This time is not different!

 Share an epic write-up about the history of the rate hike and the consequence. While history may not repeat itself, it often rhymes! 

 

This dismal pattern began a few years after the Forgotten Depression. As a new speculative boom took hold during the second half of the decade, the Fed started raising rates sharply in early 1928, ultimately reaching a peak of 6% in 1929.

But it wasn't until October 1929 – roughly two years from the start of that tightening cycle – that the stock market began its historic plunge (the Dow would go on to drop 89% before bottoming in 1932). And it was still another year after that before the Great Depression went global in early 1931. That's when Austrian bank Creditanstalt – one of the largest and most important banks in Europe – collapsed, setting off a deflationary crisis that quickly spread across the continent.

The 1960s and '70s saw this cycle repeat several times.

In mid-1967, in an effort to fight inflation, Fed Chair William Martin began an aggressive tightening cycle. In just over two years, he more than doubled the federal-funds rate from 3.75% to nearly 10%.

Yet, it still took another 10 months – and three years in total – before trouble began. Economic shockwaves followed the failure of railroad giant Penn Central, at the time the largest corporate bankruptcy in history. Since the railroad controlled a third of the nation's passenger trains and a majority of freight traffic in the Northeast, its collapse created significant economic and financial market fallout.

In addition to the obvious disruption of interstate trade and significant losses among the company's many pensioners, the collapse triggered a liquidity crisis in the short-term corporate-debt market that nearly bankrupted renowned investment bank Goldman Sachs.

Martin's successor – the much-maligned Arthur Burns – presided over a similar tightening cycle a few years later.

Despite his legacy of being "soft" on inflation, the Burns Fed aggressively raised rates from less than 4% in early 1972 to a whopping 13% in July 1974. And it was not until October 1974 – nearly three years into the tightening cycle – that his Fed finally relented.

In that cycle, the central bankers feared the recent collapse of Franklin National Bank, the largest bank failure in U.S. history at that time, could trigger a financial crisis (much like the failure of Lehman Brothers several decades later).

Regulators quickly stepped in – orchestrating the first federal wind down of a major financial institution in history – and Burns cut rates back down to 5% to ease financial conditions, even as inflation remained high.

Even famed inflation fighter Paul Volcker was a victim of this lag.

As many recall, Volcker held rates as high and as long as necessary to defeat inflation – rapidly pumping up the fed-funds rate above 20% by 1981.

But when Volcker finally gave up his fight in 1984 – again, roughly three years after his final tightening cycle began – it was not because inflation had been defeated. Consumer prices would continue to rise between 4% and 6% annually – well above the Fed's target – for much of the next decade.

Rather, Volcker began cutting rates following the near-failure of Continental Illinois National Bank – the country's largest commercial and industrial lender and arguably the first "too big to fail" bank – that threatened to trigger a financial crisis that spring.

Most notably, Volcker's successor, Alan Greenspan, played a role in multiple such cycles in the following decades. Those lags culminated in the "Black Monday" stock market crash in October 1987, the savings-and-loan crisis in the early 1990s, the dot-com boom and bust in the late 1990s, and ultimately, the 2000s housing bubble and the great financial crisis that followed.

And despite all that history could have taught him, former Fed Chair Ben Bernanke – who took over the reins from Greenspan in 2006 – was most famously fooled by the lag.

In a speech in March 2007 – almost three years after the start of the Fed's most recent rate-hike cycle – Bernanke assured Congress that the growing problems in the subprime mortgage market were "contained" and unlikely to impact the "broader economy and financial markets."

Of course, we now know that the worst financial crisis since the Great Depression was already brewing, and the Fed would begin cutting rates in a panic just a few months later.

Bernanke's misplaced confidence is among the biggest blunders in modern financial market history. But as we've seen, virtually every Fed chair – along with most investors and market pundits – has made similar mistakes in every tightening cycle in U.S. history.

P.SB