When Interest Rates Rise

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Long-term interest rates are now unsustainably low, implying bubbles inthe prices of bonds and other securities. When interest rates rise, as theysurely will, the bubbles will burst, the prices of those securities will fall,and anyone holding them will be hurt. To the extent that banks and other highlyleveraged financial institutions hold them, the bursting bubbles could causebankruptcies and financial-market breakdown.

The very low interest rate on long-term United States Treasury bonds is aclear example of the current mispricing of financial assets. A ten-yearTreasury has a nominal interest rate of less than 2%. Because theinflation rate is also about 2%, this implies a negative real interest rate,which is confirmed by the interest rate of -0.6% on ten-year Treasury InflationProtected Securities (TIPS), which adjust interest and principal payments forinflation.

Historically, the real interest rate on ten-year Treasuries hasbeen above 2%; thus, today’s rate is about two percentage points below itshistorical average. But those historical rates prevailed at times when fiscaldeficits and federal government debt were much lower than they are today. Withbudget deficits that are projected to be 5% of GDP by the end of the comingdecade, and a debt/GDP ratio that hasroughly doubled in the past five years and is continuing to grow, the realinterest rate on Treasuries should be significantly higher than it was in thepast.

The reason for today’s unsustainably low long-term rates is not a mystery.The Federal Reserve’s policy of “long-term asset purchases,” also known as“quantitative easing,” has intentionally kept long-term rates low. The Fed isbuying Treasury bonds and long-term mortgage-backed securities at a rate of $85billion a month, equivalent to an annual rate of $1,020 billion. Since thatexceeds the size of the government deficit, it implies that private markets donot need to buy any of the newly issued government debt.

The Fed has indicated that it will eventually end its program of long-termasset purchases and allow rates to rise to more normal levels. Although it hasnot indicated just when rates will rise or how high they will go, theCongressional Budget Office (CBO) projects that the rate on ten-year Treasurieswill rise above 5% by 2019 andremain above that level for the next five years.

The interest rates projected by the CBO assume that future inflation willbe only 2.2%. If inflation turns out to be higher (a very likely outcome of theFed’s recent policy), the interest rate on long-term bonds could becorrespondingly higher.

Investors are buying long-term bonds at the current low interest ratesbecause the interest rate on short-term investments is now close to zero. Inother words, buyers are getting an additional 2% current yield in exchange forassuming the risk of holding long-term bonds.

That is likely to be a money-losing strategy unless an investor issagacious or lucky enough to sell the bond before interest rates rise. If not,the loss in the price of the bond would more than wipe out the extra interest that he earned, evenif rates remain unchanged for five years.

Here is how the arithmetic works for an investor who rolls over ten-year bondsfor the next five years, thus earning 2% more each year than he would byinvesting in Treasury bills or bank deposits. Assume that the interest rate onten-year bonds remains unchanged for the next five years and then rises from 2%to 5%. During those five years, the investor earns an additional 2% each year,for a cumulative gain of 10%. But when the interest rate on a ten-year bondrises to 5%, the bond’s price falls from $100 to $69. The investor loses $31 onthe price of the bond, or three times more than he had gained in higherinterest payments.

The low interest rate on long-term Treasury bonds has also boosted demandfor other long-term assets that promise higher yields, including equities, farmland, high-yield corporate bonds, gold, and real estate. When interest ratesrise, the prices of those assets will fall as well.

The Fed has pursued its strategy of low long-term interest rates in thehope of stimulating economic activity. At this point, the extent of thestimulus seems very small, and the risk of financial bubbles is increasinglyworrying.

The US is not the only country with very low or negative real long-terminterest rates. Germany, Britain, and Japan all have similarly low long rates.And, in each of these countries, it is likely that interest rates will riseduring the next few years, imposing losses on holders of long-term bonds andpotentially impairing the stability of financial institutions.

Even if the major advanced economies’ current monetary strategies do notlead to rising inflation, we may look back on these years as a time whenofficial policy led to individual losses and overall financial instability.

