Suppose you were driving a car that careened toward a cliff and stopped as it went half on, half off the edge and swayed. You want to get out but, if you try, the delicate balance may shift and you could easily die.
Enter Ben Bernanke, or any of his several successors. The White House posts its offering: Fed chairman to replace dangling driver wanted.
Would you apply? Would you trust anyone who does? I didn't think so.
Such is the inevitable fate to follow an easing of the Federal Reserve Board's $85 billion bond buying program, or its phase out of ridiculously low interest rates. Many people, including us modestly supported retirees, have fled the bond market in anticipation of these outcomes.
Many years ago, when I lawyered the world's first interest-rate futures contracts, I learned that existing bonds decline in value when interest rates rise. As a mathematics illiterate, I found that phenomenon to be bizarre, but true. No one will buy a bond with a 2% coupon when a new bond in the same amount is offering a 4% coupon, unless you reduce the old bond by an amount that turns its coupon into a 4% rate.
Either Ben or his successor will face this problem when interest rates begin to rise to historically normal levels. Existing Treasuries, private bonds, mortgages — you name it — will sink like a rock.
With mortgages, many banks will only lend if they can promptly sell the loans to Fannie Mae, Freddie Mac, or a private firm that bundles the mortgages into securities and sells them to investors. They know what could happen if they kept the risk.
No, before we select a new Fed chairman, we should interview former military personnel who acted as bomb detectors in hostile lands, especially those who tapped their boots on the ground to "find" improvised explosive devices, assuming that any of them survived. Meanwhile, I would not wish the job on my worst enemy.