A bond bubble?

We’re now very familiar with the term housing bubble. First, housing prices doubled from 1997 to 2006, but then they crashed and had a big role in causing the recession. Now, some people are worrying about another possible bubble for bonds. What does this mean? N.C. State University economist Mike Walden responds.

“Well first, a bond is an investment, a very standard investment where you purchase a bond for a certain amount of money, and then you get a fixed interest rate on that bond.

The point is today interest rates on bonds are very low. People, however, are still buying them because most bonds tend to be a fairly safe way of investing, and many people also get bonds indirectly through their mutual funds.

Now here’s the problem. With interest rates very, very low — in fact, historic lows — many experts think eventually those rates are going to go up. And some think they’ll go up a lot — maybe double or triple in the next five to six years.

If that happens then someone who owns a bond that was issued with a low interest rate — let’s say one or two percent — they’re going to find the value of that bond is going to go way down. That is, if they tried to sell it, people would not only offer them much less because obviously they could buy new bonds and pay much higher interest rates.

This is the bond bubble that some investment people worry about. They worry that when interest rates rise, all those hundreds of millions, hundreds of billions of dollars of bonds that people are holding that are paying low interest rates are going to suffer big losses.

Now, this all hinges on an expectation of higher interest rates. And many economists have been saying higher interest is around the corner for many years, and interest rates have not yet risen. But nevertheless, this is something that people owning bonds should be aware of and should watch.”