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.

Like What You’ve Read? Support CounterPunch
August 31, 2015
Michael Hudson
Whitewashing the IMF’s Destructive Role in Greece
Conn Hallinan
Europe’s New Barbarians
Lawrence Ware
George Bush (Still) Doesn’t Care About Black People
Joseph Natoli
Plutocracy, Gentrification and Racial Violence
Franklin Spinney
One Presidential Debate You Won’t Hear: Why It is Time to Adopt a Sensible Grand Strategy
Dave Lindorff
What’s Wrong with Police in America
Louis Proyect
Jacobin and “The War on Syria”
Lawrence Wittner
Militarism Run Amok: How Russians and Americans are Preparing Their Children for War
Binoy Kampmark
Tales of Darkness: Europe’s Refugee Woes
Ralph Nader
Lo, the Poor Enlightened Billionaire!
Peter Koenig
Greece: a New Beginning? A New Hope?
Dean Baker
America Needs an “Idiot-Proof” Retirement System
Vijay Prashad
Why the Iran Deal is Essential
Tom Clifford
The Marco Polo Bridge Incident: a History That Continues to Resonate
Peter Belmont
The Salaita Affair: a Scandal That Never Should Have Happened
Weekend Edition
August 28-30, 2015
Randy Blazak
Donald Trump is the New Face of White Supremacy
Jeffrey St. Clair
Long Time Coming, Long Time Gone
Mike Whitney
Looting Made Easy: the $2 Trillion Buyback Binge
Alan Nasser
The Myth of the Middle Class: Have Most Americans Always Been Poor?
Rob Urie
Wall Street and the Cycle of Crises
Andrew Levine
Viva Trump?
Ismael Hossein-Zadeh
Behind the Congressional Disagreements Over the Iran Nuclear Deal
Lawrence Ware – Marcus T. McCullough
I Won’t Say Amen: Three Black Christian Clichés That Must Go
Evan Jones
Zionism in Britain: a Neglected Chronicle
John Wight
Learning About the Migration Crisis From Ancient Rome
Andre Vltchek
Lebanon – What if it Fell?
Charles Pierson
How the US and the WTO Crushed India’s Subsidies for Solar Energy
Robert Fantina
Hillary Clinton, Palestine and the Long View
Ben Burgis
Gore Vidal Was Right: What Best of Enemies Leaves Out
Suzanne Gordon
How Vets May Suffer From McCain’s Latest Captivity
Robert Sandels - Nelson P. Valdés
The Cuban Adjustment Act: the Other Immigration Mess
Uri Avnery
The Molten Three: Israel’s Aborted Strike on Iran
John Stanton
Israel’s JINSA Earns Return on Investment: 190 Americans Admirals and Generals Oppose Iran Deal
Bill Yousman
The Fire This Time: Ta-Nehisi Coates’s “Between the World and Me”
Scott Parkin
Katrina Plus Ten: Climate Justice in Action
Michael Welton
The Conversable World: Finding a Compass in Post-9/11 Times
Brian Cloughley
Don’t be Black in America
Kent Paterson
In Search of the Great New Mexico Chile Pepper in a Post-NAFTA Era
Binoy Kampmark
Live Death on Air: The Killings at WDBJ
Gui Rochat
The Guise of American Democracy
Emma Scully
Vultures Over Puerto Rico: the Financial Implications of Dependency
Chuck Churchill
Is “White Skin Privilege” the Key to Understanding Racism?
Kathleen Wallace
The Id(iots) Emerge
Andrew Stewart
Zionist Hip-Hop: a Critical Look at Matisyahu
Gregg Shotwell
The Fate of the UAW: Study, Aim, Fire