Cheap money can lead to very expensive lessons. Unfortunately, the time between an era of cheap money and the expensive lesson can be long, so we do not often make the important connection.
There are two problems here: one, investors don't realize that there is a disconnect between cheap money and expensive lessons, and two, the learning of this lesson is confounded by the delay between the event and consequences. We learn quickly when the time difference between cause and effect is short. If there is a delayed response, learning is slow. A quick feedback loop is a "kind" learning environment, while a long lag will often be called a "wicked" learning environment.
Cheap money means that we will accept projects that have a lower return based on the assumption that cheap money will last forever. When the market moves back to normal, investors will be holding lowering returning projects that can only be sold at a loss. If cheap money exists for a longer period of time, investors get used to it or in some cases get addicted to it. They will not be prepared for more expensive money. The reach for yield at lower absolute levels must be reversed. Remember just a few years ago, there was well over a trillion dollars of global government debt at negative rates. That seems like ancient history.
The key banking problem is that financial institutions were living off cheap deposits that can move anywhere for higher yields. The flow could be to larger banks or to MMF that do reverse repos with the Fed which causes a reduction of reserves. Those cheap deposits funded longer term assets at low yields. Now, the cheap money game is over, so banks must adjust and reprice their low yielding asset portfolios.
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