Please ensure Javascript is enabled for purposes of website accessibility
Why the Fed Has No Choice but to Keep Cutting Interest Rates – if It Wants to Avoid a Financial Crisis
The-Conversation
By The Conversation
Published 5 years ago on
November 1, 2019

Share

The U.S. Federal Reserve is stuck between an apparently booming economy and a financial crisis that might be right around the corner.
That’s why its decision to cut interest rates by another quarter point on Oct. 30 – its third reduction in as many months – seems so odd. Lowering rates when the economy is as strong as the numbers make it out to be is practically unheard of. And, according to textbook economics, lowering interest rates during a boom is a sure recipe for disaster.


Andreas Kern
The Conversation
The trouble is, as someone who studies financial booms and busts, I know that not lowering rates may be even worse. That’s because the corporate sector is dangerously over-indebted, creating a financial bubble.
A hike in borrowing costs could kick-start a cascade of bankruptcies in a financial contagion that would derail the U.S. economy.

Troubles Below the Surface

On the surface, the U.S. economy appears to be humming along just fine.
Unemployment’s at a half-century low. Inflation is near its target of 2%. And, at about 125 months, the U.S. is charting its longest economic expansion since at least the 1850s.
Look under the hood, however, and things look very troublesome.
Numerous trade wars have cost U.S. companies, farmers and consumers dearly. The manufacturing industry – once America’s job engine and ostensibly the sector the trade war was supposed to supportis seeing its worst year since 2009.
And looking abroad, the situation is even worse, with the global economy slowing and the International Monetary Fund warning there’s little ammunition left to fight a recession.

The Corporate Debt Bubble

While that’s bad, we haven’t gotten to the scary part yet.

All American companies are currently sitting on a record US$15.5 trillion in debt, 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 key cause of the 2008 financial crisis was too much debt in the housing market, much of which ultimately went bad.
Today, the problem is in corporate America. Since 2008, when the Fed drove its target interest rate to a record-low 0.25%, markets have been flooded with cheap money. That was too much to resist for U.S. companies, which went on a borrowing binge.
All American companies are currently sitting on a record US$15.5 trillion in debt, 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.
The problem will come when the party stops – when interest rates begin rising and companies, particular the ones that took more risks, can’t refinance or pay back their debts. This is what turns a credit boom into a financial crisis, as happened in 2008.
The IMF estimates that half of corporate debt – excluding small businesses – is high risk, or junk rated, which has a much higher chance of default than investment grade debt.
What makes the situation even worse is that $660 billion of companies’ so-called leveraged debt is held in collateralized loan obligations 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.

The Downward Cycle

As this cycle spirals, it spurs rising unemployment, a drop in consumer spending, more bankruptcies and – if it’s not stopped – an economic recession. This is what happened in 2008 when subprime borrowers couldn’t pay back their mortgages in large numbers.
In other words, in this environment of high – and in some pockets highly risky – corporate debt and faltering profits, the slightest interest rate move in the wrong direction has the potential to transform debt into junk worth pennies on the dollar.
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.
If they don’t, we could be in for a world of pain.
About the Author
Andreas Kern, Associate Teaching Professor, Georgetown University
This article is republished from The Conversation under a Creative Commons license. Read the original article.
[activecampaign form=31]

DON'T MISS

Senate Rebukes Trump’s Tariffs as Some Republicans Vote to Halt Taxes on Canadian Imports

DON'T MISS

Supreme Court Sides With the FDA in Its Dispute Over Sweet-Flavored Vaping Products

DON'T MISS

Trump Announces Sweeping New Tariffs to Promote US Manufacturing, Risking Inflation and Trade Wars

DON'T MISS

Fresno Firefighters Save Dog From Canal and Now She’s Ready for Adoption

DON'T MISS

Big Brands Spend Just Enough on X to Avoid Musk’s ‘Naughty List’

