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Is rising debt a threat to the U.S. economy?

Former Fed Chair Janet Yellen thinks it could be

Photo (c) JONGHO SHIN - Getty Images
The stock market has been a wild roller coaster since October as traders sell stocks just as soon as they rally. Analysts blame the headlines -- China, the Fed, and political turmoil -- for the uncertainty roiling the market.

Another underlying factor is concern about rising government, corporate, and consumer debt at a time when interest rates are also going up. It was a concern former Federal Reserve Chairwoman Janet Yellen raised this week, suggesting another financial crisis is possible in the future.

Speaking at an event at City University of New York (CUNY), Yellen expressed concern with highly leveraged loans by banks, which are at the heart of the financial system. When banks make leveraged loans, a drop in the value of the collateral can put the lender’s solvency at risk.

Seeds of the 2008 crisis

That’s what happened during the 2008 financial crisis when financial institutions bought too many securitized subprime mortgages. When the mortgages went into default and the homes went into foreclosure, the bonds lost much of their value.

Regulations were put into place after the crisis to make banks stronger. Major banks had to hold more of their money reserves to reduce risk. But Yellen is worried the push in Washington is to roll back much of that regulation.

“I think things have improved, but then I think there are gigantic holes in the system,” Yellen said. “The tools that are available to deal with emerging problems are not great in the United States.”

The housing market is in much better shape than in the past, but banks have other areas of exposure. When oil prices began to rise two years ago, banks increased lending to U.S. shale producers who had been largely sidelined after Saudi Arabia flooded the market with oil.

But oil prices have dropped sharply in the last few months, meaning some of these oil producers who have borrowed heavily to finance their operations may struggle to repay the loans.

Rising corporate debt

Then, there’s corporate debt. During much of the decade, the Fed kept interest rates near zero percent and corporations borrowed heavily to buy back their stock and expand their operations. Now that interest rates are rising again, the cost of those loans is rising.

“With over $9 trillion of corporate debt on the balance sheets, that’s concerning,” CFRA Research’s Lindsey Bell told CNBC this week, suggesting the debt could threaten the nearly 10-year-old bull market in stocks.

Consumers are doing their fair share in running up debt levels as well. A new NerdWallet study of household debt shows U.S. consumers are now paying on a total of more than $13 trillion in debt.

With a robust job market, consumers may be handling that debt level at the moment, but NerdWallet’s Kimberly Palmer says credit card rates are still going up, making interest payments more costly.

Credit card debt is still one of the most expensive types of debt, and carrying the current average balance of $6,929 could cost $1,141 per year in interest.

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