Too Low, Too Long: How zero-interest policy inflated the biggest bubble in human history

After the Great Financial Crisis of 2008-2009, central banks embarked on a period of monetary experimentation which has totally deformed modern capitalism to its core. The most understood elements of that experiment were the rescue of the banks. In late 2008, following the collapse and sale of Bear Stearns, US policy makers wrestled with how to stop 'contagion' from affecting the entire financial system. As the effects of the subprime crisis began to metastasize across Wall Street, the US government worried about moral hazard of continuing to rescue bank after bank, and as a result the US Treasury allowed Lehman Brothers to collapse in a disorganized bankruptcy, which acted as a true catalyst for the crisis.

The next day the 'credit crunch' began as interbank lending stopped, multiple banks around the world began to struggle to finance their balance sheets, and the world entered a full blown financial panic. The US Congress and the Federal Reserve were ultimately able to re-capitalize the US banks with $700B in funds provided by the US taxpayer, and the Federal Reserve began their Troubled Asset Relief Program whereby the exchanged cash for billions in toxic financial products.

Following the stabilization of the crisis, the US economy began a free fall as not only did the housing industry face serious challenges in the wake of the subprime crisis, but the US economy as a whole began to struggle in an environment of limited access to capital. Having weathered the crisis, banks were not lending to anyone but the most creditworthy borrowers and as a result the economy crashed. To shore up the economy, the US Congress passed the Recovery and Reinvestment Act which was designed to support state and local governments. As property taxes made up much of the revenue for local governments, the housing collapse dramatically reduced the tax receipts of those governments and they would have laid off millions of civil services to balance their budgets. The stimulus package was in the end, mostly a backstop.

After the $700B TARP 'bailout', and an $800B stimulus program, Congress had little appetite for additional spending programs as the size of the national debt began to create political challenges. As a result the Fed took over the role of stimulating the economy.

With the economy on the brink of a deflationary spiral, the Fed felt they had aegis to stimulate the economy through less conventional means. The experiment described as Quantitative Easing, is easily described as the central bank prints new money to buy assets, usually government debt with the goal of injecting money directly into the economy. From 2009 to 2014, the Fed bought more than $2T in mortgage-backed securities and US Treasuries, directly injecting a tremendous amount of capital into the economy and aiding the recovery.

The Fed, while stimulating the economy, was also offering a deal of a lifetime to business. They could borrow money for free.

The Fed had dropped interest rates to zero in an effort to shore up the credit markets and encourage businesses and individuals to borrow money to stimulate the economy. This worked dramatically well, as the amount of corporate debt began to skyrocket.

Unfortunately, by 2014 when QE3 began to ebb, corporate debt was already hitting new highs. Rather than begin to wean business off of cheap money, the Fed struggled to maintain a balance. Every time the Fed would try to raise rates, the stock market would react with a 'taper tantrum' because increase costs of debt would slow future growth. As such, the Fed continued to take a very dovish tone on interest rates, and in Europe, central bankers at the ECB were flirting with negative interest rates and what they dubbed QE Infinity, the idea that the ECB will print money indefinitely to stimulate the economy.

From 2014-2018, the zero-interest rate policy (ZIRP) created huge bubbles. In markets that hadn't seen a collapse in housing post the subprime crisis, prices skyrocketed. In countries like Netherlands, Australia and Canada, house prices began rising 20+% YoY as free money flooded the market.  

With such monumental returns, other buyers began flooding into the market hoping to flip homes for quick money, and this process continued until 2017 when the bubble began to peak.

As 2018-2019 began to saw the inevitable decline in home prices, governments around the world were looking for ways to stabilize their housing markets to avoid another US-style market crash. Central bankers are also concerned that with so much free capital and easy access to debt, that when the next recession hits, there will not be any tools available to government to stabilize and stimulate the economy, 

The same logic has applied to the stock market, where financial companies and individuals  have been actively buying stocks through a tremendous bull market led largely by ZIRP.