time.
Governments are borrowing more money to build new schools and parks. Developers are having trouble finding loans to buy land and build homes. Companies that are forced to refinance their debt at rapidly higher interest rates are more likely to lay off employees, especially if they are already operating with little or no profits.
Over the past few weeks, investors have noticed that market-based measures of long-term borrowing costs continue to rise even as the U.S. Federal Reserve nears an end to short-term interest rate increases. . In other words, the economy may no longer be able to avoid a sharp slowdown.
“It's a trickle-down effect for everyone,” said Mary Kay Bates, CEO of Midwest Bank in Spirit Lake, Iowa.
Small banks like Mr. Bates are at the epicenter of the credit crunch for small businesses in the United States. During the pandemic, she was able to get loans at 3% to 4% because the Fed's benchmark interest rate was near zero and consumers had accumulated savings in bank accounts. She also put money into safe securities such as government bonds.
But when Fed interest rates began to rise sharply, the value of Midwest Bank's securities portfolio fell. This means that if Mr. Bates were to sell the bonds to finance further loans, he would have to incur significant losses. Deposits were also falling as consumers withdrew their savings and moved money into higher-yielding assets.
As a result, Bates borrows money from the Fed and other banks to make loans, which are more expensive. She also pays higher deposit interest rates to her customers.
For these reasons, Bates charges high interest rates to his borrowers and is cautious about who he lends to.
“I don't think interest rates will be cut anytime soon,” he said. “We are watching closely and focusing internally, and you can see us taking care of our bank rather than innovating and entering new markets.”
On the other side of the equation are people like Liz Field, who started a bakery called The Cheesecakes in her home in Cincinnati and focuses on miniature cheesecakes, in which she sells 200 different flavors. developed. She gradually built up her business through catering and a mobile food truck, and in 2019, she borrowed $30,000 to open her cafe.
In 2021, Field was ready for the next step: purchasing a property that included a building to use as a commissary kitchen. She received help from the Small Business Administration, which gave her a $434,000 loan with an interest rate of 5.5 percent and monthly payments of $2,400.
However, in the second half of 2022, payments began to increase. Mr. Field realized that his interest was fixed at the “prime rate,” and would move up and down depending on interest rates controlled by the Fed. Therefore, her monthly payment increased to her $4,120. In addition to backlogged cheesecake orders, she was forced to cut the hours of 25 employees and sell one food truck and one freezer van.
“It really hurt when you could buy one or two stores for that price,” Field said of his payment. “Until we get control of this huge loan, we won't be able to open any more stores.”
Interest payments for small businesses will average about 7% of revenue next year, up from 5.8% in 2021, according to analysts at Goldman Sachs. No one knows when companies will be bailed out, but if the economy slows down sharply enough, interest rates are likely to fall on their own.
For much of 2023, many investors, consumers and business executives eagerly awaited a rate cut next year, hoping the Fed would determine it had defeated inflation for good.
Surprised that prices continued to rise even after supply chain disruptions began to ease, the Fed launched its most aggressive rate hike campaign since the 1980s, raising interest rates by 5.25 percentage points over a year and a half.
But the economy remained hot, job openings outstripped the supply of workers, and consumers were free to spend. Some categories that caused inflation, such as furniture and food, quickly fell, while others, such as energy, rebounded.
The central bank kept interest rates on hold in September, but signaled that they would remain high for longer than the market expected. For many companies, this required change.
“We were in an environment where the best strategy was to hold our breath and wait for the cost of capital to come back up,” said Gregory Daco, chief economist at consulting firm EY Parthenon. “What we're starting to see is not just business leaders, but to some extent consumers, are starting to realize that they've got to start swimming.”
For large companies, that means making investments that are likely to pay off quickly, rather than spending on speculative bets. For startups that have proliferated in recent years, the concern is whether the business will survive or fail.
Most entrepreneurs start their businesses using their own savings and help from friends and family. Only about 10% rely on bank loans. Luke Perdue, an economist at small business payroll company Gusto, said pandemic-era startups tend to have an advantage because they have lower costs and business models that accommodate hybrid working.
But high costs and a lack of capital can hinder a company's growth, especially if the owners don't have wealthy investors or a home to borrow from.
“We spent three years patting ourselves on the back as we watched entrepreneurship skyrocket among women and people of color,” Pardue said. “When the rubber meets the road and starts to struggle, we need to get into the next phase of the conversation, which is how can we support these new businesses?”
It's not just new businesses that are struggling. The same goes for older companies, especially if the prices of their products are falling.
Let's take agriculture as an example. Commodity prices have fallen, contributing to lower overall inflation, which is also pushing down farm incomes. At the same time, high interest rates make purchasing new equipment more expensive.
Ann Schwagel and her husband grow corn and soybeans on 1,100 acres in west-central Minnesota. They are gradually buying out the land from his parents on favorable terms that compensate for the high interest rates. But their loan line carries an interest rate of 8%, forcing him to make difficult decisions like whether to invest in new equipment now or wait a year.
“It would be really great to get another good grain cart so we can keep the combine running during harvest,” Schwagel said. “Deferring and not being able to afford such financial decisions means your farm is becoming less efficient.”
At a time when mortgage rates exceeding 7% have made buying a home unaffordable for many people, stubbornly high capital costs are also hurting companies that need capital to build homes.
Homebuilding activity has suffered over the past year, with industry employment flat as interest rates suppressed home sales. Builders who secured financing before interest rates rose are offering discounts on units they sell or lease, according to the National Association of Home Builders.
The real problem may come in a few years. That's when a new generation of renters starts looking for properties that weren't built because of high borrowing costs.
Dave Lippe is a former Nebraska economic development director who now spends his time converting old buildings into apartments and retail space in Hastings, a town of 25,000 people near the Kansas border. Two years ago, it was easier because even though materials were expensive, interest rates were half what they are now.
“If you go around to developers and say, 'What's your next project?' It's crickets,” Lippe said, referring to government programs that provide low-cost financing for affordable housing projects. We are considering.
Through all of this, consumers continued to spend, even though they used up their pandemic-era savings and began relying on expensive credit card debt. So far, this spending appetite has been enabled by a strong job market. The situation could change if the pace of wage increases slows.
Car dealers may soon feel that change. In recent years, dealers have compensated for inventory shortages by raising prices. Automakers have been rolling out interest rate campaigns, but the average interest rate on a new four-year auto loan has risen to 8.3%, the highest level since the early 2000s.
Lisa Borchess is president of Carter-Myers Automotive, a Virginia dealership that sells many brands of cars. He said automakers are producing too many expensive trucks and sport-utility vehicles and need to shift to making affordable cars that many customers want.
“That adjustment needs to happen quickly,” Borchess said.
Of course, interest rates aren't an important factor for people who have the cash to buy a car outright. Borchess has seen more customers put down more funds to minimize funding costs. These customers can earn high returns by keeping their cash in high-yield savings accounts or money market funds.
An era of high interest rates over an extended period of time is less favorable for people who must borrow for everyday needs and also have to deal with rising housing costs and slowing wage growth.
Kristin Pugh, a financial advisor to wealthy individuals in Atlanta who waives fees for some low-income individuals, sees both types of people. It is an image of divided fate.
“Coupled with rising rents and stagnant wages, pro bono clients will not fare well in a high interest rate environment,” Pugh said. “It's mathematically impossible.”
