With stocks currently at extreme valuations and near all-time highs, let’s take a moment to revisit history and debunk a few common myths along the way.
Let’s focus on the Global Financial Crisis (GFC) from 2007 to 2009 (see chart below). While the GFC was undeniably painful, from both a historical and statistical perspective, it wasn’t as severe as it could have been.
Debunking the Myths of the 2007-2009 Financial Crisis: Interest Rates and QE
Myth #1: Lowering interest rates stopped the market decline.
This is easily debunked. The bear market officially began in October 2007 and bottomed out in March 2009. The Federal Reserve had already started cutting interest rates steadily between August 2007 and December 2008, yet stocks continued to lose value during this period.
Myth #2: Quantitative Easing (QE1) immediately halted the market’s fall.
This myth is also false. While QE1 began in November 2008, the bear market had started in October 2007 and didn’t find its bottom until March 2009. Stocks continued to decline for four more months after QE1 was implemented. By March 2009, the Fed already had $1.75 trillion in bank debt, mortgage-backed securities, and Treasury notes on its balance sheet—a staggering amount at the time.
So, what finally stopped the stock market from freefalling? It wasn#t interest rate cuts or QE1, but rather the suspension of FAS Rule 157, which required banks to value their assets using “mark-to-market” accounting methods. They privately suspended that rule to save Citi along with half a trillion dollars guarantees. That gave the signal to Wall Street to get ready for the bottom in November and a few months later they suspended mark to market for everyone.
Stocks hit their bottom on March 9, 2009. The Financial Accounting Standards Board (FASB) had been under intense pressure from Congress to suspend Rule 157, which they finally did on April 2, 2009.
When people suggest that lowering interest rates or increasing liquidity through QE automatically leads to better stock performance, understand that this view is either based on ignorance or a deliberate misrepresentation of historical facts.
