Homebuyers, entrepreneurs and government officials face a new reality: If they want to hold off on big purchases or investments until borrowing is cheaper, the wait will likely be long.
Governments pay more to borrow money for new schools and parks. Developers are struggling to find loans to buy land and build homes. Companies, forced to refinance their debts at significantly higher interest rates, are more likely to lay off employees, especially if they were already operating with little or no profit.
Over the past few weeks, investors have realized that even though the Federal Reserve is close to ending its short-term interest rate hikes, market-based measures of long-term borrowing costs continued to increase. In short, the economy may no longer be able to avoid a deeper slowdown.
“It’s a trickle-down effect for everyone,” said Mary Kay Bates, managing director of Bank Midwest in Spirit Lake, Iowa.
Small banks like Ms. Bates’s are at the epicenter of America’s small business credit crisis. During the pandemic, when the Fed’s benchmark interest rate was near zero and consumers piled up savings in their bank accounts, it was able to provide loans at a rate of 3 to 4 percent. She also invested money in safe securities, such as government bonds.
But when the Fed’s rates began to soar, the value of Bank Midwest’s securities portfolio fell, meaning that if Ms. Bates sold the bonds to fund more loans, she would face a big loss. Deposits were also falling as consumers spent their savings and shifted their money to higher-yielding assets.
As a result, Ms. Bates makes loans by borrowing money from the Fed and other banks, which costs more. It also pays its customers higher rates on deposits.
For all these reasons, Ms. Bates charges higher rates to borrowers and is careful who she lends to.
“We are not considering a rate cut in the near future,” she said. “I really see us watching closely and focusing internally, not so much on innovation and entering new markets, but more on running the bank that we have.”
On the other side of that equation are people like Liz Field, who started a bakery, Cheesecakery, at her home in Cincinnati, focusing on miniature cheesecakes, of which she has developed 200 flavors. She gradually grew her business through catering and mobile food trucks until 2019, when she borrowed $30,000 to open a cafe.
In 2021, Ms. Field was ready to take the next step: purchasing a property that included a building to use as a commissary kitchen. She got a $434,000 loan, guaranteed by the Small Business Administration, with an interest rate of 5.5 percent and a monthly payment of $2,400.
But in the second half of 2022, payments began to increase. Ms. Field realized that her interest was tied to the “prime rate,” which moves up and down depending on the rate controlled by the Fed. With this, his monthly payments increased to $4,120. In addition to slowing down cheesecake orders, she was forced to reduce the hours of her 25 employees and sell a food truck and a freezer van.
“It really hurts, because I could get one or two stores for that price,” Ms. Field said of her payments. “I won’t be able to open more stores until I get this big loan under control.”
According to Goldman Sachs analysts, interest payments for small businesses will average about 7% of revenue next year, up from 5.8% in 2021. No one really knows when businesses will benefit from a certain relief, but if the economy slows sharply enough, rates will likely fall on their own.
For much of 2023, many investors, consumers and business executives looked forward to rate cuts next year, expecting the Fed to determine that it had beaten inflation for good.
Surprised by the persistence of price increases even after supply chains began to unravel, the Fed launched its most aggressive interest rate hike campaign since the 1980s, raising rates by 5.25 percentage points over a year and a half.
Yet the economy continued to be red-hot, with job openings outstripping the supply of workers and consumers spending freely. Some categories that caused inflation quickly declined, such as furniture and food, while others, such as energy, re-emerged.
In September, the central bank maintained its key rate, but indicated that it would remain high for longer than the market expected. For many businesses, this has required change.
“We’ve been in an environment where the best strategy has been to just hold your breath and wait for the cost of capital to come down,” said Gregory Daco, chief economist at consultancy EY-Parthenon. “What we’re starting to see is that business leaders and, to some extent, consumers are realizing that they need to start swimming.”
For large companies, this means making investments that can quickly pay off, rather than spending on speculative bets. For start-ups, which have proliferated in recent years, the worry is about the survival or failure of their business.
Most entrepreneurs use their savings and help from friends and family to start a business; only about 10 percent rely on bank loans. Luke Pardue, an economist at small business payroll provider Gusto, said the pandemic generation of new businesses tends to have an advantage because they have lower costs and use business models suited to hybrid work.
But the high cost and scarcity of capital could prevent them from growing, especially when their owners don’t have wealthy investors or homes to borrow against.
“We’ve spent three years celebrating this rise in entrepreneurship among women and people of color,” Pardue said. “Now when the rubber meets the road and they start to struggle, we need to move into the next phase of this conversation, which is how we can support these new businesses.” »
New businesses aren’t the only ones struggling. Older people are too, especially when the prices of their products fall.
Take agriculture. Commodity prices fell, helping to lower overall inflation, but this depressed farm incomes. At the same timehigh interest rates have made purchasing new equipment more expensive.
Anne Schwagerl and her husband farm corn and soybeans on 1,100 acres in west-central Minnesota. They gradually bought back the land from his parents, under advantageous conditions that compensated for the high interest. But their line of credit comes with an 8% interest rate, forcing them to make tough decisions, like whether to invest in new equipment now or wait a year.
“It would be really nice to have another good grain cart so we can keep moving the combine during harvest season,” Ms. Schwagerl said. “Not being able to afford it because we’re putting off these kinds of financial decisions just means we’re less efficient on our farm. »
The stubbornly high cost of capital also hurts businesses that need it to build homes — while mortgage rates above 7% make buying a home out of reach for many people.
The residential construction activity has took a hit over the past year, with jobs in the industry flatten as interest rates dampened home sales. Builders who obtained financing before rates increased are offering discounts for selling or renting homes, according to the National Association of Home Builders.
The real problem could come in a few years, when a new generation of renters start looking for properties that were never built due to high borrowing costs.
Dave Rippe is a former Nebraska economic development official who now spends part of his time rehabilitating old buildings in Hastings, a town of 25,000 near the Kansas border, into apartments and commercial space. It was easier two years ago, when interest rates were half as high as today, even though material costs were higher.
“If you go around and talk to developers about, ‘Hey, what’s your next project? “They’re crickets,” said Mr. Rippe, who studies government programs offering low-cost loans for affordable housing projects.
Through it all, consumers have continued to spend, even as they depleted their pandemic-era savings and began relying on costly credit card debt. So far, this willingness to spend has been made possible by a strong labor market. This could change as the pace of wage increases slows.
Car dealers may soon feel this change. In recent years, dealers have compensated for low inventory by raising prices. Automakers are offering promotional interest rates, but the average interest rate on new four-year auto loans has climbed to 8.3 percent, the highest level since the early 2000s.
Liza Borches is president of Carter Myers Automotive, a Virginia dealership that sells cars from many brands. She said automakers were producing too many expensive trucks and sport-utility vehicles and should shift to making more of the affordable vehicles many customers want.
“This adjustment must happen quickly,” Ms. Borches said.
Of course, interest rates aren’t a factor for those with the cash to buy a car, and Borches has seen more customers putting more money aside to minimize financing costs. These clients can also earn a good return by keeping their cash in a high-yield savings account or money market fund.
The era of sustained high rates is less beneficial for those who must borrow to meet daily needs and who also face rising housing costs and moderate wage growth.
Kristin Pugh considers both types of people in her Atlanta practice as a financial advisor for high-net-worth individuals, which waives her fees for some low-income clients. It’s a picture of divergent fortunes.
“Coupled with higher rents and stagnant wages, pro bono clients will not fare as well in a higher interest rate environment,” Ms Pugh said. “It’s just mathematically impossible.”
