Starving the Savers with Operation Twist

August 20, 2012

The news that the Federal Reserve Bank expanded its Operation Twist program by another $267 billion was meet with somewhat surprising yawn by Wall Street.

In case you've been ignoring the Fed (which is not such a bad idea if they weren't so powerful), Operation Twist is the process in which the Fed sells billion of dollars of short-term bonds and uses those funds to purchase long-term Treasury bonds on the open market.

The goal is to reduce long-term interest and make mortgages as well as business loans more affordable.

According to the Federal Open Market Committee, Operation Twist “should put downward pressure on longer-term interest rates and help to make broader financial conditions more accommodative.”

That strategy didn't work so well on the day of the announcement as  yields on the 10-year Treasury note rose from 1.62% to 1.65%.

Operation Twist is on top of the Fed commitment to keep interest rates '"exceptionally low" at least until late 2014.

The idea is to lower the interest rate of the longer bonds, which in turn is supposed to lower interest rates for borrowers on mortgages, cars, and business loans. While Operation Twist may be helpful to people and businesses who want to borrow money, the result for savers is financial starvation.

These are the people that have responsibly spent less than they made, socked away those savings for a rainy day, presumably the golden years of retirement.

Savers are simply getting what my father described as diddly squat on their savings. One has to go out beyond 5 years to get more than a 1% yield. Who is buying this stuff?

And if this additional waste of taxpayer money doesn't work, Bernanke promises to spend even more borrowed money. “If we don’t see continued improvement in the labor market, we’ll be prepared to take additional steps if appropriate,” promises Bernanke.

Those appropriate steps will certainly be the third round of Quantitative Easing or QE3.

QE3, however, is effectively the last bullet in the Federal Reserve Bank's pistol and if it proves to be an ineffective as the QE1 and QE2, some other division of the government cavalry will need to ride to the rescue.

Operation Twist, Quantitative Easing, and keeping interest rates at historic lows are all acknowledgements that our economy is weak and going to get weaker.


Meanwhile...back on the Congressional Ranch

At the same time, our elected officials need to turn their focus away from getting re-elected to finding a solution --- at least a temporary one --- for the fiscal cliff we are approaching.

By the end of this year, unless lawmakers intervene, some automatic spending cuts will go into effect, the Bush-era tax cuts will expire and incometax rates will rise, along with taxes on long-term capital gains and dividends.

  • The maximum tax on long-term capital gains from the sale of securities will rise from the current 15% to 23.8% in 2013.
  • Dividends will be taxed as ordinary income so the tax will rise from the current 15% to as high as 43.4%.

And don't forget the expiration of the payroll tax cut on social security.

While I believe our idiota(see what a couple weeks in Tuscany does to me?) legislators will find some solution as we approach year end, there is no way to know what they will do so you would be wise to have a plan in place to protect your portfolio,

If the Bush tax cuts expire, you may want to harvest some of your capital gains in 2012.

Not only because tax rates will rise, but you should also consider the very real possibility that our economy may fall back into a recession and take the stock market with it.


Europe here we come

Our country is at an important crossroad. Our politicians want to spend even more money that we don't have and like Europe, have built up a mountain of debt.

The U.S. will soon be faced with similar sovereign debt problems. As the bond investors look at Europe and a soon-to-implode Japan, they will decide that the U.S. is only different in size and scale.

Our national debt surpassed our country's GDP last year. Think about that: our politicians have spent their way to the point that we owe more than the collective output of all our individuals and businesses in the entire United States.

And our debt problem is going to get worse.


The interest on our $16 TRILLION of national debt is rapidly becoming a huge part of the overall budget, and any rise in interest rates will put severe constraints on spending or force large tax increases or require the Federal Reserve to monetize the debt.

None of those have positive outcomes.

Our ballooning deficit creates the very real risk of the bond market treating us just as it is treating Italy and any other country that gets to the point where its debt is unsustainable.

NO country can run deficits the size we are currently running, along with unfunded deficits over four times the size of the economy and a growing overall debt burden, without consequences.

At some not-too-distant point, investors in bonds will start to question the ability of the United States to service that debt and treat our government debt like a red-headed stepchild.

But until that time comes, which is a ways off, it’s clear that the Federal Reserve, other central banks, and even our esteemed leaders in Washington are going to take whatever measures they deem fit to rectify Washington’s problems --- even if it means effectively re[pressing your income, your returns on savings and investments and more.

That is, unless you take action NOW.

However, the rules for successful income investing have changed and income investors will need to discard old investment habits and adapt to a new way of investing for income.

To help you navigate these dangerous times, I recently launched a new advisory service called Yield Shark that will offer specific buy and sell recommendations specifically tailored for income-oriented investors and adapted to the new realities of an over-indebted world.