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:

CounterPunch Magazine

minimag-edit

bernie-the-sandernistas-cover-344x550

zen economics

March 30, 2017
William R. Polk
What Must be Done in the Time of Trump
Howard Lisnoff
Enough of Russia! There’s an Epidemic of Despair in the US
Ralph Nader
Crash of Trumpcare Opens Door to Full Medicare for All
Carol Polsgrove
Gorsuch and the Power of the Executive: Behind the Congressional Stage, a Legal Drama Unfolds
Michael J. Sainato
Fox News Should Finally Dump Bill O’Reilly
Kenneth Surin
Former NC Governor Pat McCory’s Job Search Not Going Well
Binoy Kampmark
The Price of Liberation: Slaughtering Civilians in Mosul
Bruce Lesnick
Good Morning America!
William Binney and Ray McGovern
The Surveillance State Behind Russia-gate: Will Trump Take on the Spooks?
Jill Richardson
Gutting Climate Protections Won’t Bring Back Coal Jobs
Robert Pillsbury
Maybe It’s Time for Russia to Send Us a Wake-Up Call
Prudence Crowther
Swamp Rats Sue Trump
March 29, 2017
Jeffrey Sommers
Donald Trump and Steve Bannon: Real Threats More Serious Than Fake News Trafficked by Media
David Kowalski
Does Washington Want to Start a New War in the Balkans?
Patrick Cockburn
Bloodbath in West Mosul: Civilians Being Shot by Both ISIS and Iraqi Troops
Ron Forthofer
War and Propaganda
Matthew Stevenson
Letter From Phnom Penh
James Bovard
Peanuts Prove Congress is Incorrigible
Thomas Knapp
Presidential Golf Breaks: Good For America
Binoy Kampmark
Disaster as Joy: Cyclone Debbie Strikes
Peter Tatchell
Human Rights are Animal Rights!
George Wuerthner
Livestock Grazing vs. the Sage Grouse
Jesse Jackson
Trump Should Form a Bipartisan Coalition to Get Real Reforms
Thomas Mountain
Rwanda Indicts French Generals for 1994 Genocide
Clancy Sigal
President of Pain
Andrew Stewart
President Gina Raimondo?
Lawrence Wittner
Can Our Social Institutions Catch Up with Advances in Science and Technology?
March 28, 2017
Mike Whitney
Ending Syria’s Nightmare will Take Pressure From Below 
Mark Kernan
Memory Against Forgetting: the Resonance of Bloody Sunday
John McMurtry
Fake News: the Unravelling of US Empire From Within
Ron Jacobs
Mad Dog, Meet Eris, Queen of Strife
Michael J. Sainato
State Dept. Condemns Attacks on Russian Peaceful Protests, Ignores Those in America
Ted Rall
Five Things the Democrats Could Do to Save Their Party (But Probably Won’t)
Linn Washington Jr.
Judge Neil Gorsuch’s Hiring Practices: Privilege or Prejudice?
Philippe Marlière
Benoît Hamon, the Socialist Presidential Hopeful, is Good News for the French Left
Norman Pollack
Political Cannibalism: Eating America’s Vitals
Bruce Mastron
Obamacare? Trumpcare? Why Not Cubacare?
David Macaray
Hollywood Screen and TV Writers Call for Strike Vote
Christian Sorensen
We’ve Let Capitalism Kill the Planet
Rodolfo Acuna
What We Don’t Want to Know
Binoy Kampmark
The Futility of the Electronics Ban
Andrew Moss
Why ICE Raids Imperil Us All
March 27, 2017
Robert Hunziker
A Record-Setting Climate Going Bonkers
Frank Stricker
Why $15 an Hour Should be the Absolute Minimum Minimum Wage
Melvin Goodman
The Disappearance of Bipartisanship on the Intelligence Committees
FacebookTwitterGoogle+RedditEmail