Former Federal Deposit Insurance Corp. Chairwoman Sheila Bair is warning that the Federal Reserve's low-interest-rate policy is setting up the nation for more economic calamity. In an opinion column appearing in the April 30 edition of Fortune, Bair cites the Fed's actions as a rerun of the situation that led to the housing bubble collapse.
‘In a recent series of college lectures, [Fed Chairman] Ben Bernanke sounded a positive note, extolling the Fed's low-interest-rate policy and predicting sustainable economic growth,’ Bair writes. ‘I want to believe him, but his words echo the confidence exuded by the Fed in late 2006 when it missed the housing bubble. Is it missing the bond bubble now?’
Bair adds that keeping Treasury bond prices high while keeping the federal government's interest costs low is the wrong approach, especially in view of the current state of the economy. Citing both the subprime mortgage meltdown of the past decade and the savings and loan (S&L) industry fiasco of the 1980s, Bair argues that the central bank has been incorrect in maintaining interest rates ‘at or near zero for four years running, even though the financial system has been relatively stable since 2009.’
‘As we saw in the years leading up to the subprime crisis, yield-hungry investors are taking on more and more risk,’ she continues. ‘Pension managers are investing in hedge funds, and gullible investors are buying up junk bonds. Meanwhile, low-yielding assets pile up on the balance sheets of more risk-averse banks. If interest rates suddenly spike, bankers may find that the paltry returns on their loans are insufficient to cover interest on their deposits. Does anybody remember the S&L crisis?’
Bair observes that ultra-low interest rates have enabled Wall Street to enjoy ‘paper gains’ while homeowners have a better opportunity to refinance their mortgages. However, she ultimately declares that a bigger picture is being ignored.
‘These benefits may help in the short term, but they do not address the long-term problem with our economy: We consume too much and produce too little,’ she argues. ‘Some banks and investment funds benefit from low rates because they can take the cheap money and get higher yields with it overseas. Unfortunately, loan growth in the U.S. is moribund. Community banks that rely on domestic lending – particularly small-business lending – tell me they would lend more if they could get a higher rate on loans. But who wants to lend into an uncertain fiscal and economic environment for a few hundred basis points?’
Bair also identifies the ‘biggest beneficiaries of loose money’ as being ‘our profligate elected officials who refuse to come to grips with budget deficits and an exemption-laden tax code. As long as Treasury can borrow cheaply to paper over the real problems, politicians can demagogue about overspending (GOP) or undertaxing (Democrats) while dodging their responsibility to work together to fix our problems.’