This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

Low Interest Rates Get Sharp Look as Cause of Great Recession

NEW YORK ( TheStreet) -- A theory out of academia is putting more blame on low interest rates for greasing the skids to the near-collapse of the U.S. banking system in 2008 and the worst economic slide since the Great Depression.

And it could happen again if banks and financial regulators aren't careful.

The theory is being pushed by Robert S. Marquez, a business professor at the University of California, Davis.

Banks and economists weren't aware of the interest rate fiasco as it was unrolling, Marquez says, and never saw the disaster that would decimate the economy.

"It wasn't until after the crisis that people, including policymakers as well as academic economists, started realizing that the level of interest rates may induce particular bank behavior," said Marquez, at the UC Davis Graduate School of Management. "Prior to the crisis, few expected that low interest rates for extended periods were problematic and could have led to bank failures as there was very little, if any, guidance on this issue."

Before the economic tsunami, banks were more than OK with the concept of easy money and "significantly expanded their loan portfolios," Marquez notes, and raised the stakes by extending credit to high-risk borrowers lured by lower rates.

But when the financial system overloaded and borrowers experienced heavy liquidity problems, they couldn't repay those loans, sending banks into a death spiral that required taxpayer rescue.

You can blame banks for playing a huge role in the Great Recession, but it seems financial institutions just can't help themselves when it comes to leveraging low rates to make a buck. "Reduction in real interest rates, such as occur as part of a monetary expansion, lead banks to increase their leverage and expand their loan portfolios," Marquez says.

Ordinarily, that might not be a big problem, but banks generate too much heat by extending credit to customers who "are less likely to repay their loans in full."

That kick-starts a financial cycle in which banks put themselves and their depositors in peril. They take on more risk and significantly heighten their odds of imploding.

The solution?

Marquez is calling for "strict enforcement" of sturdier equity-to-debt ratios inside banks and, in a more emotional sense, having banks step away from the brink when tempted by "over-loaning" to riskier customers in low-interest rate environments.

"To the extent, however, that low-interest rate periods may sow the seeds of future crises, care needs to be taken in balancing the two objectives of price and financial stability," he said.

Find the entire report here. It's a good read, and a much-needed flashing yellow light on the perils of easy money in a low rate environment.

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free
AAPL $117.81 0.00%
FB $105.45 0.00%
GOOG $750.26 0.00%
TSLA $231.61 0.00%
YHOO $32.94 0.00%


Chart of I:DJI
DOW 17,798.49 -14.90 -0.08%
S&P 500 2,090.11 +1.24 0.06%
NASDAQ 5,127.5250 +11.3820 0.22%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs