Let’s ignore another warning from the BIS. Do we enjoy paying for burst bubbles?

Summary: As one market after another drifts off into bubble valuations, a few institutions warn of the consequences. As usual (we’ve done this so many times), we ignore them — our passivity and ignorance earning our role as the deep pockets paying for the resulting damage. This post looks at a few of the warnings from the venerable Bank of International Settlements — the “world’s oldest international financial organization”, the central banks’ central bank.

For more about this see How we’ve become accustomed to bubbles bursting the economy, instead of fighting them.

This is post #3,000, with over 5.5 million page views since opening in Nov 2007.

 

The BIS gives us yet another warning about the increasing prevalence of asset price bubbles in our financial system: “Asset Bubbles: Re-thinking Policy for the Age of Asset Management“. A excerpt appears at the end of this post, but the message should be obvious to all by now. Earlier analysis by the BIS pointed to the dangers of rising leverage (traditional buying on margin plus and endless array of derivatives) coupled with expansive monetary policy — and (although they can hardly mention this) little regulation of banks).  This report (carefully labeled as not representing BIS views) warns of structural factors encouraging speculative buying (e.g., herding and trend-following by investment managers). After all, it’s not their money.

It’s an enlightening report, typical of the BIS. It carefully avoids more than gentle questions about central banks’ role in this, especially the “put” (price guarantee) they’ve created on prices of financial assets. On the other hand, let’s be grateful for any warnings we get. Although we’ll ignore them, as we did during the housing and tech bubbles. FAILure to learn is an expensive vice.

Previous warnings from the BIS

These are unusually blunt warnings from an institution such as the BIS. Of course they know better than most that nobody is listening because the game must continue while there is money to be made by the financial industry. It’s the public’s role afterwards to politely write checks for the damage.

William R. White (former CIS chief economist)

“I see speculative bubbles like in 2007.” (Interview, 11 April 2014)

 

Bank of International Settlements

BIS Annual Report, 29 June 2014

Financial markets have been exuberant over the past year, at least in AEs {advanced economies}, dancing mainly to the tune of central bank decisions (Chapter II). Volatility in equity, fixed income and foreign exchange markets has sagged to historical lows. Obviously, market participants are pricing in hardly any risks. … Overall, it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally.

… Despite the euphoria in financial markets, investment remains weak. Instead of adding to productive capacity, large firms prefer to buy back shares or engage in mergers and acquisitions. And despite lacklustre long-term growth prospects, debt continues to rise. There is even talk of secular stagnation.

… As history reminds us, there is little appetite for taking the long-term view. Few are ready to curb financial booms that make everyone feel illusively richer. Or to hold back on quick fixes for output slowdowns, even if such measures threaten to add fuel to unsustainable financial booms. Or to address balance sheet problems head-on during a bust when seemingly easier policies are on offer. The temptation to go for shortcuts is simply too strong, even if these shortcuts lead nowhere in the end. The road ahead may be a long one. All the more reason, then, to start the journey sooner rather than later.

BIS Quarterly Review, 14 September 2014

By fostering risk-taking and the search for yield, accommodative monetary policies thus continued to support elevated asset price valuations and exceptionally subdued volatility.

… There are also signs that investor confidence in the continuation of low volatility and ample funding at low rates has encouraged market participants to take increasingly speculative positions on volatility in derivatives markets.

Bubbles

Excerpts from the latest warning

Asset Bubbles: Re-thinking Policy for the Age of Asset Management“, Bradley Jones, BIS, 11 February 2015.

Summary

… In distilling a vast literature spanning the rational — irrational divide, this paper offers reflections on why asset bubbles continue to threaten economic stability despite financial markets becoming more informationally-efficient, more complete, and more heavily influenced by sophisticated (i.e. presumably rational) institutional investors. Candidate explanations for bubble persistence — such as limits to learning, frictional limits to arbitrage, and behavioral errors — seem unsatisfactory as they are inconsistent with the aforementioned trends impacting global capital markets.

