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Low Interest Rates Are Hurting, Not Helping, the Economy: Sheila Bair

Daily Ticker

Historically low interest rates have helped the U.S. housing market recover by attracting new buyers into the market and allowing current homeowners to refinance their mortgages at a lower rate and save money. The Federal Reserve has kept short-term overnight lending rates near zero since 2008 to encourage consumer and business spending.

Economic growth has yet to return to its pre-recession levels and the latest GDP report showed that the economy grew at an annual rate of 0.4% in the fourth quarter of last year. The Commerce Department will release its first reading of Q1 GDP on April 26.

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Homeowners are not the only group that have benefited from the mortgage-refinancing trend. The nation’s largest banks have seen their mortgage businesses skyrocket as more Americans took advantage of super low interest rates. But recent reports by JPMorgan (JPM) and Wells Fargo (WFC) indicate that the rush to refinance may be slowing and the lucrative profits earned in recent years could be falling.

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Wells Fargo, the nation’s largest home lender, said the volume of its mortgage applications fell 25% in the January to March quarter versus the same quarter in 2012. It also acknowledged that its margins for originating and selling home loans would likely be squeezed in future quarters. JPMorgan revealed that its mortgage applications fell 8% last quarter, leading to a drop in mortgage banking income.

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Sheila Bair, the former FDIC chair and senior advisor to the Pew Charitable Trusts, says in an interview with The Daily Ticker that the low interest rate strategy promoted by the Fed to goose the economy is backfiring.

“The Fed has got the best of intentions…but it’s counterintuitive,” she argues. “Low rates dampen the incentives to invest.”

The Fed’s monetary policies have made it more difficult for banks to generate revenue, forcing them to seek profits in other ways, she notes.

Related: The Real Reason the U.S. Economy Won’t Take Off

“It’s very difficult to make a loan of a multi-year duration because you have this very low interest rate on your balance sheet,” Bair explains. “That’s not good for business lending. Banks can make money in other ways – trading profits, investment banking fees, deposit accounts – other ways…that don’t necessarily help the economy.”

Business lending, not home refinancing, holds the key to the economic recovery, according to Bair. The U.S. needs to shift its economic priorities if a full recovery is to happen, Bair adds.

“Our economic policies are too much aligned with trying to revitalize the economy we had pre-2007,” she says. “To have a sustainable growth model for everybody, including banks, we need to get more jobs and we need to get real wages going up again.”

Bair would like to see the Fed increase rates but in a gradual and methodical manner so the market can adjust. The Fed has reiterated that it will not reverse its strategy until unemployment falls to 6.5%. The jobless rate in March dropped to 7.6% from 7.7% in February.

Some Fed members have become more vocal about ending the central bank’s aggressive monetary easing while others such as Federal Reserve Vice Chair Janet Yellen and Chicago Fed Governor Charles Evans have argued that the bank needs to do more to stimulate the economy and boost hiring.

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