Monday, February 23, 2015

Another day, Another IMF Work Paper Warning on Asset Bubbles

Just add this new work paper to the long list. IMF work papers don't reflect actual IMF policy or official opinion, but the IMF is publishing this white paper which means the content is viewed as worthwhile to consider. This one is titled "Asset Bubbles: Re-thinking Policy for the age of Asset Managment." 

It is yet another analysis of the potential dangers of asset bubbles and why they still exist. This paper concludes that financial incentives for investment managers lure them into "asset bubble riding."

Here are some paragraphs from the concluding remarks section of the report:

By process of deduction, this paper seeks to offer an explanation for why asset bubbles have posed—and will likely continue to do so—a threat to economic stability despite financial markets being characterized by more complete information, a greater array of securities through which to express views, and a more pronounced impact of sophisticated institutional investors, than ever before.

The arguments advanced here suggest other candidate explanations for the persistence of bubbles, such as limits to learning, frictional limits to arbitrage, and behavioral errors, are unsatisfactory (by themselves at least) as they are inconsistent with the aforementioned trends sweeping across global capital markets.

By contrast, investment manager incentives, the nature of the principal-agent relationship, and the growing presence of institutional investors, are all entirely consistent with the persistence of financial bubbles. Importantly, this explanation does not require a baseline assumption of widespread irrationality in the conventional sense.

Simply put, it can be entirely rational— from the perspective of business and compensation risk—for asset managers to knowingly ride bubbles because of benchmarking and the short-term performance appraisal periods often imposed on asset managers by asset owners.

This is a fairly lengthy report, but the portion underlined above summarizes things pretty well. The paper says asset bubbles exist now and likely will continue to do so in the future due to financial incentives to investment managers to "ride bubbles."

The IMF and the BIS have completely covered themselves if we do get another financial crisis. They have analyzed and warned on this situation over and over and over again. We have documented that here on this blog by providing direct links to the reports. Unfortunately, the media gives these reports almost no attention and almost no one even knows they exist. But they are out there on the record and they are documented here for anyone willing to read them.

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