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What Keeps Sheila Bair Up At Night (And Why You Should Care)


Sheila Bair, former head of the FDIC, says that along with our failure to fix and deal with the issues that caused the 2008 credit crisis, interest rate risk and the unintended consequences of a zero interest rate policy (ZIRP) are her major concerns going forward.

What she’s talking about here is solvency. Meaning, in a rising interest rate environment high loan-to-value debtors’ payments could increase (on the interest side) to the point the debtor could no longer afford to repay their debts. This presents the debtor as insolvent, forcing a default and/or bankruptcy. So, who are these debtors that could default if interest rates suddenly took off? Hmmm, let’s see… how about, the federal government, state and local governments, all the major banks, pension funds, and retirement plans, along with thousands of corporations. And yeah, millions of individuals as well.

Aside from some ‘black swan’ fat-tail risk trigger event (like a war, an assassination, a major bank failing, etc.), this is, in my estimation, the most realistic and likely cause of a full-scale global economic collapse. Why? It is the mathematically accurate corrective action for the current scenario (increasing debt increases risk which results in higher interest rates), therefore, it – regardless of politics or public wants or needs – cannot be avoided forever.  Interest rates will rise. When they do, you better be ready.

To combat this mathematical eventuality in the hopes they can somehow otherwise figure out how to dodge the bullet (hint: they can’t and they won’t), the Federal Reserve has continued, and will continue (“To infinity and beyond!“), to do everything in its power (by artificial rate manipulation and continued borrowing/printing) to keep interest rates below this unknown cataclysmic trigger rate. So what is the rate we should be afraid of? Some economists put this ‘to hell in a hand basket’ rate as low as 3% – 5%.  Which, for context, is well within what was considered ‘normal’ fewer than 10 years ago. To be sure, if that happens, all hell breaks loose.

That said, even if we somehow muddle through without allowing a collapse we will ultimately have to deal with the “unintended consequences” of a (decade or more?) zero-interest rate policy. Which, simply put, means we get  more debt, higher deficits, a further devalued currency, crippling inflation and/or stagflation, depressed lending, continued capital/savings destruction, and greater mal-investment of existing capital into non-productive ‘investments’ (i.e. – consumption). Yeah, that sounds fun.

The entire video is worth watching, as is ‘Capital Account’ in general. But just these two points above are enough to hammer home the reality that all is not well on the economic home front. While the world is currently pretending the ‘fiscal cliff’ is important, the worst, as they say, is yet to come.

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