Home buyers, entrepreneurs and public officials are facing a new reality: If they want to put off big purchases or investments until borrowing becomes less expensive, it will probably be a long wait.
Governments are paying more to borrow money for new schools and parks. Developers are struggling to find loans to buy lots and build homes. Companies that are forced to refinance loans at extremely high interest rates are more likely to lay off their employees – especially if they are already operating with little or no profits.
Over the past few weeks, investors have realized that even though the Federal Reserve is close to raising short-term interest rates, Market-Based Measures of Long-Term Borrowing Costs Is continuously increasing. In short, the economy will no longer be able to avoid a sharp recession.
“It’s a trickle-down effect for everybody,” said Mary Kay Bates, chief executive of Bank Midwest in Spirit Lake, Iowa.
Small banks like Ms. Bates’ are at the center of America’s lending crisis to small businesses. During the pandemic, the Fed’s benchmark interest rates were near zero and as consumers parked savings in bank accounts, it could make loans at 3 to 4 percent. They also invested money in safe securities like government bonds.
But when the Fed started raising rates, the value of Bank Midwest’s securities portfolio fell — meaning that if Ms. Bates sold the bonds to fund more loans, she would suffer huge losses. Deposits were also falling, as consumers spent down their savings and shifted money to higher yielding assets.
As a result, Ms. Bates is making debt by borrowing money from the Fed and other banks, which is more expensive. It is also offering higher rates on deposits to customers.
For all those reasons, Ms. Bates is charging borrowers higher rates and is careful about who she lends to.
“We are not looking at reducing rates in the near future,” he said. “I really see us focusing on tight monitoring and internal focus, rather than innovating and entering new markets.” But rather taking care of the bank we have.”
On the other side of that equation are people like Liz Field, who started a bakery, Cheesecakery, out of her home in Cincinnati, focusing on miniature cheesecakes, of which she has developed 200 flavors. He slowly built his business through catering and mobile food trucks until 2019, when he borrowed $30,000 to open a café.
In 2021, Ms. Fields was ready for the next step: purchasing a property including a building to use as a commissary kitchen. They received a $434,000 loan backed by the Small Business Administration, with a 5.5 percent interest rate and monthly payments of $2,400.
But payments started increasing in the second half of 2022. Ms. Fields realized that her interest was linked to the “prime rate”, a rate controlled by the Fed that moves up and down. Because of this, her monthly payment drops to $4,120. With cheesecake orders slowing, she has been forced to cut the hours of her 25 employees and sell a food truck and a freezer van.
“It really hurts, because at that price I could have one or two shops,” Ms Field said of her payments. “Until I get this big debt under control, I won’t be able to open more stores.”
Interest payments for small businesses will rise on average to about 7 percent of revenue next year, up from 5.8 percent in 2021, according to Goldman Sachs analysts. No one is sure when businesses might get some relief — though if the economy slows sharply, rates are likely to lower on their own.
For much of 2023, many investors, consumers and corporate executives were anxiously anticipating a rate cut next year, hoping that the Fed would determine that it had beaten inflation down once and for all.
Surprised by prices continuing to rise even as supply chains unraveled, the Fed mounted its most aggressive campaign of interest rate increases since the 1980s, raising rates by 5.25 percentage points over a year and a half. .
Yet the economy continued to boom, with job opportunities exceeding the supply of workers and consumers spending freely. Some inflation-boosting categories recovered sharply, such as furniture and food, while others – such as energy – have reemerged.
In September, the central bank kept its rates steady, but signaled rates would remain high longer than the market expected. For many businesses, this requires change.
“We’re in an environment where the best strategy is to hold our breath and wait for the cost of capital to come down,” said Gregory Deco, chief economist at consulting firm EY-Parthenon. “What we’re starting to see is that business leaders, and to some extent consumers too, are realizing that they have to start swimming.”
For larger businesses, this means making investments that are likely to pay off quickly rather than spending on speculative bets. For start-ups, which have grown rapidly in the last few years, the concern is about the survival or failure of their business.
Most entrepreneurs use their savings and the help of friends and family to start a business; Only 10 percent are dependent on bank loans. Luke Pardue, an economist at small-business payroll provider Gusto, said the pandemic generation of new firms benefited because they had lower costs and used business models that catered to hybrid work.
But high costs and a lack of capital can prevent them from growing – especially if their owners don’t have wealthy investors or homes to borrow from.
“We spent three years patting ourselves on the back when we saw this surge in entrepreneurship among women and people of color,” Mr. Pardue said. “Now that the rubber hits the road and they start to struggle, we need to enter into the next phase of that conversation, this is the way we can support these new businesses.”
It’s not just new businesses that are struggling. There are older people too, especially as the prices of their goods are falling.
Take agriculture only. Commodity prices are falling, helping to reduce overall inflation, but this has led to a decline in farm incomes. At the same timeHigher interest rates have made purchasing new equipment more expensive.
Anne Schwagerl and her husband grow corn and soybeans on 1,100 acres in west central Minnesota. They are slowly buying land from his parents, offsetting the high interest with favorable terms. But their credit line carries an 8 percent interest rate, which is forcing them to make tough decisions, like whether to invest in new equipment now or wait a year.
“It would be really nice to get another good grain cart so we can keep the combine running during harvest season,” Ms. Schwagerl said. “Not being able to afford it is why we are putting off these types of financial decisions, which means we are less efficient on our farm.”
The extremely high cost of capital also hurts the businesses that need it to build homes – at a time when mortgage rates above 7 percent have put buying a home out of reach for many.
Residential construction activity is got a shock In the last year, with employment in the industry flatten out Because interest rates suppressed home sales. According to the National Association of Home Builders, builders who secured financing before rates increased are offering discounts for selling or leasing units.
The real problem may come in a few years, when a new generation of renters starts searching for properties that were never built due to high borrowing costs.
Dave Rippe is the former head of economic development for Nebraska who now spends some of his time restoring old buildings into apartments and retail spaces in Hastings, a town of 25,000 people near the Kansas border. This was easy two years ago, when interest rates were half what they are now, even though the cost of materials was higher.
“If you go around and talk to developers about ‘Hey, what’s your next project?’ This is cricket,” said Mr. Rippe, who is overseeing government programs that provide low-cost loans for affordable housing projects.
Through it all, consumers have kept spending, even if they have made do with pandemic-era savings and have begun relying on expensive credit card debt. So far, the willingness to spend has been made possible by a strong job market. This may change, as the pace of wage growth has slowed.
Car dealers may soon feel this change. In recent years, dealers compensated for low inventory by raising prices. Carmakers are offering promotional interest deals, but the average interest rate on new four-year auto loans has climbed to 8.3 percent, the highest level since the early 2000s.
Lisa Borches is president of Carter Myers Automotive, a Virginia dealership that sells cars from multiple brands. He said automakers are making too many expensive trucks and sport utility vehicles and should switch to making more affordable vehicles that many customers want.
“This adjustment needs to happen quickly,” Ms. Borches said.
Of course, interest rates aren’t a factor for those who have the cash to buy a car outright, and Ms. Borches has noticed that more customers are putting more money down to reduce financing costs. Those clients can also earn good returns by keeping cash in a high-yield savings account or money market fund.
The era of higher rates for longer periods is less beneficial for those who have to borrow for everyday needs and are also struggling with rising housing costs and slow wage growth.
Kristin Pugh sees both types of people as a financial advisor to wealthy individuals in her Atlanta practice, which waives her fees for some low-income clients. This is a picture of changing fortunes.
“With higher rents and stagnant wages, free customers may not fare as well in a higher interest rate environment,” Ms Pugh said. “It’s mathematically impossible.”