Second Wave of Financial Crisis?

Jim Bianco warns, "Punishingly High" Interest Rates Coming in Second Wave of Financial Crisis:

As this week's earnings show, banks are once again printing money, lots of it; and most economists believe the recession is a thing of the past, even if jobs are still hard to come by.

Unfortunately, Jim Bianco President of Bianco Research in Chicago thinks this might be the eye of the storm rather than the dawn of a new day. "My fear is, history shows, we might have a second leg to the financial crisis in [the form of] a sovereign debt crisis."

The crisis is of course already visible in Greece where yields on their 10-year government bonds just hit a record high as Europe works out a bailout package for the heavily indebted nation. Meanwhile, in Portugal - another one of Europe's so-called PIIGS - bond yields are also spiking, fueling suspicion the debt crisis may spread.

With huge federal deficits, this something the U.S. also needs to worry about. "I'm not suggesting the U.S. is on the verge of defaulting," Bianco says, but the market is already signaling it's hesitation to lend to the government. Two-year notes sold by Berkshire Hathaway Inc. in February yielded less than U.S. Treasuries of similar maturity; the same is true of paper issued by Procter & Gamble, Johnson & Johnson and Lowe's, Blooomberg reports.

As growing budget crises in states and municipalities from California to New York come to a head, Bianco fears it will be too much for the Treasury to bear. "If one of these municipalities has to borrow from [the federal government] they're all going to have to borrow from them, pretty much on the same day," he speculates.

If that happens, Bianco is confident you can bet on "very high, punishingly high interest rates for the economy." And that storm may cause even more damage than the first.

The big fear is that there is so much leverage in the bond market right now, that when rates do start to rise, watch out, it could get real ugly, real fast.

Why should we be concerned about rising rates? Go back to read Paul Krugman's comment on Greece, where he ends with this ominous warning:

Equally important, however, we need to steer clear of deflation, or even excessively low inflation. Unlike Greece, we’re not stuck with someone else’s currency. But as Japan has demonstrated, even countries with their own currencies can get stuck in a deflationary trap.

What worries me most about the U.S. situation right now is the rising clamor from inflation hawks, who want the Fed to raise rates (and the federal government to pull back from stimulus) even though employment has barely started to recover. If they get their way, they’ll perpetuate mass unemployment. But that’s not all. America’s public debt will be manageable if we eventually return to vigorous growth and moderate inflation. But if the tight-money people prevail, that won’t happen — and all bets will be off.

Let's hope the liquidity party continues. If rates rise too high, too soon, we're in deep trouble. Watch out, the second half of 2010 is getting more interesting. Are pensions prepared for a second wave of financial crisis? If not, it will be another bloodbath.


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