Debt Lessons Not Learned to Yield the Same Problems, Again, Worse

City Journal  ( Original )
MAY 3, 2018

What “should” interest rates be these days? After ten years of roaring QE, which was supposed to have shored up the shaky financial foundations of the markets, we should certainly be back on firm footing by now, no?

Unless all of that bailout, all of that Fed-printed insurance went right back into more risk. Which is exactly what has happened. In attempting to anesthetize the markets from the pain of subprime excesses, the Fed has instead inflated a far larger bubble that has encompassed every risk asset class.

Interest rates on the United States’ ten-year Treasury bond recently hit 3 percent, which should be regarded as historically low. Instead, a decade after the financial crisis began, it’s remarkable for being that high, and economic and financial experts can’t agree on whether this new rate portends a brewing economic miracle or a looming economic crisis.

What it really reflects is a conundrum: the economy is doing well, but in large part because Americans have borrowed too much, too fast, and at too-low rates—and a real risk exists that normal interest rates will kill this debt-fueled boom. In the decade after the 2008 debt-based meltdown, the U.S. still hasn’t kicked its addiction to borrowing.

Interest rates are a useful signal, but no one knows what message higher rates are sending now or how they will affect the broader economy. One view is that the Fed is raising rates because the economy is good, and such hikes directly impact Treasury rates. Another view is that the way in which rates are rising—faster on short-term rates than on long-term—could foreshadow a recession. Indeed, growth slowed in the first quarter of 2018.

In either case, the 3 percent mark is a milestone. Though rates have fallen back over the past week, they have not been this high, on a sustained basis, in nearly seven years. It’s hard to believe now, but from the 1960s through the beginning of the financial crisis, Treasury rates never fell below 3 percent, and they were often several percentage points above that. It’s natural to think that if the economy didn’t collapse with 6 percent interest rates in, say, 1995, it won’t do so today—but this time, as they say, is different.

The U.S. didn’t learn the right lessons from the financial crisis. After powerhouse investment bank Lehman Brothers collapsed on September 14, 2008, experts focused on complexity: financial engineers had created obscure instruments, from credit-default swaps to complex securities, backed by subprime mortgages.

Nobody really understood these creations—even the smart people who made them, sold them, and bought them. Things fell apart, and the financial industry needed the simplest, bluntest instrument of all—federal government intervention—to bail it out, along with the rest of us.

ORIGINAL SOURCE: Technically Speaking: Bullish Hopes Clash With Bearish Signals by Nicole Gelinas at City Journal on 4/30/18