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关键词：interest inter Rates Inte Rate interest holding extent

Rehiring Retirees as Consultants Is Bad Business
Why would any organization set up a system that discourages experts from sharing their business-critical knowledge?  
Obviously, no leader deliberately set out to do such a thing. Yet it happens all the time when companies make a practice of hiring back retirees as consultants to perform the same functions they did before, at higher pay.  
Prior to 2008, GE Global Research Center (GEGRC) followed this process.  A scientist or engineer would retire from the organization, wait the mandatory six months, and then field a call from a former manager with an offer to re-engage. The corresponding consulting fees, combined with their pension, generated an income not too different from the person's pre-retirement salary, with far fewer hours worked. In HR groups around (and beyond) the company, this scenario was the norm. Retirees were simply another, albeit expensive, form of contingent labor. And the arrangement seemed like a win-win. The retiree satisfied financial and personal goals while the organization reinserted someone with unrivaled knowledge and expertise into a project and took its time sourcing  replacement talent.
So what was wrong with this picture? For one thing, at GEGRC, internal analysis predicted a potential tsunami of retirements hitting the two top technical levels between 2008 and 2013.  That meant a costly practice could get prohibitively expensive.  Worse, the rehiring agreements were structured only to provide project continuity, not to retain or transfer knowledge. After all, why would a soon-to-be or recent retiree want to impart his smarts? Most wanted to be paid, and to be missed, when they eventually quit for good.
Not all the knowledge in the head of every departing employee is valuable, of course.  Some may be outdated or strategically irrelevant. But at GEGRC and many other companies, increasing numbers of Baby Boomers walking out the door are taking a lot of valuable deep smarts  — that is, business-critical, experience-based knowledge about not only technical issues but also "soft skills" like customer relations, project management, creative team leadership and stakeholder management  — with them. That can be devastating to competitive advantage.  
Ironically, the financial downturn of 2008 gave GEGRC an opportunity to change. In an effort to reduce costs, the organization forbade re-hiring of retirees in 2009. An outcry ensued, of course, but management and HR began to face the painful fact that they had been aiding and abetting a vicious cycle of capability dependency and knowledge loss.
For a while, would-be retirees simply stayed on longer than they had planned. And it was that lull in departures which allowed the organization to redesign some of its incentives, practices and culture. It launched a significant knowledge-sharing program drawing on some of the advice outlined in this article and set up a phased retirement program, offering flexible work schedules and leaves of absence to spend more time with family or to winter in a warmer climate. GEGRC still has a handful of returned retirees, but a condition of rehiring is that they agree to teach and mentor others or otherwise contribute to the long-term capabilities of their successors. They are not permitted to merely resume their preretirement roles.
Companies must work harder to make sure retirees pass on their valuable knowledge. Until more do, they will continue to undermine their own long-term capabilities.

Long-term interest rates are now unsustainably low,implying bubbles in the prices of bonds and other securities. When interestrates rise, as they surely will, the bubbles will burst, the prices of thosesecurities will fall, and anyone holding them will be hurt. The very low interest rate on long-term United StatesTreasury bonds is a clear example of the current mispricing of financialassets.(overestmation)
The reason for today’s unsustainably low long-termrates is not a mystery. The Federal Reserve’s policy of “long-term asset purchases,”also known as “quantitative easing,” has intentionally kept long-term rateslow.

Investors are buying long-term bonds at the currentlow interest rates because the interest rate on short-term investments is nowclose to zero. In other words, buyers are getting an additional 2% currentyield in exchange for assuming the risk of holding long-term bonds.The low interest rate on long-term Treasury bonds hasalso boosted demand for other long-term assets that promise higher yields,including equities, farm land, high-yield corporate bonds, gold, and realestate. When interest rates rise, the prices of those assets will fall as well.

The Fed has pursued its strategy of low long-term interest rates in thehope of stimulating economic activity. At this point, the extent of thestimulus seems very small, and the risk of financial bubbles is increasinglyworrying.

The US is not the only country with very low or negative real long-terminterest rates. Germany, Britain, and Japan all have similarly low long rates.And, in each of these countries, it is likely that interest rates will riseduring the next few years, imposing losses on holders of long-term bonds andpotentially impairing the stability of financial institutions.