Lessons from the 2008 Financial Crisis and COVID19 – Punish the Saver

During the 2008 Financial Crisis, interest rates in the UK collapsed from 5.5% at the end of 2007 to 0.5% by 2009 [1]. A decade on and in a 2019 pre-COVID UK, rates were at 0.75%, now they sit rather bleakly at 0.10% [2]. What does this tell us? When there is a crisis no-one is safe, including the savvy-saver. Is there a better way of supporting the economy than to hurt the people who are the most prepared? Shouldn’t we be rewarding, rather than punishing, our rainy-day savers? It is right that savers should bear the cost of government action to support corporates that used their cash reserves to pay dividends, and used debt for share buybacks, rather than building a cash buffer for harder times such as those now upon us?

Savers are picking up the bill left by Corporates 

The likelihood of lower interest rate advantages trickling down to our savvy savers in the real economy are slim and there are a few common reasons for this. More often the case is that large corporates will binge on debt, taking advantage of record low rates and quantitative easing, and use debt to finance share buybacks. According to Harvard Business Review [3], in 2018 companies in the S&P 500 Index completed a combined $806 billion in buybacks – approximately $200 billion more than the previous record set in 2007.

Share buybacks financed by debt – which can boom in the attractive borrowing and tax treatment environment – go against the very reason rates are low in the first place, to stimulate real economic growth. The intention behind these low interest rates, is to encourage spending by consumers and corporations. Savers already pulled the short straw here, as they’ll see their wealth dwindle with underwhelming rates which don’t keep up with inflation. However, when corporations use debt to purchase their stock instead of investing it in growth, this adds zero real value. It is just financial smoke and mirrors. Shareholders and high-level executives with lucrative share options may be laughing all the way to the bank in low interest rate environments. Savers however, are not invited to the party. Left out in the cold, they don’t get to enjoy the perks of being a large corporate and they suffer from record-low interest rates.

Long-term thinking needs to replace short-term gains

Often, CEOs and other high-level execs have a compensation scheme with share options linked to the performance of the company. This is to align the individual’s financial interests with the company’s shareholders. In classrooms and academic theory, this works. In reality, it’s flawed at best and open to criminal manipulation at worst. If a CEO has a compensation scheme tied to the stock price, from a purely economic perspective it makes sense to allocate capital to the area of the business most likely to drive the stock price higher with the least risk attached. Why invest capital in long-term product innovation that might fail or take a long time to pay off when buybacks immediately benefit you the CEO and shareholders?

Along with buybacks, another route companies take to please shareholders and support the stock price, that adds little growth to the real economy, are dividend payments. Dividend payments are attractive to income-seeking investors, even more so when central banks slash rates to near-zero. At time of writing, the 10-year gilt yields are around 0.16% and the FTSE 100 comparatively yields are around 4%. Using our example of a company issuing debt to finance buybacks, it’s unlikely they are allocating enough capital to sustain future revenue to pay the attractive dividend that keeps the shareholders happy. Not a problem in the short-term, operational efficiencies and a cap on salary increases for most staff (including any savvy savers) will generate enough cash. However, operational efficiencies can only compensate for stagnating revenue for so long, and to cut back the dividend would likely send a negative statement out to the market and send the share price down. To avoid disappointing shareholders and losing out on any compensation benefits, the CEO issues more debt at record low rates, but this time to finance the dividend payment. A strategy known as dividend recap.

A race to zero interest rates

Buybacks, dividend recaps and a lack of investment towards future revenue creates an environment where some companies now depend on low interest rates for survival. This dependency doesn’t go unnoticed by central banks, and once a company is hooked on low rates it can be very hard to kick the habit. So, instead of the company getting in shape, central banks keep feeding these unhealthy companies more and more sugar in the form of low rates, to the detriment of the savvy saver. What then emerges is a group of companies that provide employment, goods and services to the economy which is addicted to low rates. As a result, at any sign of danger, central banks, with broadly good intentions, cut rates again to protect these companies and the wider economy.

This unfortunate paradox doesn't just hit our savvy saver’s nest egg, it reduces future prosperity and sustainability of the whole economy. However, whilst central banks and governments remain highly accommodative, the merry-go-round of low rates punishing savers and benefiting large corporations to the detriment of the economy is likely to continue spiralling out of control for some time.  

Demonising savings

Today in the UK, we’re seeing our government encourage more consumer spending. They’re slashing VAT for some of the worst-hit industries, offering discounts on meals out “Eat Out to Help Out” and scrapping stamp duty. These measures may help bolster the economy, jobs and businesses in the short term. But what about the people behind the purchases? Those who may not have a job in a matter of months or face more cuts to their income? Is it fair that they’re being encouraged to spend in this environment – or are we seeing once again that households are being used as a human shield to protect corporates? With each crisis it’s becoming clearer that ordinary, well-meaning people, like savers, are getting the short end of the deal. Savers should be supported and commended during times of crisis, after all, they were better prepared for rainy days than many of the large-scale corporates out there, and not punished.

[1] https://www.bankrate.com/uk/mortgages/bank-of-england-base-rate/

[2] https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp

[3] https://hbr.org/2020/01/why-stock-buybacks-are-dangerous-for-the-economy