How Low Can Interest Rates Go? Bernanke Says: Let's Twist

September 21, 2011

By Catherine New

Fed Chairman Ben Bernanke announced on Wednesday that he would shuffle up the Fed's portfolio, selling $400 billion worth of shorter-term securities and buying longer-term ones to boost the economy. The latest move is aimed at lowering long-term interest rates and prompting more investment.

The move, dubbed "Operation Twist," is reminiscent of a similar maneuver with the same name undertaken by the Fed in 1960s to twist down long-term interest rates. Economists and other industry analysts shared mixed reactions to the news with DailyFinance, even as stocks plunged Wednesday afternoon after the announcement.

Mixed Reaction From Industry

Robert Rainish, a professor of finance and economics at the University of New Haven, says the "Twist" will have little impact on consumers because it does little to change the current restrictive lending environment.

"Financial institutions and regulators have tightened credit requirements to minimize possible losses rather than managing their lending portfolios for optimal profitability," he said. "Optimal profitability allows for some defaults, but the number of profitable loans can absorb those losses. Restrictive underwriting criteria reduces profitability by limiting the number of loans even with smaller losses to be absorbed. The net effect is lower economic growth."

Alan McKnight, director of global investment strategy at investment management firm Balentine, says that despite lower short-term interest rates over the last two years, the nation hasn't seen a commensurate improvement in lending, borrowing or job creation. That has left the Fed with very few options. "It is very much a "throw the kitchen sink at the problem," he said.

The "Twist" was sexier when it was still a teenage dance move, says Terry Connelly, dean emeritus of Golden Gate University. However, he says that it could hold down longer-term interest rates and lower rates on consumer loans, like mortgages.

"Lowering the interest rate banks pay to keep their excess reserves on deposit with the Fed will also help at the margins to push them to lend, finally," he said. But he cautions, that "the step should be staged to prevent a huge wash over of deposits into money market funds and risking their valuation."

"The economy depends on spending and any stimulus to get the consumer spending is a net positive", said Joseph Fichera, a senior managing director and CEO at Wall Street firm Saber Partners. "Every step in the right direction is a step in the right direction."

© 2011, Daily Finance, September 21, 2011