In lieu of the short-term nature of the asset owner-manager relationship, and the momentum bias inherent in financial benchmarks, I argue that the business risk of asset managers acts as strong motivation for institutional herding and ‘rational bubble-riding.’ Two key policy implications follow. First, procyclicality could intensify as institutional assets under management continue to grow. Second, remedial policies should extend beyond the standard suite of macroprudential and monetary measures to include time-invariant policies targeted at the cause (not just symptom) of the problem. …

Introduction

… The transmission mechanism between asset markets and the economy is generally well understood. Asset booms that compress risk premiums to abnormally low levels can lead to a misallocation of resources; induce excessive consumption, investment and debt accumulation; distort derivative markets commonly used to manage risk; and give an impression of false health for private and public sector balance sheets.

As boom gives way to bust, the ensuing chain reaction can include: a negative wealth effect (stemming from a hit to the balance sheet and confidence of households and firms) which results in sharply reduced aggregate demand; a second round credit crunch, as banks respond to the decline in the value of collateral held on their balance sheet by tightening lending standards; and possibly sovereign-banking sector contagion, where the health of the sovereign balance sheet is impaired due to a collapse in tax revenues and bank recapitalization costs, with feedback effects for banks which are exposed to sovereigns in their asset holdings and as their funding costs derive from the sovereign borrowing rate.

In extreme cases, severe asset price busts can also give rise to longer-term issues of intertemporal equity as future taxpayers become liable for ‘crimes they did not commit.’ More generally, the global financial crisis demonstrated that the adverse effects of financial disruptions on economic activity can be far worse than previously anticipated; with 93 countries (and most advanced economies) recording outright declines in real GDP in 2009, globally synchronous busts are especially virulent.

… One of my central arguments is that the business risk of rapidly growing asset managers lends itself toward herding and ‘rational bubble-riding,’ and that even in the absence of leverage, this industry will tend to contribute to procyclicality and financial instability. It should perhaps serve as a shot across the bow that the rise of the institutional investment management industry — populated with what are presumably the most sophisticated, well resourced and rational speculators in the world — has coincided with three of history’s largest bubbles in the last 25 years: the Japanese Heisei bubble of the late 1980s, the global equity bubble of the late 1990s, and the structured credit bubble of the mid 2000s. Because asset bubbles have continued to pose a threat to financial stability despite the increasing sophistication and institutionalization of financial markets, conventional explanations for bubbles — such as information shortages (‘limits to learning’) and incomplete markets (‘frictional limits to arbitrage’) — no longer seem a complete or useful guide. …

Conclusion

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.

For More Information

  1. Larry Summers gives us the bad news. Worse, the only solution is more of the same.
  2. The new tech bubble takes us to a new world. A mad world.
  3. A guide into the weird numbers that run our world, describing both financial bubbles & climate change.
  4. Lessons from WWI about “markets” ability to see the future. (spoiler: often they don’t).
  5. Let’s ignore another warning from the BIS. Do we enjoy paying for burst bubbles?
  6. How we’ve become accustomed to bubbles bursting the economy, instead of fighting them.

 

43 thoughts on “Let’s ignore another warning from the BIS. Do we enjoy paying for burst bubbles?

  1. If one lends by buying a bond from a borower and the bond has zero coupon and infinite duration that is not a loan it is a gift. If a central bank does the lending this way the transaction is effectively a helicopter drop of central bank money onto the recipient of the cash used to purchase the bond. We have been moving in this direction for some time now. Duration of central bank near zero coupon bond purchases are increasing with the beneficiaries being the FIRE sector. Looked at from this perspective we are already defacto doing a targeted helicopter drop onto a selected cohort. When central bank intervention by asset purchases started no one looked at it this way. Now that we are in year six of zero Fed funds rate and duration of CB purchases climbs and BOJ is buying index funds many are seeing the truth.

    1. Peter,

      “We have been moving in this direction for some time now. Duration of central bank near zero coupon bond purchases are increasing…”

      Where do you get your news about economics? It’s often wrong. As is this. Fed assets are aprox $4.5 trillion. Of that $2.4 T are gov’t-guaranteed mortgage-backed securities plus $1.8 T in Treasuries.

