How high interest rates hurt bakers, farmers and consumers

Homebuyers, entrepreneurs and government officials are facing a new reality: If they want to postpone major purchases or investments until borrowing becomes cheaper, it will likely be a long wait.

Governments pay more to borrow money for new schools and parks. Developers are struggling to find loans to buy lots and build homes. Companies forced to refinance debt at sharply higher interest rates are more likely to lay off workers – especially if they were already operating at little or no profit.

In recent weeks, investors have realized that even as the Federal Reserve nears an end to its increases in short-term interest rates, market-based measures of long-term financing costs have continued to rise. In short, the economy may no longer be able to avoid a sharper slowdown.

“It’s a trickle-down effect for everyone,” said Mary Kay Bates, CEO of Bank Midwest in Spirit Lake, Iowa.

Small banks like Ms. Bates are at the epicenter of America’s small business credit crisis. During the pandemic, when Fed interest rates were near zero and consumers were piling their savings into bank accounts, she was able to make loans at 3 to 4 percent. She also put money into safe securities, such as government bonds.

But when Fed rates soared, the value of Bank Midwest’s securities portfolio fell — meaning that if Ms. Bates sold the bonds to finance more loans, she would have to take a big loss. Deposits also declined as consumers spent their savings and moved money to higher-yielding assets.

As a result, Mrs. Bates makes loans by borrowing money from the Fed and other banks, which is more expensive. It also pays customers higher rates on deposits.

For all these reasons, Ms. Bates charges borrowers higher rates and pays close attention to who she lends to.

“We don’t expect interest rates to fall anytime soon,” she says. “I really see us keeping a close eye and having an internal focus, not so much on innovation and entering new markets, but on taking care of the bank that we have.”

On the other side of that equation are people like Liz Field, who started a bakery, the Cheesecakery, from her home in Cincinnati, focusing on miniature cheesecakes, of which she has developed 200 flavors. She gradually built 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 for the next step: purchasing a property including a building to use as a commissary kitchen. She got a $434,000 loan backed 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 started to increase. Ms. Field realized that her interest rate was tied to the “prime rate,” which moves up and down with the interest rate the Fed controls. This increased her monthly payments to $4,120. In addition to declining cheesecake orders, she has been forced to reduce the hours of her 25 employees and sell a food truck and a frozen food truck.

“That really hurts because at that price I could have one to two stores,” Ms. Field said of her payments. “I can’t open more stores until I get this big loan under control.”

According to analysts at Goldman Sachs, interest payments for small businesses will rise on average to about 7 percent of revenue next year, up from 5.8 percent in 2021. No one knows for sure when companies will get any relief — but if the economy slows down sharply enough, the rates will likely fall on their own.

For much of 2023, many investors, consumers and business leaders eagerly awaited next year’s rate cuts, expecting the Fed to conclude that it had defeated inflation for good.

Surprised by continued price increases even after supply chains began to unravel, the Fed continued its most aggressive campaign of rate hikes since the 1980s, raising rates by 5.25 percentage points in a year and a half.

Still, the economy remained blazing hot, with job openings far outstripping supply for workers and consumers. Some categories that fuel inflation have declined rapidly, such as furniture and food, while others – such as energy – have rebounded.

In September, the central bank kept interest rates stable, but indicated that interest rates would remain high for longer than the market had expected. This requires changes for many companies.

“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 back 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, realize that they need to take a swim.”

For large companies, this means making investments that are likely to pay off quickly, rather than spending money on speculative bets. For start-ups, which have developed in recent 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 businesses; only about 10 percent rely on bank loans. Luke Pardue, an economist at small business payroll firm Gusto, said the pandemic generation of new businesses tended to have an advantage because they had lower costs and used business models that focused on hybrid work.

But the high costs and scarcity of capital can hinder its growth, especially if owners don’t have wealthy investors or homes to borrow against.

“For three years, we’ve been patting ourselves on the back seeing this wave of entrepreneurship among women and people of color,” Mr. Pardue said. “As the rubber hits the road and they start to struggle, we need to move into the next phase of that conversation, which is how we can support these new businesses.”

New businesses aren’t the only ones struggling. So do the elderly, especially when prices for their goods fall.

Take agriculture. Commodity prices have fallen, bringing down overall inflation, but that has depressed farm incomes. At the same timeHigh interest rates have made buying new equipment more expensive.

Anne Schwagerl and her husband grow corn and soybeans on 1,100 acres in west-central Minnesota. They gradually buy the land from his parents, on favorable terms that compensate for the high interest rates. But their line of credit carries an interest rate of 8 percent, forcing them to make tough decisions, such as whether to invest in new equipment or wait a year.

“It would be really nice to get another good grain cart so we can keep the combine moving during harvest season,” Ms. Schwagerl said. “If we can’t afford that, because we postpone these kinds of financial decisions, it just means that we are less efficient in our business.”

Stubbornly high capital costs are also hurting companies that need capital to build homes – while mortgage rates above 7 percent have put home buying out of reach for many people.

There are housing construction activities got hit over the past year, with employment in the sector flatten because interest rates suppressed home sales. According to the National Association of Home Builders, builders who secured financing before rates started to rise are offering discounts to get units sold or rented.

The real problem may emerge in a few years, when a new generation of renters will look for properties that were never built due to high financing costs.

Dave Rippe is a former chief of economic development for Nebraska who now spends some of his time rehabilitating old buildings in Hastings, a city of 25,000 near the Kansas border, into apartments and retail spaces. That was easier two years ago, when interest rates were half what they are today, even though material costs were higher.

“When you talk to developers about ‘Hey, what’s your next project?’ they are crickets,” said Mr. Rippe, who researches government programs that offer low-cost loans for affordable housing projects.

Through all of this, consumers have done just that kept publishing, even as they’ve depleted their pandemic-era savings and become dependent on expensive credit card debt. So far, that willingness to spend money has been made possible by a strong labor market. That could change if the pace of wage increases slows.

Car dealers may soon notice that shift. In recent years, dealers have compensated for low inventory by raising prices. Automakers have offered promotional interest rate deals, but the average interest rate on new four-year auto loans has risen to 8.3 percent, the highest level since the early 2000s.

Liza Borches is the president of Carter Myers Automotive, a Virginia dealership that sells cars from many brands. She said automakers had put too many expensive trucks and SUVs on the market and should switch to making more affordable vehicles that many customers wanted.

“That adjustment needs to happen quickly,” Ms. Borches said.

Of course, interest rates are not a factor for those who have cash to buy cars outright, and Ms Borches has seen more and more customers putting down more money to minimize financing costs. Those customers can also earn good returns by keeping cash in a high-yield savings account or money market fund.

The era of higher interest rates is less beneficial for those who need to borrow for daily needs and also face rising housing costs and subdued wage growth.

Kristin Pugh sees both types of people in her Atlanta practice as a financial advisor to high-net-worth individuals, who waives her fees for some low-income clients. It is a picture of divergent fortunes.

“Combined 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.”