Root cause of current asset buble

Root cause of asset bubble

The Fed fund were kept low for too long

It all started in 2000 when Federal Reserve chairman Alan Greenspan; faced four challenges that caused near deflation. 

  1. Bursting .com bubble in March 2000
  2. Cyclical recession in March 2001 
  3. 9/11 Attacks that generated 40 billion in insurance losses and 7.5% stock decline in one day and closure of the stock market
  4. China membership to WTO in Dec 2001 that opened the market to the cheap labor that put downward pressure on prices ever since

The customer CPI in 2001 was 1.5%, the lowest since 1986. The CPI rosed to 2.83% in 2002 but dipped again to 1.88% in 2003. In response, the annualized effective Fed fund rate declined from 6% in Jan 2001 to 1.8%. 

Greenspan kept fund rate below 2% till Feb 2004 to stop the deflation. However, the three years stretch of sub 2% Fed funds 2001-2004 was too low too long. Cheap money flowed into the housing market and resulted in the housing bubble and subprime mortgage crises that exploded in 2007.