      The amount of low yield Treasury securities (i.e., a maturity less than one year) is almost zero.

      http://research.stlouisfed.org/publications/usfd/page10.pdf

    2. True. I should have said if a CB opens its discount window to selected agents and sets the discount rate to zero and holds that rate at zero for prolonged periods like six years and counting for the Fed, those agents are receiving a gift. As the number of years with this policy grows this gift becomes absolute and is equivalent to a helicopter drop to the privilege group.

    3. Peter,

      “I should have said if a CB opens its discount window to selected agents …”

      Where do you get your information? It’s consistently quite wrong.

      The Fed borrows from banks and buys treasuries and mortgages. Bank reserves at the Fed are massive, and the Fed pays banks on these dollars.

      Only banks in distress borrow from the Fed at the Discount Window. Outstanding loans are now only $17 million.
      http://www.federalreserve.gov/releases/h41/current/
      http://www.federalreserve.gov/newsevents/reform_discount_window.htm

    4. Peter,

      “Now, I think it may be the overnight reverse repo window. Never underestimate the virtuosity of banks when it comes to obfuscating and dissembling the sources of Fed largesse.”

      It’s a waste of time to give you facts, as you just come back with more gibberish. You’re just making stuff up, the 3rd round of this. Please either start citing sources with your assertions, or I will moderate future comments. No further warnings.

      The article you cite, which I assume you found by mindless use of Google, refers to events a quarter century ago.

    5. Yea, loans that can have a significant negative rate. Loans only available to selected institutions. Loans with total extended
      capped at 0.3 $trillion notional for now. I’m definitely learning as I go here FM. Trying to follow the money. Sorry.

    6. Peter,

      Almost everything you have said in this thread has been factually wrong. When that was pointed out, you replied with another falsehood. As you have here. The Fed is not offering loans to anyone at negative rates.

      I’m moderating your comments, since you are wasting everybody’s time with your arrogant misinformation. Only those citing authoritative sources or questions will be posted.

    7. I finally understand the disconnect. When the current bubble bursts there will once again be a freeze of liquidity as for example money market funds refuse to buy assets due to counterparty risk. Again the Fed will have to step in and provide liquidity. The Fed is publishing paper studies on which broader classes of assets it might buy in this scenario. The Fed already owns slightly less than a third of all Treasuries. One problem the Fed has is being front run by investors. The Fed knows this but there is little they can do. By wading into the markets the Fed moves them. We are not in a crisis now. We are in a bubble. When the bubble pops the Fed will act to save the banking system again. The Fed will buy assets again, loan at zero or negative interest again, and ultimately come closer to owning everything just like the BOJ has done. If we are going into recession the Fed will already be starting these activities and I’m thinking out loud how this might be happening right now.

    8. Peter,

      “When the current bubble bursts there will once again be a freeze of liquidity as for example money market funds refuse to buy assets due to counterparty risk.”

      On what basis do you say this? That did not happen after the tech bubble burst in 2001, or the real estate bubble in the late 1980s (that knocked down the S&Ls). You assume that 2008 will repeat, which seems unlikely. The money market funds are now quite tightly regulated.

    9. Peter,

      “the Fed already owns slightly less than a third of all Treasuries.”

      Almost every one of your comments makes a false statement easily disproven by a look at the St Louis Fed’s weekly report of “US Financial Data“. In this case: the Fed owns 18% of publicly held Treasury securities. Where do you get all this misinformation? Why do you ignore people who point this out to you? Sad, really.

  2. Bubbles, bubbles everywhere

    Bloomberg interviews Thomas von Koch, managing partner at EQT Partners (the largest buyout firm in the Nordic region).

    “There are financial bubbles being built up and how they’ll be solved, I don’t know,” Thomas von Koch, managing partner at EQT Partners in Stockholm, said in an interview. “The problem is global, not just for Europe. It’s the asset bubbles in general that concern me. It’s wherever we look.”

