Interest rates on the United States’ ten-year Treasury bond recently hit 3 percent, which should be regarded as historically low. Instead, a decade after the financial crisis began, it’s remarkable for being that high, and economic and financial experts can’t agree on whether this new rate portends a brewing economic miracle or a looming economic crisis. What it really reflects is a conundrum: the economy is doing well, but in large part because Americans have borrowed too much, too fast, and at too-low rates—and a real risk exists that normal interest rates will kill this debt-fueled boom. In the decade after the 2008 debt-based meltdown, the U.S. still hasn’t kicked its addiction to borrowing.
Interest rates are a useful signal, but no one knows what message higher rates are sending now or how they will affect the broader economy. One view is that the Fed is raising rates because the economy is good, and such hikes directly impact Treasury rates. Another view is that the way in which rates are rising—faster on short-term rates than on long-term—could foreshadow a recession. Indeed, growth slowed in the first quarter of 2018.
In either case, the 3 percent mark is a milestone. Though rates have fallen back over the past week, they have not been this high, on a sustained basis, in nearly seven years. It’s hard to believe now, but from the 1960s through the beginning of the financial crisis, Treasury rates never fell below 3 percent, and they were often several percentage points above that. It’s natural to think that if the economy didn’t collapse with 6 percent interest rates in, say, 1995, it won’t do so today—but this time, as they say, is different.
The U.S. didn’t learn the right lessons from the financial crisis. After powerhouse investment bank Lehman Brothers collapsed on September 14, 2008, experts focused on complexity: financial engineers had created obscure instruments, from credit-default swaps to complex securities, backed by subprime mortgages. Nobody really understood these creations—even the smart people who made them, sold them, and bought them. Things fell apart, and the financial industry needed the simplest, bluntest instrument of all—federal government intervention—to bail it out, along with the rest of us.
Complex financial instruments disguised how the country was drowning in debt, making the debt look safer than it was. In 2000, American households had borrowed $7.2 billion—or $8.8 billion in 2007 dollars. By 2007, they owed $14.2 billion—a 61 percent increase in real terms. The market message that the broken financial system tried to send in the fall of 2008 was that debt levels were unsustainably high. Washington decided to solve the problem with more debt. The Federal Reserve not only lowered interest rates to zero but also bought trillions of dollars of bonds to force rates even lower. (When the Fed buys bonds, it pushes the price up, driving rates down.) Congress and then-President Obama (who took office in January 2009) preserved the solvency of Fannie Mae and Freddie Mac—formerly quasi-federal mortgage companies that became wards of the state after 2008— so that they could do more lending to homebuyers, at record-low rates. The government encouraged low-interest car loans and credit-card lending, too. The goal: use low interest rates to get people to borrow even more.
Eventually, the blitz worked. After falling steadily, if modestly, for three years, household debt levels started inching up again, fitfully, in 2011. As of the final quarter of 2017, household borrowing stood at $15.3 trillion—just shy, in inflation-adjusted dollars, of what it was in 2005, the year before the housing bubble peaked.
Two things have changed since then—and not in a good way. Though Americans are now spending less of their income on debt—about 10.3 percent, down from roughly 13 percent between 2005 and 2008—they didn’t use the period of super-low rates to reduce their debt, which means that they’re vulnerable to higher rates. Yes, most people locked in their mortgage rate for 30 years. But if they plan to sell their house before then, they’ll likely rely on a buyer who needs the same low rates to maintain house prices.
And people haven’t locked in low credit-card rates. Credit-card debt stands at an all-time high of $787 billion, according to Experian; including other short-term loans with terms mimicking those of credit cards, this figure now tops $1 trillion. Auto-loan rates, too, aren’t locked in beyond the five-year term for a new car—and outstanding auto debt now totals $1.1 trillion, above its pre-crisis peak. As interest rates go up, can people continue to borrow as their own costs rise? It’s not an academic question. The average credit-card rate was below 12 percent before the Fed began increasing rates; now it’s close to 15 percent. Auto-loan rates, similarly, were less than 4.2 percent three years ago; now they’re above 4.8 percent.
The economic activity that this debt finances is real—but fragile. As rates rise, fewer people can buy new cars. And though it’s hard to know the extent of the problem, many people use their credit cards to supplement their income. The New York Times reported last fall on the case of a retired Brooklyn woman who finances her monthly expenses on “more than a dozen credit cards. Her prescription medication often goes on a Capital One card. She pays for groceries with one from Discover services.” She “struggles each month to make the minimum payments.”
As with the mortgage crisis of a decade ago, people with lower incomes and less financial sophistication tend to rely upon unwise financial strategies. They’re not the only ones, though. Many six-figure earners in New York, New Jersey, and Connecticut look affluent to the outside world but are busy figuring out how long they can juggle $20,000, $30,000, or more in revolving-credit debt. As this borrowing grows more expensive, they, too, will reduce their spending, with a real economic impact.
Before 2008, the federal government had ample wiggle room to borrow in a crisis. In 2007, the federal government—that is, taxpayers—owed $7.5 trillion in today’s dollars; today, it owes $16.5 trillion. That borrowing did not buy us the modern infrastructure that we need to support a growing economy and population, or wean us from private-sector debt. In the next crisis, President Trump or his successor could find himself having to slash spending and raise taxes during or just after a recession, the worst time to do so. And when the next crisis hits, we may not have the luxury to borrow ourselves into recovery, as we did last time.
The ten years since the meltdown have seen seismic political and cultural shifts, as the 2016 election demonstrated. Americans are far more skeptical of the status quo than they were a decade ago. But in terms of the imbalances plaguing the U.S. economy, we could turn back the clock and see little difference between then and now.
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