FacebookTwitterGoogle+RedditEmail

Silly Season at the Fed

by

Throughout this recovery there have been a number of economists and policy types expressing concern about a “bond bubble.” This is the idea that bonds are overpriced and could take a sudden tumble giving financial markets and the economy the same sort of hits we saw from the collapse of the housing and stock bubbles. This is seriously misguided thinking from any conceivable perspective.

At the most basic level the concern is misplaced because there is nowhere near as much money at stake. Former Fed economist Andrew Flowers put the amount of money at stake in the bond market as $40 trillion in a recent FiveThirtyEight column. This compares to a stock market valued at around $28 trillion and housing market at a bit over $20 trillion.

While that may make the bond market seem more important, the $40 trillion number is hugely misleading. The $40 trillion figure refers to total debt, much of which is short-term. This is important because short-term debt doesn’t lose much value when interest rates rise. If we restrict our focus to debt that stands to lose substantial value when interest rates rise – remaining duration of five years or more – the volume of debt would be well under $20 trillion.

Even here, the room for losses in this market is not nearly as large as it was in the case of either the stock or housing bubbles. The stock market lost more than half of its value from its 2000 peak to its 2002 trough. House prices lost more than one third of their real value from the 2006 peak to the 2011 trough. By contrast, it is difficult to envision a scenario where the bond market loses even 10 percent of its value.

Let’s consider an extreme case: suppose the interest rate on 30-year mortgages, which is currently around 4.15 percent, rose to 5.5 percent in a short period of time. This would be an extraordinary, albeit not impossible, increase. This would imply a drop in the price of a newly issued 30-year mortgage of roughly 19 percent, a much smaller drop percentage decline than we saw with the collapse of either the stock or housing bubbles.

Furthermore, the overwhelming majority of outstanding debt has much less than 30 years until maturity. This means the potential loss in value would be far less than this 19 percent figure even in the wake of a sharp jump in interest rates.

In fact, we already did a sort of trial run of the impact of higher interest rates on financial markets and the economy. After Bernanke’s famous taper talk last summer, the interest rate on 30-year mortgages rose from less than 3.5 percent in the spring of 2013 to more than 4.5 percent in the summer. If there was any serious stress created by the associated fall in bond prices, the financial media neglected to mention it. It is unlikely that any future rise in interest rates will lead to as large a drop in prices.

While the new interest in bubbles can be appreciated by those of us who warned of the stock and housing bubbles, it seems that those who missed these bubbles still don’t have a clear understanding of what is at issue. The collapse of the stock and housing bubbles posed large problems for the economy because they were the forces driving growth. The stock bubble led to an investment boom and a surge in consumption as people spent based on their ephemeral stock wealth. The housing bubble led to a boom in construction and another surge in consumption fed by bubble generated housing equity.

When these bubbles burst there was nothing to replace the huge amounts of demand they had generated. As a result, we had weak recoveries from both downturns, with the weakness of the stock bubble recession being limited in part by the demand created by the growth of the housing bubble.

While low interest rates are certainly providing a lift to the economy, it is not possible to tell a story of a comparable collapse in demand if bond prices were to tumble. In other words, there is no horrifying event that we need fear if the bond “bubble” were to burst.

The bad story in this picture would be if the Fed were to raise interest rates in the hope of preventing a future collapse in bond prices. This would slow the economy and raise the unemployment rate.

The collapse of both the stock and housing bubbles was certainly bad news for the economy. The Fed should have taken steps, ideally on the regulatory side, to keep these bubbles from growing so large. However the Fed would seriously compound its past mistakes if its takeaway is to take steps to deliberately slow growth when the economy is still below its potential level of output.

Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.

The essay orignally appeared on CNN Money.

 

Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.

More articles by:
Weekend Edition
May 27, 2016
Friday - Sunday
John Pilger
Silencing America as It Prepares for War
Rob Urie
By the Numbers: Hillary Clinton and Donald Trump are Fringe Candidates
Andrew Levine
Hillary’s Gun Gambit
Paul Street
Feel the Hate
Daniel Raventós - Julie Wark
Basic Income Gathers Steam Across Europe
Gunnar Westberg
Close Calls: We Were Much Closer to Nuclear Annihilation Than We Ever Knew
Jeffrey St. Clair
Hand Jobs: Heidegger, Hitler and Trump
S. Brian Willson
Remembering All the Deaths From All of Our Wars
Dave Lindorff
With Clinton’s Nixonian Email Scandal Deepening, Sanders Must Demand Answers
Pete Dolack
Millions for the Boss, Cuts for You!
Peter Lee
To Hell and Back: Hiroshima and Nagasaki
Karl Grossman
Long Island as a Nuclear Park
Binoy Kampmark
Sweden’s Assange Problem: The District Court Ruling
Robert Fisk
Why the US Dropped Its Demand That Assad Must Go
Martha Rosenberg – Ronnie Cummins
Bayer and Monsanto: a Marriage Made in Hell
Brian Cloughley
Pivoting to War
Stavros Mavroudeas
Blatant Hypocrisy: the Latest Late-Night Bailout of Greece
Arun Gupta
A War of All Against All
Dan Kovalik
NPR, Yemen & the Downplaying of U.S. War Crimes
Randy Blazak
Thugs, Bullies, and Donald J. Trump: The Perils of Wounded Masculinity
Murray Dobbin
Are We Witnessing the Beginning of the End of Globalization?
Daniel Falcone
Urban Injustice: How Ghettos Happen, an Interview with David Hilfiker
Gloria Jimenez
In Honduras, USAID Was in Bed with Berta Cáceres’ Accused Killers
Kent Paterson
The Old Braceros Fight On
Lawrence Reichard
The Seemingly Endless Indignities of Air Travel: Report from the Losing Side of Class Warfare
Peter Berllios
Bernie and Utopia
Stan Cox – Paul Cox
Indonesia’s Unnatural Mud Disaster Turns Ten
Linda Pentz Gunter
Obama in Hiroshima: Time to Say “Sorry” and “Ban the Bomb”
George Souvlis
How the West Came to Rule: an Interview with Alexander Anievas
Julian Vigo
The Government and Your i-Phone: the Latest Threat to Privacy
Stratos Ramoglou
Why the Greek Economic Crisis Won’t be Ending Anytime Soon
David Price
The 2016 Tour of California: Notes on a Big Pharma Bike Race
Dmitry Mickiewicz
Barbarous Deforestation in Western Ukraine
Rev. William Alberts
The United Methodist Church Up to Its Old Trick: Kicking the Can of Real Inclusion Down the Road
Patrick Bond
Imperialism’s Junior Partners
Mark Hand
The Trouble with Fracking Fiction
Priti Gulati Cox
Broken Green: Two Years of Modi
Marc Levy
Sitrep: Hometown Unwelcomes Vietnam Vets
Lorenzo Raymond
Why Nonviolent Civil Resistance Doesn’t Work (Unless You Have Lots of Bombs)
Ed Kemmick
New Book Full of Amazing Montana Women
Michael Dickinson
Bye Bye Legal High in Backwards Britain
Missy Comley Beattie
Wanted: Daddy or Mommy in Chief
Ed Meek
The Republic of Fear
Charles R. Larson
Russian Women, Then and Now
David Yearsley
Elgar’s Hegemony: the Pomp of Empire
FacebookTwitterGoogle+RedditEmail