What if LT goes over 8%?

What if Long Term rates go over 8%? [¹]

By Rick Bookstaber | 26 October 2007

What if Long Term rates go over 8%?

It might seem now that it was in a different world, but it was in this one, and in fact it was in the United States. Traders watched their bank of broker screens as the 30-year Treasury dropped below 8% for the first time in their youthful memory. That was in the 1980s. I was working at Morgan Stanley at the time, and someone on the Treasury desk made a trade for his own account just so he could frame the ticket from that momentous event. Yes, interest rates can go above 8%. In fact, at the time an 8% rate seemed quite reasonable.

I mention this because over the past decade or so we have constructed a financial landscape where an 8% interest rate not only is hard for us to envision, but where it would be disastrous. The reason is the huge stock of adjustable rate mortgages. Looking at the dislocations that are coming about from the subprime problems and the related credit crunch, it is hard to fathom the effect on the housing market and the overall economy if all those remaining homeowners with various flavors of adjustable rate mortgages saw rates shoot up hundreds of basis points. I don’t know how to quantify the effect, but I would hope that there are researchers at the Fed who do. And I would bet that the implications are pretty scary. Maybe so scary that the Fed would start buying LT bonds, to keep interest rates down, for fear of triggering a populist revolt otherwise.

[ Normxxx Here:  In the '70s, when rates shot up, most mortgages were fixed-rate, so the institutions that bore the brunt of the rapidly increasing interest rate were the savings and loan banks, and we all know how that turned out!  ]

Of course, now all of the discussion is about possible Fed loosening. So I am worrying about something that is not even on the radar screen? [[But LT interest rates have not come down very much— and may not, if our foreign investors decide to leave us as they did in August.: normxxx]] And can anyone envision a scenario where a substantial increase in interest rates would make sense from an economic standpoint, but where the Fed finds its hands tied because the costs to homeowners would be just too great? [[For example, a precipitous drop in the value of the dollar?: normxxx]]

Normxxx    
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