Here’s the moment I realized the next financial crisis is inevitable. It wasn’t Aug. 23, when the president wondered who was our呆igger enemy,”erome Powell, the chair of the Federal Reserve Board, or President Xi Jinping of China. It wasn’theeek before those comments, when it looked as ifhe trade war would tip the world into recession. Rather, it was several months ago, at the end of November, whenr. Powell was giving a speechat the Economic Club of New York.
By that point, the Federal Reserve had alreadyaised short-term interest rates three timesn 2018, and the crowd of economists, policy wonks and business journalists at the lunch were looking for any sign that he might do so again. Fed chairs rarely make their policy changes explicit, but it was clear from Mr. Powell’s comments that he was putting on the brakes.
“Interest rates are still low by historical standards,” Mr. Powell said, “and they remain just below the broad range of estimates of the level that would be neutral for the economy — that is, neither speeding up nor slowing down growth.” His use of the word “neutral” at that moment was the key. While he was talking, the Dow Jones industrial averageocketed up 618 points, its biggest one-day gain in months.
But although a sense of euphoria spread through the room, as well as through debt and equity markets, I was overcome by a sense of dread. A decade of historically low interest rates has begun to warp our economy. As we learned to our collective horror during the 2008 financial crisis, a period of sustained low interest rates forces investors on a desperate search for higher yields,inflating asset pricesnd the risks of owning loans and debt of all kinds.
Instead of continuing to try to right the ship, by gradually raising interest rates, Mr. Powell, in that speech, seemed to be caving to political pressure — from the president and from Wall Street bankers and traders — to keep rates low. Indeed, that is what he has done. On July 31, for thefirst time in more than a decade, he lowered short-term interest rates.
That was a mistake. Mr. Powell and his colleagues at the Fed need to stand up to Mr. Trump and do what’s right for the economy. If they don’t, the only question that remains is, when will it all blow up? When it does — and that day will be soon — we will be staring down yet another financial panic.
We’re now more than a decade into an era of super-low interest rates. The Fed’s decision to keep capital cheap and plentiful made sense after the financial crisis. It allowed companies and consumers to get the money they needed to rev up the economy after the recession choked the capital markets.
But the years of low interest rates have also caused debt investors — who couldn’t get good returns on low-yielding Treasury securities pegged to the Fed rate — to start chasing higher yields. As a result, they’ve been taking on far too much risk, for far too low a return, for far too long.
All that risk is not hidden on the balance sheets of the big Wall Street banks, as it was during the 2008 financial crisis. But it doesn’t just disappear into thin air. Like the oxygen we breathe but cannot see, it’s all around us, in hedge funds, private equity firms, and pension funds and university endowments that have beennvesting in risky debt, in the form of corporate bonds and other securities, to the tune of trillions of dollars.
What do those securities look like? There is, first of all, a proliferation of dodgy bank loans, issued without the covenants that are designed to protect the lender in case of default. In typical Wall Street fashion, those loans are turned into securities and sold to investors around the world. (Japanese banks are among the largest investors in these securities, called呃ollateralized loan obligations.”) It’s the current version of the mortgage-backed securities phenomenon that helped to sink the
economy in 2008.
There is also an eye-popping amount of risk propagated by some of the biggest names in American business. Bonds rated BBB — a notch above “junk” bonds — issued by big companies such as AT&T, Verizon, G.E., G.M. and Ford, represent more than half of the investment-grade corporate bond market. That raises the ugly specter of the “triple-B cliff,” the losses bondholders will incur when the economy dips and some of those companies can’t repay their debt.