Zero Percent Rates: Fueling Risky Financial Decisions

Zero interest rate policy (ZIRP) brought about the "cheap money" era that drove people to make risky financial decisions.

Authored by James Bollen

Zero interest rate policy (ZIRP) was a central bank monetary policy. Rates were kept at, or near, zero. The consequence was that people had to take on more risk to get a return on investment.

What Was ZIRP?

Zero interest rate policy (ZIRP) was an unconventional policy that central banks in the United States, Europe, and Japan took in an attempt to stimulate the economy. ZIRP was a monetary policy that central banks used to respond to the financial crisis.

In the United States, the Federal Reserve implemented a zero interest rate policy (ZIRP) as a response to the 2008 financial crisis.

Japan was one of the first countries to use ZIRP. Japan’s central bank implemented ZIRP to respond to the fall in asset prices. Japan’s central bank used ZIRP for a decade. The decade would be known as the Lost Decade. ZIRP failed to resolve Japan’s problems of deflation and stagnation.

The goal of ZIRP was to kickstart the economy again by using low-interest rates, close to or at zero, to incentivize more significant investment. A consequence of ZIRP was money directed toward startups and new tech companies that showed potential, even if they were operating at a loss.

Risks Of ZIRP

There are economic risks that come with ZIRP. Zero interest rates create liquidity traps. Zero interest rates are often implemented too late as a policy. ZIRP leads people to invest money in riskier asset classes.

Central banks lag behind the market. Central banks are a centralized institution that controls the monetary system by dictating monetary policy and managing a nation's money supply. The risk of being behind the market means that a central bank may implement a policy too late, cause unintended consequences in the financial markets and economy, or a policy may harm people and investors.

Interest rates are the price of money. That is why interest rates are vital in financial markets as a market signal. Central banks control interest rates. They, therefore, control the price of money. Central banks created an era of “cheap money” with ZIRP.

The Era Of “Cheap Money”

Cheap money is when a person or a company can get a loan or line of credit at a low rate. Savings accounts would also have low interest rates. Low rates encourage borrowing.

Savings accounts were at near zero. Money could not go to work in a savings account. Investors would look anywhere to put money to get a return on an investment.

Borrowers seek ways to leverage money when rates are low. Investors become speculators to find ways to make a profit. Companies do not need to be productive or provide a product or service since they can receive valuations by including the right buzzwords.

Startup companies were given high valuations. A startup did not need to have a viable product or service that had been brought to market. The startup just needed an appealing name to market itself and sell its idea. Venture capitalists or a more prominent company may then buy the company outright.

A startup or company that marketed itself as tech, tech adjacent, or as a growth company would draw attention and investors. “Tech” merely needed to be somewhere in a company’s mission statement to attract venture capitalists or to get retail investors to invest.

A company could lose revenue but still be considered a good company if it is IPOed on the stock market. WeWork is now a classic example of the “cheap money” phenomenon that ZIRP brought about.

Source (Screenshot): Yahoo Finance, “WeWork Inc. (WEWKQ).

ZIRP created artificial bubbles in tech, growth, real estate, and startups. A bubble must eventually pop. ZIRP's “good times” drove people to speculate in ever-riskier assets.

Cheap money. Artificial good times in the economy. Risky financial decisions by retail investors and companies until eventually, the ZIRP party would be over.

While in college, I heard an advertisement on the Denver radio (when I was not listening to music) that High Times was planning to go public on the stock market. I was not familiar with investing in the time. The sales pitch sounded promising. I decided to invest some money into the company.

The company was working on an IPO. I did not know what an IPO was at the time. I was busy reading books to pass tests in college. Almost a decade later, the company never went public on the stock market.

High Times received a New York Stock Exchange (HTHC) ticker symbol. According to Seeking Alpha, High Times is now defunct on the stock market. The IPO failed to go public. The company was able to get money from investors through its marketing campaign.

Investors become speculators. Investors and companies misallocated valuable capital in the pursuit of making more money. ZIRP normalized risk for companies and investors.

How Zero Percent Interest Rates Drove People To Risky Investments

Central banks zero interest rate policy (ZIRP) made it normal to accept risk. It drove people to direct money toward riskier investments.

I was not aware of ZIRP when I was in college in the early 2010s. Startups were all the rage in college. The show Shark Tank also became popular. Shark Tank encouraged startup culture during the era of ZIRP. People wanted to be the next person to make millions from their startup idea.