Beginning in 2010, which coincided with Dodd-Frank, the Fed did everything within its considerable power to discourage businesses and individuals from saving their money, and to take on as much debt as possible to supposedly stimulate the economy . Even beyond their ability to ever repay.
As a result, the low interest rates have contributed to inflated prices (‘price inflation’) on consumer good. A very simple explanation for ‘price inflation’ is that the more money there is in the economy means more competition for goods that are available, causing their price to go up. Supply and demand.
It’s far more complicated than that — but that is the basic cause. Low Fed rates put more money in to the economy.
Personal consumer debt has skyrocketed in large part because of the flood of low-interest money the Fed has dumped into the economy. Along with increased consumer debt, price inflation resulting from low interest rates means consumers need to borrow more.
Higher prices at the grocery store impact all of us – especially families with children. Inflation is another thing the government and their stooges in the mass media try to gaslight us about.
If they tell you the “rate of inflation” has “dropped” from… oh, say… 7% to 5%… what does that really mean? It means that prices are now only 5% higher than last year, which were 7% higher than the year before – meaning they are still 12% higher than two years ago.
But there is an insidious inflation that is potentially a more catastrophic risk to the economy than price inflation. ‘Asset inflation’ which (again, a very simple explanation) means that the value of assets (such as stocks, homes and businesses) becomes inflated.
As a result of the Fed’s policy of historically low interest rates, the “value” of a business can increase as it takes on more debt. As absurd as that sounds, in some circumstances the value of a business is not in the products or services it actually provides — but in the interest payments it generates on the money it borrows.
Rolling over commercial loans is how the businesses can avoid — perpetually — having to pay them off. They pay the interest only. When the principle comes due at the end of the loan term, it’s refinanced, and the interest only payments start anew.
Lenders like roll-overs, because the interest payments just keep on rolling in. A whole sector of the financial industry emerged to help businesses borrow money, and keep rolling it over.
The 1987 movie Wall Street portrays the villain, Gordon Gecko, as one of a small group of ‘corporate raiders’ who get very rich by predatory investments in businesses. In the past decade, the Fed’s artificially low interest rates have institutionalized and encouraged a swarm of Gordon Geckos.
When asset inflation increase their value, the media will call it a ‘boom’. But it’s lenders, rather than the actual owners of inflated assets, are who really benefit. They will lend more based on the inflated asset value used as collateral for the loans.
Savvy economists will point out that it was the inflated value of an asset — family homes (the ‘housing bubble’) — that caused the home mortgage collapse and ensuing financial disaster in 2008. It was the inflated value in tech stocks that caused the ‘tech bubble’ collapse in 2000.
Asset inflation encourages borrowing on the premise that the asset values will continue to grow. But, as has always happened down through history, the assets reach a point beyond which they can no longer inflate… like a bubble…
The bubble bursts. Values begin to drop. Loans based on the inflated values default — followed by a downturn in the economy.
How bad of a downturn depends on a multiplicity of factors. It can be 2008 — or 1929.
When the Florida inflated real estate ‘bubble’ collapsed in 1928, it was a precursor to the 1929 stock market crash. The 1929 crash resulted from assets (stocks) that got inflated because so much of the stock market investment was with borrowed money.
The Great Depression followed.
Inflated stock values were also the cause of the 1987 stock market downturn. A recession followed.
In 2018 there was chaos in the stock market because of inflation of stock values. On February 5, the market suffered the largest single-day loss since the ‘housing bubble’ crisis — simply because the incoming Chairman of the Fed indicated the days of historic low rates were over.
To some experts this was a signal that the inflated assets had serious, long-term potential hazards — triggering a stock ‘sell-off’ by the big institutional investors. The little guys got left holding the bag of falling stock values
Now in 2024, there are two more ‘bubbles’ that are financial disasters waiting to happen. Commercial real estate, and business debt.
The‘commercial real estate bubble’ is essentially the same as the 2007 residential real estate ‘bubble’. There are an ever-increasing number of mortgaged buildings that are unable to maintain tenant occupancy rates due to a number of factors — the vestiges of the pandemic ‘work from home’ being one.
When the owners of those buildings can not longer make a profit, or even afford to maintain the buildings, they simply default on their mortgages — and hand the buildings over to the lenders.
