{"id":18421,"date":"2019-10-30T01:19:21","date_gmt":"2019-10-30T01:19:21","guid":{"rendered":"https:\/\/www.lifeandnews.com\/articles\/?p=18421"},"modified":"2019-10-31T05:52:28","modified_gmt":"2019-10-31T05:52:28","slug":"why-the-fed-has-no-choice-but-to-keep-cutting-interest-rates-if-it-wants-to-avoid-a-financial-crisis","status":"publish","type":"post","link":"https:\/\/www.lifeandnews.com\/articles\/why-the-fed-has-no-choice-but-to-keep-cutting-interest-rates-if-it-wants-to-avoid-a-financial-crisis\/","title":{"rendered":"Why the Fed has no choice but to keep cutting interest rates \u2013 if it wants to avoid a financial crisis"},"content":{"rendered":"

Andreas Kern<\/a>, Georgetown University<\/a><\/em><\/p>\n

The U.S. Federal Reserve is stuck between an apparently booming economy and a financial crisis that might be right around the corner.<\/p>\n

That\u2019s why its decision to cut interest rates by another quarter point<\/a> on Oct. 30 \u2013 its third reduction in as many months<\/a> \u2013 seems so odd. Lowering rates when the economy is as strong<\/a> as the numbers make it out to be is practically unheard of. And, according to textbook economics<\/a>, lowering interest rates during a boom is a sure recipe for disaster.<\/p>\n

The trouble is, as someone who studies financial booms and busts<\/a>, I know that not lowering rates may be even worse. That\u2019s because the corporate sector is dangerously over-indebted, creating a financial bubble<\/a>.<\/p>\n

A hike in borrowing costs could kick-start a cascade of bankruptcies in a financial contagion that would derail the U.S. economy.<\/p>\n

Troubles below the surface<\/h2>\n

On the surface, the U.S. economy appears to be humming along just fine.<\/p>\n

Unemployment\u2019s at a half-century low<\/a>. Inflation is near its target of 2%<\/a>. And, at about 125 months, the U.S. is charting its longest economic expansion since at least the 1850s<\/a>.<\/p>\n

Look under the hood, however, and things look very troublesome.<\/p>\n

Numerous trade wars have cost U.S. companies<\/a>, farmers<\/a> and consumers<\/a> dearly. The manufacturing industry \u2013 once America\u2019s job engine and ostensibly the sector the trade war was supposed to support<\/a> \u2013 is seeing its worst year since 2009<\/a>.<\/p>\n

And looking abroad, the situation is even worse, with the global economy slowing and the International Monetary Fund warning there\u2019s little ammunition left<\/a> to fight a recession.<\/p>\n

The corporate debt bubble<\/h2>\n

While that\u2019s bad, we haven\u2019t gotten to the scary part yet.<\/p>\n

A key cause of the 2008 financial crisis was too much debt<\/a> in the housing market, much of which ultimately went bad.<\/p>\n

Today, the problem is in corporate America. Since 2008, when the Fed drove its target interest rate to a record-low 0.25%<\/a>, markets have been flooded with cheap money. That was too much to resist for U.S. companies, which went on a borrowing binge.<\/p>\n

All American companies are currently sitting on a record US$15.5 trillion in debt<\/a>, equivalent to about two-thirds of U.S. GDP. Unfortunately, this debt was not primarily used to finance expansion and growth but more commonly to jack up stock prices through dividends, stock buybacks and acquisitions<\/a>.<\/p>\n

The problem will come when the party stops \u2013 when interest rates begin rising and companies, particular the ones that took more risks, can\u2019t refinance or pay back their debts. This is what turns a credit boom into a financial crisis, as happened in 2008<\/a>.<\/p>\n

The IMF estimates that half of corporate debt \u2013 excluding small businesses \u2013 is high risk, or junk rated<\/a>, which has a much higher chance of default than investment grade debt.<\/p>\n

What makes the situation even worse is that $660 billion of companies\u2019 so-called leveraged debt is held in collateralized loan obligations<\/a> that have been sold to a variety of investors and financial institutions. While this has helped keep rates even lower, a rise in delinquencies and defaults would cause losses in this market as well and a stampede of selling by investors.<\/p>\n

The downward cycle<\/h2>\n

As this cycle spirals, it spurs rising unemployment, a drop in consumer spending, more bankruptcies and \u2013 if it\u2019s not stopped \u2013 an economic recession. This is what happened in 2008 when subprime borrowers couldn\u2019t pay back their mortgages in large numbers.<\/p>\n

In other words, in this environment of high \u2013 and in some pockets highly risky \u2013 corporate debt and faltering profits<\/a>, the slightest interest rate move in the wrong direction has the potential to transform debt into junk worth pennies on the dollar<\/a>.<\/p>\n

This is why the Fed has no choice but to keep lowering interest rates and keep them there. The gamble is that companies will use the breathing space to get their houses in order<\/a>.<\/p>\n

If they don\u2019t, we could be in for a world of pain.<\/p>\n

[ Like what you\u2019ve read? Want more?<\/em> Sign up for The Conversation\u2019s daily newsletter<\/a>. ]
\nScreen reader support enabled.\"The<\/p>\n

Andreas Kern<\/a>, Associate Teaching Professor, Georgetown University<\/a><\/em><\/p>\n

This article is republished from The Conversation<\/a> under a Creative Commons license. Read the original article<\/a>.<\/p>\n","protected":false},"excerpt":{"rendered":"

Andreas Kern, Georgetown University The U.S. Federal Reserve is stuck between an apparently booming economy and a financial crisis that might be right around the corner. That\u2019s why its decision to cut interest rates by another quarter point on Oct. 30 \u2013 its third reduction in as many months \u2013 seems so odd. Lowering rates […]<\/p>\n","protected":false},"author":44,"featured_media":18416,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[277],"tags":[7163,7166,7165,7164,2272,446,350,2197,5212,3231,1580,348,7102],"_links":{"self":[{"href":"https:\/\/www.lifeandnews.com\/articles\/wp-json\/wp\/v2\/posts\/18421"}],"collection":[{"href":"https:\/\/www.lifeandnews.com\/articles\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.lifeandnews.com\/articles\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.lifeandnews.com\/articles\/wp-json\/wp\/v2\/users\/44"}],"replies":[{"embeddable":true,"href":"https:\/\/www.lifeandnews.com\/articles\/wp-json\/wp\/v2\/comments?post=18421"}],"version-history":[{"count":2,"href":"https:\/\/www.lifeandnews.com\/articles\/wp-json\/wp\/v2\/posts\/18421\/revisions"}],"predecessor-version":[{"id":18424,"href":"https:\/\/www.lifeandnews.com\/articles\/wp-json\/wp\/v2\/posts\/18421\/revisions\/18424"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.lifeandnews.com\/articles\/wp-json\/wp\/v2\/media\/18416"}],"wp:attachment":[{"href":"https:\/\/www.lifeandnews.com\/articles\/wp-json\/wp\/v2\/media?parent=18421"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.lifeandnews.com\/articles\/wp-json\/wp\/v2\/categories?post=18421"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.lifeandnews.com\/articles\/wp-json\/wp\/v2\/tags?post=18421"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}