Sovereign Debt and the Paradox of Low Bank Rates

For the time being, the financial markets have been somewhat calmed by news that the European Union would help the nation of Greece deal with its debt crisis. However, the calm may be short-lived, as concerns about other sovereign debts, such as those of Spain and Portugal, are not far from boiling over. Indeed, one can't help but look at the mounting U.S. debt and wonder just how much borrowing the market will bear -- or, how much any one borrower can repay.

Sovereign debt is like the mortgage crisis on steroids. Low interest rates have encouraged borrowing. Exotic financial instruments have helped mask the risk as borrowing became excessive. Eventually though, a day of reckoning comes. Only this time, nations are in danger of defaulting, not individual home owners.

If you've been frustrated with low savings account rates, money market rates, or CD rates, the sovereign debt crisis may be yet another reason to curse low bank rates. Depositors have already paid a price for low bank rates in the form of lost interest, and there may be an economic price to come.

Government bailouts of failed loans create a drag on the economy going forward. Losses on loans and loan-backed investments discourage future lending, even when it is for reasonable purposes. In short, the hangover for a decade of easy borrowing may be painfully slow economic growth.

This is the paradox of low bank rates. For years, the accepted wisdom has been that low bank rates stimulate the economy. Unfortunately though, they also make it possible for expanding debt burdens to create the illusion of growth, which now threatens economic growth going forward. It's clear now that low bank rates can contribute to a climate of unsustainable growth.

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