Corporate bond sales are at their lowest levels in a decade. On one level, that is a good thing: corporations are doing what individuals are doing–and government is not doing–and relying less on debt and more on equity for their operations.
Still, that does not bode well for an economy that depends on debt for its very existence.
As I–and others–have pointed out, debt is becoming more expensive. It does not matter that the Fed keeps rates at zero; you could set the Fed Funds Target Rate at -50%, and that hardly guarantees that banks will lend. This is because banks are only intermediaries between investors and borrowers.
The only reason you or I can borrow money at a bank, is because investors are laying down the bucks. Those investors are individuals, pensions, brokerage houses, hedge funds, even counties, states, and countries.
When/if investors start demanding higher rates and lower prices for the bonds, that will cause borrowers to have to pay more for their money. If a mortgage rate for a 30-year fixed is 4.8%, a spike in interest rates can easily cause that mortgage rate to double. (Some folks–who are old enough to remember–can recall when mortgage rates approached 20% in the early 1980s.)
If interest rates approached such levels–which would require a spike of about 15%, or 1500 basis points–it would be nothing short of catastrophic. Banks have entire departments–called Asset and Liability Management (ALM) teams–that spend their entire time developing mathematical models for different interest rate scenarios. Most banks will develop ALM policies that hedge against interest rate spikes of 400, perhaps as much as 500, basis points. Very few–if any–are prepared for a spike higher than that.
This is because, as interest rates spike that high, the cost of hedging against interest rate risk also rises.
What does that mean in English?
(1) If you make $70,000 per year–and have a mortgage of $150,000 at 6%, with 20 years remaining, and no credit card debt–you are okay as long as you can keep making that $70,000 per year. (Your monthly payment is just south of $900 per month, not including taxes and insurance.)
(2) Let’s say, however, that due to economic stresses, interest rates double–making the borrowing costs for your employer more expensive. This will cause massive layoffs in both public and private sectors.
(3) Let’s say that, due to these factors, you are able to find another job, but your best offer is, say, $40,000. You are now making 57% of what you were making before, but your debt load has not changed. That $900 per month is now almost 30% of your gross income. That’s before insurance. That’s before property taxes. That’s not including ordinary expenses. That assumes nothing about whether you are married and/or have children. That assumes nothing regarding health insurance.
With lower income and no reduction in terms of debt, it’s harder to save money. If you must sell the house, higher interest rates will cause the your selling price to fall. If you are upside down–owing more than the home is worth–you may be forced into a “short sale”, which–if you cannot cover the difference out of pocket–will burn your credit badly. If you relocate and seek to purchase a new house, your rates will be high, as will be the required down payment.
On a mass scale, that means (a) less borrowing, (b) less economic activity due to higher borrowing costs, (c) more layoffs, as businesses seek to stay afloat, (d) more mortgaged homes in foreclosure/short sale situations, (e) tighter lending practices, and (f) more pressure on government to cut spending.
That least part–(f)–is what Denninger and others are warning about. I call it the “Top Gun” dilemma: government has written too many checks that the body of taxpayers cannot even come close to cashing.
If you are I do that with credit cards, eventually the creditors will come knocking. At that point, we must either find a way to pay up, or declare bankruptcy and face the music, but we will not be able to continue spending on credit.
This is because you can only spend on credit, if others are willing to lend to you. Once they decide that the gig is up, your reckoning draweth nigh.
When will investors in Treasurys make this decision? I don’t know. But if I were a betting man, I’d wager that it will happen within 5 years, during which time we will see wild spikes and crashes in the stock markets.
As for the political ramifications, that is anyone’s guess. The scenarios can range from outright fascism to secessionist libertarianism and some combination of both.