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The Potential Bubble the Federal Reserve Cares Most About

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It is not unreasonable to think that the ongoing academic study of the Great Depression of the 1930s, the stock market collapse of 1987, and the bursting of the “dot com” bubble in the late 1990s, would lead to a financial and banking sector that is well prepared to avoid having negative history repeat itself. Then came the Wall Street collapse of 2008, the increased rate in the growth of government and government debt, and the continuing stagnant economy which has left us with a work force size equal to that of 1978. “Put not your trust in princes,” the Psalmist said, and he could’ve easily added, “nor in the great minds of banking and finance.” Read the excerpted article below from Five Thirty Eight Economics and see if you don’t have an easier time imagining a conversation between meteorologists back in Noah’s time when it started to rain and it seemed like it was never going to stop.

By Andrew Flowers

In the aftermath of the 2008 financial crisis, economists debated whether the Federal Reserve should be involved — at all — in pricking bubbles. The housing bubble, and subsequent financial crisis, had led to a disastrous result: Hundreds of banks had failed and millions of Americans had lost their jobs. At the time, many still believed the emergence of future bubbles could only be prevented through financial regulation, and not through interest rate hikes.

Today, however, as interest rates remain at historically low levels and are expected to stay low at least into next year, there is growing concern among investors, economists and central bankers that a new bubble has emerged, and that increased regulation isn’t enough to stop it. Led by a powerful Fed governor, there’s a growing call for the Federal Reserve to raise interest rates to prevent this bubble from growing.

So what bubble are we talking about? It’s not the one you might expect.

Most of us worry about bubbles in housing and stocks because that’s what we own. But those markets are not really what worries the Fed the most. Central bankers are more concerned about the far bigger, but less sexy, bond market. That’s because a bubble exploding in this market could lead to another devastating financial crisis.

Today’s low interest rates have encouraged companies, home owners and investors to borrow money. With all this money sloshing around, economists have become increasingly worried about speculation — that these companies, home owners and investors are making riskier bets with their borrowed money — and rising levels of indebtedness.

The Fed lowered short-term interest rates to nearly zero in 2008, and they have yet to budge. The Fed has even signaled that it plans to keep interest rates at very low levels “for a considerable time” after it ends its bond-buying program; and, as the economy gains momentum, it will refrain from raising rates “for some time.” Extremely low short-term interest rates have fed through to lower long-term rates, as seen in mortgage rates and Treasury yields.

In this low-interest-rate environment, economists have been paying closer attention to bubbles.

Read more: FiveThirtyEight.com

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