Interest-Rate Risk's Ticking Time Bomb: News Analysis

It is not outlandish to expect the fiscal cliff to be the start of America’s sovereign debt problem that just won’t go away.

That’s not how Americans currently view the problem. We had a debt ceiling crisis in the summer of 2011 that ended when politicians crafted a legislative compromise that included an expiration of Bush-era tax cuts and across-the-board spending cuts. The agreement also created a joint select committee – remember the “supercommittee”? – that was supposed to come up with more nuanced revenue hikes, spending cuts and tax and entitlement reform that would avoid the pain of sequestration.

The not so super committee utterly failed to reach any agreement and the country waited a year, post-election, for the president and the current lame duck Congress to solve the problem. As we know, only Sunday and Monday remain as working days and so far there’s no deal in sight.

In any event, what may seem to Americans as an annual budget crisis, recurring at the end of each year, could starting now morph into a more European style perma-crisis.

Of course, the Fed has no intention of raising rates any time soon, but markets can raise rates. The rise in rates on Greek bonds is what lit the fuse of Europe’s economic crisis after all.

A year ago, when S&P lowered its credit rating on U.S. government debt, the stock market fell 5.6% in a single day. But the other shoe – the bond market – never dropped. With Europe deep in crisis and stock markets worldwide falling, U.S. Treasuries were ironically seen as a safe haven.

We can’t assume that will recur. Markets make unexpected moves. A bond market crash could occur if ratings firms move to downgrade U.S. debt after the fiscal cliff goes unresolved; or perhaps the market will crater if an ultimate tax on the wealthiest Americans brings in little (or declining) revenue, as has occurred in the U.K. recently.

Rising long-term interest rates could have devastating consequences for all the banks and insurance companies that have been lured by the Fed into buying bonds. The value of their portfolios would tank. For consumers buying mortgages or borrowing at today’s cheap rates, these are the best of times for debt.

But suddenly and unexpectedly, we may be entering a time when debt is as cool as another failed Euro-summit.