Thursday Thump – Suddenly Things Matter?

According to Business insider: Hoenig, who delivered a powerful speech today in Santa Fe blasting the Fed’s ongoing zero interest rate policy, lovingly known as ZIRP.  Hoenix acknowledges reasons why the Fed is in no rush to tighten: The job market isn’t so hot, the construction business is still horrible, and real estate has yet to come back to life.  But what Hoenig gets is that the current regime is a free lunch to Wall Street.  Hoenig says:

Low rates, over time, systematically contribute to the buildup of financial imbalances by
leading banks and investors to search for yield.  The Wall Street Journal article tells a story about the market coming back that also makes my point.  The search for yield involves investing in less-liquid assets and using short-term sources of funds to invest in long-term assets, which are necessarily riskier.  Together, these forces lead banks and investors to take on additional risk, increase leverage, and in time bring in growing imbalances, perhaps a bubble and a financial collapse.

I make no pretense that I, or anyone, can reliably identify and “prick” an economic bubble in a timely fashion.  However, I am confident that holding rates down at artificially low levels over extended periods encourages bubbles, because it encourages debt over equity and consumption over savings.  While we may not know where the bubble will emerge, these conditions left unchanged will invite a credit boom and, inevitably, a bust.