Looking at today's mortgage rates it's not unreasonable to wonder if this is it, if we are now at the very lowest possible interest level with nowhere to go but up.

Indeed, David Reed -- a shrewd and knowledgeable loan officer -- reported last week that "most in the financial services industry will agree that interest rates are at their bottom...."

It's not easy to dispute those who handle loans each day, but this is one case where room for doubt exists.

First, rates can go lower -- much lower. For instance, while the discount rate in the U.S. -- the rates banks pay for overnight borrowing -- is now at 1.5 percent after 11 reductions by the Federal Reserve last year, further reductions are surely possible. The Bank of Japan now has a discount rate of just 0.1 percent -- 1/15th of the rate we consider ridiculously low.

Second, interest rates in the U.S. have been lower -- not in theory, but in practice. As Forbes magazine has reported, "T-bills got so popular that for brief periods between 1938 and 1941 they carried negative interest rates." (See: A Brief History of Stock Fads, September 14, 1992)

Third -- and this is where lenders and borrowers might want to take note -- investors today are willing to accept negative interest rates.

Negative Interest

Aside from folks still willing to buy shares in unprofitable dot coms, why would anyone invest $100 to get back something less? In the Depression years the attraction of negative interest was that it potentially represented a smaller loss then other investments -- but what is the attraction today?

A few weeks ago Berkshire Hathaway, the firm headed by famed investor Warren Buffett, made this offer:

Berkshire Hathaway Inc. (NYSE: BRK.A and BRK.B), announced today that it intends to sell $250 million of a new type of security, named "SQUARZ", in a private placement to qualified institutional investors. The initial purchasers will have an option to purchase up to an additional $37.5 million of securities to cover over-allotment. The SQUARZ security is a unit consisting primarily of a senior note and a warrant to purchase the company's stock at a premium. Berkshire expects the interest rate on the note will be lower than the installment payment rate on the warrant and as a result this will be the first security to carry a negative coupon.

Now you might think, whoa -- who's going to go for this? A bunch of folks, apparently. Berkshire did not raise $250 million. It took in $400 million!

Essentially the deal is this: You buy warrants which allow you to purchase Berkshire Hathaway shares during the next five years at 15 percent more than the May 21st price. You pay 3.75 percent yearly to maintain your warrant. You also receive a note equal to the warrant amount which generates 3 percent interest. In effect, your warrant has a negative interest rate equal to .75 percent.

Berkshire Hathaway shares need to appreciate only 2.83 percent annually to increase 15 percent in value compounded over five years. Given Mr. Buffett's market prowess and excellent reputation over many years, 2.83 percent annually doesn't strike many people as much of a hurdle. Alternatively, there is risk here and other considerations: Past performance is not a guarantee of future results, there is that pesky .75 percent annual cost whether the shares rise or not, and dollars spent on warrants are not getting interest from alternative investments such as Treasury securities, a savings account, or something similar.

More significantly, a line has been breached. Negative interest is here and it's accepted by at least some investors.

The parallel is that mortgage rates may be absurdly low today -- the 11th District Cost of Funds Index (11th District COFI) used by many ARMs was at 2.653 for March -- but why can't rates go lower? No doubt when the COFI was at 3.368 percent in December many seers, soothsayers, and lenders "agreed" that the index and mortgage rates generally could not possibly decline.

Alas, those tiny, puny, minuscule rates we saw in December were not the lowest of the low -- rates have shrunk since then and even lower rates may loom ahead.

For more articles by Peter G. Miller, please press here.

Published: June 4, 2002

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Peter G. Miller, also known as OurBroker®, is the author of six real estate books -- including The Common-Sense Mortgage -- and is the original creator and host of America Online's Real Estate Center. Peter's weekly columns appear in more than 100 newspapers nationwide, he is also published in a variety of other media outlets and he is a frequent speaker at national events and conventions. Peter welcomes your questions, comments, and news releases via e-mail at .