The owners can do so because, unlike residential loans where the homeowner must still pay the lender any difference between the unpaid mortgage debt and what the foreclosed home can be re-sold for, when a commercial borrower gives the collateral property to the lender, the borrower walks away free and clear.
As potentially problematic as commercial real estate loans are, they pale in comparison to the “commercial business loan bubble”. There is much more money on the line.
The primary factor in the 2008 collapse was the bundling of home mortgages into financial instruments that could be bought and sold like stocks. When the inflated value of the homes underlying those mortgages collapsed, and just a portion of those mortgages defaulted, the over-inflated value of the bundled mortgage instruments (an asset) collapsed – taking down big financial institutions who had bought them. It was only a government bailout that saved some of those institutions.
Commercial business loans have been bundled together by the lenders, and sold, just like the home mortgages that were the cause of the 2008 collapse. These bundled loans suffer from the same infirmity – they are comprised of too may risky loans (based on inflated assets) that will likely never get paid back. If (when?) those loans default, the same thing will happen as in 2008 – only worse.
Now, here’s the kicker. The Fed can see that ‘commercial loan bubble’ collapse on the horizon. Their solution seems to be higher interest rates to discourage ‘rolling over’ those loans.
There is serious debate whether higher rates will prevent a collapse of the bubble, or if it will actually bring it on sooner. Or if the Fed even has a clue what it’s doing.
The lenders who benefited most from low rates are convinced lowering them will fix the problem. They insist the Fed should do more of what encouraged the ‘bubble’ in the first place: lower the interest rates and dump more cheap money into the system.
There is no reason to believe lowering interest rates will prevent either the commercial loan bubbles from bursting. There is every reason to believe the lenders will profit by enabling more commercial loan roll-overs so inflated asset businesses can ‘kick the can down the road’ for a while longer (and continuing to pay interest on the loans). But it won’t solve the problem.
In the past, the Fed has tried to fix the problems they created by low interest rates by raising the interest rate, with detrimental ripple-effects throughout the economy, such as the price inflation we all experience every day at the grocery store.
Whether the higher rates this time will alleviate the problems caused by a decade of historically low rates depends on who you ask. If you ask a mom shopping for groceries the answer is a resounding ‘NO’! There is no evidence lowering the interest rate will result in lower prices.
The public and politicians won’t put up with ‘the Fed’ lowering rates just to help big banks make more money, without a corresponding lowering of consumer prices. So the Fed needs an excuse to give the lenders — who the Fed was created to serve — what they want.
I mentioned the rate of unemployment in Part One. This is where it comes in to the picture.
It illustrates why so many, myself now included, think the ‘expert economists’ running the Fed don’t really even understand the problem they’ve caused, let alone know how to fix it.
If you listen to public pronouncements coming out of the Fed one of the indicators they claim will motivate them to lower interest rates is if “the unemployment rate” drops to what they deem an “acceptable” level. The definition of “acceptable” seems to be arbitrary.
The unemployment rate is a metric the Fed has relied on since the national employment rate has been measured. In fact, maintaining low unemployment is now a part of the Fed’s mandate — so they are free to use it as a standard by which they make policy decisions.
For reasons that would take too much space here (and which I’m not sure I can accurately explain) the unemployment rate in the U.S. these days is only tangentially related to the Fed’s interest rate. The perceived linkage is, apparently, a no-longer relevant vestige of a bygone era.
Nevertheless, because how many people have a job is important politically, the Fed can claim “improving job numbers” as a justification to lower the interest rate — though there is little empirical evidence that a lower rate will impact employment at all in 2024.
Last week, the Department of Labor released employment numbers that were not good. As a result-the market “dropped”.
So the bankers and traders are now clamoring for the Fed to lower rates, claiming that will re-invigorate the economy and create jobs (theoretically). What they mean is it will be more profitable for those invested in the stock market.
That it may not have any effect on employment, or the cost of groceries (and may even make them more expensive) is irrelevant to the big institutional stock market players.
What the lower rate will impact is the ability, and willingness, of the lenders to resume their profligate ways of making risky loans that have gotten us to where we are now. And they will also be counting on us taxpayers to bail them out if (when?) it all goes to hell.
So what does all this mean?
Gary Beatty lives between Florida and Pagosa Springs. He retired after 30 years as a prosecutor for the State of Florida, has a doctorate in law, is Board Certified in Criminal Trial law by the Florida Supreme Court, and is now a law professor.