A week before the Federal Reserve cut interest rates in September, to 2 percent, President Trump took to Twitter to call Fed board members “Boneheads” and exhort them to “get our interest rates down to ZERO, or less, and we should then start to refinance our debt. INTEREST COST COULD BE BROUGHT WAY DOWN.” Though he may rue Trump’s unorthodox method of lobbying the central bank, Fed chief Jay Powell is inching toward doing what the president wants—and the Fed may as well get accustomed to doing the dirty work of the executive and legislative branches, no matter who’s in power. The global financial system is as fragile as it was back in 2007, when signs of the financial crisis started to emerge. Yet there’s no political appetite for a massive legislated bailout, à la the Troubled Asset Relief Program, or TARP, that Congress passed in late 2008, to ease the crisis. The next time around, in other words, the Fed could end up acting on its own—or become the political scapegoat for elected leaders’ failings.
How brittle is the financial system? The week after the Fed cut rates, it released its quarterly report on outstanding debt. American individuals, businesses, and government owe more money than ever before—up about 25 percent from 2008, an increase that far outpaces the roughly 8 percent population growth during that period. For the second quarter, total debt outstanding was $53 trillion—up from $42.7 trillion in 2008 (adjusted for inflation) when the financial crisis hit. Much of this increase—$9.4 trillion—was federal borrowing. But not all. Though households owe less money on mortgages than they did 11 years ago (due mostly to massive defaults), they owe far more on student loans, cars, credit cards, and other consumer credit: $4.1 trillion, or nearly $1 trillion more than back in 2008. Companies owe nearly $10 trillion, $2 trillion more than they owed back then.
The systemic risk here is not clever bankers making up funny-sounding financial instruments (though they still do that). It’s that people and companies owe so much that the financial system can’t withstand the slightest hint of higher interest rates. Sure, your 30-year mortgage may be locked in at record-low rates. But Americans’ $1 trillion in credit-card debt, as well as trillions of dollars in short-term corporate debt, is not locked in, making it highly sensitive to rate hikes. The Fed isn’t boxed in by Trump’s tweets, in other words, but by a decade’s worth of its own actions, in keeping rates artificially low.
Signs abound that the real-world distortions of cheap money are worrying previously impervious investors. Manhattan real estate, for example, has long been regarded as a safe haven for global money—yet 20 percent of the condos built in New York City over the past half-decade are unsold. Similarly, WeWork, an Uber-type “unicorn” company that loses billions of dollars a year but had been able to borrow enormous sums, postponed its initial public offering after potential stock buyers balked, seeing the company as overvalued (and its CEO has since stepped down). What if investors, newly frightened at the prospect of pouring money into money-losers like WeWork, Uber, Lyft, and overvalued, empty real estate, walk away from capital markets altogether? Despite Trump’s exhortations, the Fed’s normal tool to spur economic growth—cutting interest rates—may not bring them back. Historically, when investors fear losses in the private sector, they put money into Treasury bonds, lowering interest rates even without Fed action. The U.S. could end up borrowing at record-low, even negative, interest rates; with so much money flowing into treasuries, the private sector would be essentially cut off from cheap credit or equity.
The Fed, then, would face pressure to intervene directly in debt-starved private markets—corporate bond markets, for example, or credit-card-debt markets—to keep rates on these instruments down, too. There’s precedent: Europe and Japan do a version of this, and the Fed itself did it after 2008, purchasing hundreds of billions of dollars’ worth of mortgage-backed bonds. Congress, in the 2010 Dodd-Frank law, superficially curtailed the Fed’s ability to do it—but, if you read closely, Congress didn’t close it off. The Fed can lend to specific markets in an “emergency,” as long as it lends “broadly” to “solvent” entities—three malleable words.
The U.S. hasn’t had truly free capital markets in decades. Whole swaths of the economy, such as housing and student loans, are determined by government policy. If a reckoning is on the horizon, it will come not as the result of any presidential jockeying but from the effects of over a decade of cheap money.