DON'T MISS

Judge Dismisses Corruption Case Against New York City Mayor Eric Adams

DON'T MISS

State Center Trustees Render Split Decision on Future of PLAs

DON'T MISS

California’s Schools Chief Has a $200,000 Salary and a Side Gig

DON'T MISS

Why Project Labor Agreements Are Good for Our Schools and Students: Opinion

DON'T MISS

Trump Proposes Tax Deduction for Auto Loan Interest on US-Made Cars

UP NEXT

State Center Trustees Vote for Special Interest Giveaway Over Students: Opinion

UP NEXT

I Will Force Votes on Blocking Arms Sales to Israel: Sen. Bernie Sanders

UP NEXT

What Trump’s ‘Liberation Day’ Tariffs Could Mean for Americans: Fareed Zakaria

UP NEXT

Why the Nation Would Be Wise to Support a Third Term Amendment for Donald Trump

UP NEXT

If California Bails Out LA’s $1 Billion Budget Deficit, Beware the Slippery Slope

UP NEXT

Trump Has Had Enough. He Is Not Alone.

UP NEXT

The Real Crisis in California Schools Is Low Achievement, Not Cultural Conflicts

UP NEXT

Trump and Musk Are Suffering From Soros Derangement Syndrome

UP NEXT

CA Politicians Have an Irritating Habit of Ignoring the Downsides

UP NEXT

If Pete Hegseth Had Any Honor, He Would Resign

Fresno Firefighters Save Dog From Canal and Now She’s Ready for Adoption

12 hours ago

Big Brands Spend Just Enough on X to Avoid Musk’s ‘Naughty List’

13 hours ago

Judge Dismisses Corruption Case Against New York City Mayor Eric Adams

13 hours ago

State Center Trustees Render Split Decision on Future of PLAs

13 hours ago

California’s Schools Chief Has a $200,000 Salary and a Side Gig

14 hours ago

Why Project Labor Agreements Are Good for Our Schools and Students: Opinion

14 hours ago

Trump Proposes Tax Deduction for Auto Loan Interest on US-Made Cars

14 hours ago

Western US Sees Sharp Increase in Extreme Weather Impact

14 hours ago

Amazon Said to Make a Bid to Buy TikTok in the US

14 hours ago

Fresno Man Found Dead, Coroner’s Office Seeks Help Finding Family

15 hours ago

Senate Rebukes Trump’s Tariffs as Some Republicans Vote to Halt Taxes on Canadian Imports

WASHINGTON — The Senate passed a resolution Wednesday night that would thwart President Donald Trump’s ability to impose tariffs on Canada, ...

8 hours ago

Senate Minority Leader Chuck Schumer, D-N.Y., center, is joined from left by Sen. Tim Kaine, D-Va., Sen. Peter Welch, D-Vt., and Sen. Angela Alsobrooks, D-Md., as they speak to reporters about President Donald Trump's tariffs on foreign countries, at the Capitol, in Washington, Wednesday, April 2, 2025. (AP Photo/J. Scott Applewhite)
8 hours ago

Senate Rebukes Trump’s Tariffs as Some Republicans Vote to Halt Taxes on Canadian Imports

11 hours ago

Supreme Court Sides With the FDA in Its Dispute Over Sweet-Flavored Vaping Products

12 hours ago

Trump Announces Sweeping New Tariffs to Promote US Manufacturing, Risking Inflation and Trade Wars

A young Labrador mix rescued from a Fresno canal on Sunday, March 2, 2025, is thriving in a foster home after overcoming fear and trauma. (Instagram/Fresno Animal Center)
12 hours ago

Fresno Firefighters Save Dog From Canal and Now She’s Ready for Adoption

13 hours ago

Big Brands Spend Just Enough on X to Avoid Musk’s ‘Naughty List’

13 hours ago

Judge Dismisses Corruption Case Against New York City Mayor Eric Adams

13 hours ago

State Center Trustees Render Split Decision on Future of PLAs

14 hours ago

California’s Schools Chief Has a $200,000 Salary and a Side Gig

Help continue the work that gets you the news that matters most.

Search

Send this to a friend