Silly Season at the Fed


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.

October 08, 2015
Michael Horton
Why is the US Aiding and Enabling Saudi Arabia’s Genocidal War in Yemen?
Ben Debney
Guns, Trump and Mental Illness
Pepe Escobar
The NATO-Russia Face Off in Syria
Yoav Litvin
Israeli Occupation for Dummies
Lawrence Davidson
Deep Poverty in America: the On-Going Tradition of Not Caring
Thomas Knapp
War Party’s New Line: Vladimir Putin is Why We Can’t Have Nice Things
Brandon Jordan
Sowing the Seeds of War in Uruguay
Binoy Kampmark
Imperilled by Unfree Trade: the TPP on Environment and Labor
John McMurtry
The Canadian Elections: Cover-Up and Steal (Again)
Anthony Papa
Coming Home: an Open Letter to 6,000 Soon-to-be-Released Drug War Prisoners From an Ex-Con
Ramzy Baroud
Listen to Syrians: The Media Jackals and the People’s Narrative
Norman Pollack
Heart of Darkness: A Two-Way Street
Gilbert Mercier
Will Russia, Iran, Hezbollah and Iraqi Shiite Militias Defeat ISIS in Syria and Iraq?
John Stanton
Vietnam 2.0 and California Dreamin’ in Ukraine
William John Cox
The Pornography of Hatred
October 07, 2015
Nancy Scheper-Hughes
Witness to a Troubled Saint-Making: Junipero Serra and the Theology of Failure
Luciana Bohne
The Double-Speak of American Civilian Humanitarianism
Joyce Nelson
TPP: Big Pharma’s Big Deal
Jonathan Cook
Israel Lights the Touchpaper at Al-Aqsa Again
Joseph Natoli
The Wreckage in Sight We Fail To See
Piero Gleijeses
Cuba’s Jorge Risquet: the Brother I Never Had
Andrew Stewart
Do #BlackLivesMatter to Dunkin’ Donuts?
Rajesh Makwana
#GlobalGoals? The Truth About Poverty and How to Address It
Joan Berezin
Elections 2016: A New Opening or Business as Usual?
Dave Randle
The Man Who Sold Motown to the World
Adam Bartley
“Shameless”: Hillary Clinton, Human Rights and China
Binoy Kampmark
The Killings in Oregon: Business as Usual
Harvey Wasserman
Why Bernie and Hillary Must Address America’s Dying Nuke Reactors
Tom H. Hastings
Unarmed Cops and a Can-do Culture of Nonviolence
October 06, 2015
Vijay Prashad
Afghanistan, the Terrible War: Money for Nothing
Mike Whitney
How Putin will Win in Syria
Paul Street
Yes, There is an Imperialist Ruling Class
Paul Craig Roberts
American Vice
Kathy Kelly
Bombing Hospitals: 22 People Killed by US Airstrike on Doctors Without Borders Hospital in Kunduz, Afghanistan
Ron Jacobs
Patti Smith and the Beauty of Memory
David Macaray
Coal Executive Finally Brought Up on Criminal Charges
Norman Pollack
Cold War Rhetoric: The Kept Intelligentsia
Cecil Brown
The Firing This Time: School Shootings and James Baldwin’s Final Message
Roger Annis
The Canadian Election and the Global Climate Crisis
W. T. Whitney
Why is the US Government Persecuting IFCO/Pastors for Peace Humanitarian Organization?
Jesse Jackson
Alabama’s New Jim Crow Far From Subtle
Joe Ramsey
After Umpqua: Does America Have a Gun Problem….or a Dying Capitalist Empire Problem?
Murray Dobbin
Rise Up, Precariat! Cheap Labour is Over
October 05, 2015
Michael Hudson
Parasites in the Body Economic: the Disasters of Neoliberalism
Patrick Cockburn
Why We Should Welcome Russia’s Entry Into Syrian War