… in a negative real interest rate environment.
There’s an issue that Paul Krugman raises in “Strange Arguments for Higher Rates” that merits a response. Krugman asks rhetorically:
Are we to believe that an interest rate change that matters not at all to firms making real investments somehow has huge effects on speculators?
To which I can only respond: Yes! The speculators are often financial intermediaries and other financial players who exist on spreads. The whole point of raising interest rates is to restrict the access of the financial system to free financing and thereby reduce the quantity of punts taken on risk assets. Furthermore, because a 1% increase is likely to affect the spread much more dramatically than the real economy’s debt payments, of course, speculators respond more dramatically than non-financial firms.
Synthetic Assets 
I believe below you argue that, as loan cash flows can be sold/monetized for a premium, higher premiums have a large effect on money velocity. Therefore, and increase in rates would have an impact not just on carry-trader spreads, but on velocity directly by impacting securitization volumes. The resulting drop in velocity is part of what continues to hold back nominal growth, and it is the reason why monetary policy is now constrained in its effectiveness: they will have to push much harder to engage the monetary transmission mechanism, and therefore create more inflation tail-risk. In general, I think “velocity” is a poorly-understood concept, as most seem to think of it as a stable residual of some econometric model.
I saw something like this velocity dynamic with originators like New Century. As rates rose in 2004-2006, the premiums received from loan sales fell (they fell for competitive reasons as well). As a result, they had an incentive to book more and more loans on balance sheet (securitizations structured as financings). In quarterly conference calls, the company would discuss that they made explicit trade-offs between selling loans and booking them depending on the sale premium. As they booked more loans, they became more exposed to credit losses, and this ultimately led to bankruptcy (along with outright fraud).
BTW, along with Macro Resilience, I think your blog presents amongst the most original ideas I come across. Thanks for writing.
I’ll have to think over your comments on velocity — I’m one of those who poorly understand the concept.
What was underlying my thoughts is this. The economy is in such a bad state that real investment opportunities are in very short supply. Making funds available does not create good investment opportunities — it just creates a lot of liquidity that ends up going into speculative activity.
In my view in 2004-6 when rates were being raised, “financial innovation” was used to continue speculative activity even as it was becoming unprofitable due to collapsing interest rate spreads. This process was supported by flawed AAA ratings (that made it possible for New Century to increase originations) and culminated in the creation of the CPDO — an obviously flawed product, as evidenced by news reports at the time of its creation.
In the current regulatory environment, I don’t think that banks will be so successful in delaying the consequences of rising interest rates on their ability to finance speculation.