Financial downtrend chart and red pencil. Selective focus
The Federal Reserve announced last Wednesday that it is leaving the federal funds rate where it is, for now.  While the United States is pondering interest rate hikes, other parts of the world are plunging further into negative territory.  Last Thursday, in an attempt to bolster Europe’s weakening growth and spur inflation, the European Central Bank (the “ECB”) lowered its deposit rate by another 0.1%, pushing its deposit rate down to -0.4%.
With other central banks lowering rates into the negative, will the U.S. follow? Why is this happening? What could go wrong? How will this affect our banks?  Click through for three things you should know about negative interest rates.

At a very basic level, a negative interest rate means that a central bank (and perhaps private banks) will make depositors, instead of receiving interest on deposits, pay interest of their money to keep that money in the bank.  If a central bank charges a negative interest rate, then its member banks would be required to pay the central bank to hold its deposits.
1. Negative Interest Rates Could Come to the United States
While negative interest rates are unlikely in the United States right now, they are not impossible.  Recently, Fed Chair Janet Yellen testified before Congress that, for the Fed  negative interest rates could be “on the table”.  Some economists—including Ben Bernanke—have said that negative interest rates may be a more effective monetary policy than quantitative easing if the U.S. went into recession.
However, Chairman Yellen expressed uncertainty about whether negative rates are legally and technically feasible.  The chief legal issue is that maintaining a negative interest rate might exceed the Fed’s authority under Section 19(b) of the Federal Reserve Act (as was amended by the Financial Services Regulatory Relief Act of 2006).  The relevant statute says that depository institutions “may receive earnings to be paid by the Federal Reserve bank,” but how does one pay a negative amount?  Another challenge is that certain non-depository financial institutions (e.g., Fannie Mae, Freddie Mac and the Federal Home Loan Banks) might entirely avoid negative rates which, according to the Wall Street Journal, could lead to the strange circumstance in which depository institutions could deposit excess liquidity with these non-depository institutions for some lesser fee.  Finally, the Fed’s banking software is not currently programmed to handle negative interest rates according to a recently released 2010 internal memo.  Well, there’s a good reason not to do it.
 2. Negative Interest Rates are a Growing “Trend”
The ECB has maintained negative interest rates since June 2014.  Central banks in Japan and Germany currently maintain negative interest rates on a similar rationale to that of the ECB.  Canada is publicly mulling negative rates to assist its flagging economy while other countries like Denmark, Switzerland and Sweden run negative interest rates partly as an attempt to weaken their currency and discourage foreign deposits.  Sweden’s central bank, the Riksbank, took its main policy rate negative last February (and further lowered that rate to -0.45% this February) to weaken the krona, make imports more expensive and push inflation closer to the magical 2% target which seems to fascinate all central bankers.  Given concerns that more conventional monetary policies are no longer effective,  it would not be surprising to see more central banks attempt negative rates.
3. Negative Interest Rates are Unexplored Territory
Negative interest rates are unexplored territory. While central bankers posit that negative interest rates will spur banks to lend, the case is not yet proven.  The data currently available suggests that moderately negative interest rates have had modest success at spurring economic growth, while more negative interest rates have not been at all helpful.   Some analysts have speculated that banks will beless willing to lend, preferring instead to sit on the cash and dam the interest leakage.  On the other hand, some worry that banks will indeed , crank up the lending machinery but lower underwriting standards in the process thereby setting the stage for the next financial disaster. We are seeing evidence that negative rates are having a stimulative impact on housing markets. For example, subzero rates in Denmark and Sweden have helped fuel a surge in housing prices, but that way lies a bubble, right?  Is this what central banks really wanted to get as an output for their new policies?
So far, most banks affected by negative interest rates have been afraid to pass those rates on to consumers for fear of deposit flight.  Some banks notably Swiss banks, have recently indicated that negative interest rates may be coming for their large corporate depositors but, not yet.  Eventually negative interest rates must be passed on to the customer base, or the baked in bank losses resulting from the negative arb will start to erode bank balance sheets and capital.
Conclusion
So here in the early spring of 2016, the jury is surely out on what negative interest rates will do for (or to) the economy.  Let’s look at the score card.  Have the economies of the European Union accelerated?  No.  Are we seeing signs of asset bubbles?  Certainly.  Outside of housing, are we seeing a significant expansion of credit?  Not really.  And what about the banks?  The ECB is flooding the European banks with low or no cost loans but it’s not liquidity, stupid, it’s capital.  Has the damage already begun to set in?  It’s very hard to say as some, particularly European banks, are highly opaque, (but, go figure, the market doesn’t seem to think so.  European bank shares saw double digit rises after the ECB announcement of their latest rate cut.)
There is a nagging concern that while we haven’t figured out what all this monetary diddling is going to do, it’s actually already doing it and we just haven’t noticed.  If all this leads to an improvement in the health of the banking system, an expansion of credit and a restitution of growth throughout western economies, then that’s all great.  If this is leading us somewhere else, then one must worry that we may get there before we realize where the journey is taking us.
Photo: Sergey_P / iStock.com