Zero Interest Rates as a Risk-Forcing Mechanism

Zero interest rates force capital up the yield curve into higher risk. As Christopher Leonard argues in The Lords of Easy Money, when interest rates are held near zero, short-term Treasuries offer negligible nominal returns and negative real returns after inflation. In other words, holding risk-free assets leads to a gradual erosion of purchasing power. This creates an incentive for investors to pursue higher yields, which necessarily involves taking on more risk. In some cases, this shift is not merely optional: many institutional investors operate under fixed return targets and liability obligations that cannot be met with near-zero risk-free yields.

A clear example is pension funds and insurance companies in the 2010s buying into Collateralized Loan Obligations (CLOs). CLOs bundle leveraged loans issued to multiple companies, often originated or sponsored by private equity firms such as KKR and Apollo. While these loans carry meaningful default risk, conservative institutional investors were effectively pushed toward such instruments in order to achieve positive real yields in a zero-rate environment.