    Charting a path through markets today poses challenges most portfolio managers haven’t faced before. Economic theory taught us to expect hyper-inflation when money costs nothing; instead we now face the threat of deflation. “I can virtually toss those textbooks in the fire,” said von Koch.

  3. From the last BIS report:

    “…asset bubbles continue to threaten economic stability despite financial markets becoming more informationally-efficient, more complete, and more heavily influenced by sophisticated (i.e. presumably rational) institutional investors”

    I wonder if this phenomenon, one in which we have increasingly specific and nuanced knowledge of a wide variety of systems across many different fields of study, is related to the increasing unpredictability of markets and events happening in the world. I know FM has been writing over the past couple of years about how we have entered a time in history without precedent and how models, while useful, cannot be totally relied upon for predicting future outcomes.

    Do you think it’s a case of “The theory alters that which it describes” in which new and sophisticated methods of action in turn increase the levels of complexity of the environments in which said actions are conducted?

    And congrats on your 3000th post!

  4. AK’s observation parallels Nouriel Roubini’s suggestion that the reason for the vast increase in asset bubbles and financial crashes since the 1990s has been the introduction of cheap high-powered desktop computers into financial markets and into companies. Roubini points out that this effectively lets financial managers and speculativde traders and corporate accountants run immensely complex programs over an over again using different large data sets, tweaking the algorithms and data sets, until they get the answer they want. The corporate accountants then proclaim this phony number to be their annual profit; the speculative traders an financial managers then proclaim this phony algorithm “the golden ticket to profitable trading” an sucker in gullible dupes to invest with them.

    By the time the truth comes out and markets crash, the corporate accountants and hedge fund traders and financial managers of course have long since fled the scene with their golden parachutes.

    Statistician Tim Harford has been pointing out for years now that the holy grail of “big data” that so many data scientists an financial traders and information brokers (like the people at Google) have been showering with praise is far from the magic bullet its booster claim. See Harford’s article “Big problems with big data,” financial times magazine, 28 March 2014.

    The act that 80% of all Wall Street trades are now algorithmic automated high-frequency trades bodes ill for the next bubble, methinks.

    1. Thomas,

      I don’t understand why that is an explanation.

      People ran investment bubbles quite easily without computers, as any conman can explain. There is no reason to believe that telling stories is easier waving computer printouts rather than pretty charts or word salads.

  5. Incidentally, British banker Walter Bagehot foresaw these kinds of speculative excesses in the aftermath of very low-interest-rate policies back in 1876, when he wrote the classic Lombard Street:

    The history of the trade cycle had taught me that a period of a low rate of return on investments inexorably leads towards irresponsible investment … People won’t take 2 per cent and cannot bear a loss of income. Instead, they invest their careful savings in something impossible – a canal to Kamchatka, a railway to Watchet, a plan for animating the Dead Sea. — Lombard Street, 1876.

    In the current environment of near-zero lower bound interest rates, where the TIPS inflation-adjusted U.S. treasury bonds pay an inflation-adjusted negative real rate of return, these kinds of speculative excesses are entirely predictable. The only surprise is that any competent financial managers (especially those in the Federal Reserve Bank) are surprised.

    1. Thomas,

      Yes, that’s the point of the essay.

      We don’t act to prevent bubbles for very sound reasons — reasons of personal interest for those involved. Rather than rouse themselves to take political action, the rest of us believe pretty stories about the wonders of it all.

  6. FM claims: I don’t understand why that is an explanation. People ran investment bubbles quite easily without computers, as any conman can explain. There is no reason to believe that telling stories is easier waving computer printouts rather than pretty charts or word salads.

    A spectacular example of missing the point.

    People had wars before the machine gun. The machine gun completely changed the nature of war, however, because it made it trivial to spray so many bullets at the enemy so fast that casualties increased exponentially and entirely new warfare strategies and tactics were developed. Viz., tanks, 3GW, etc.

    Likewise, powerful desktop computers completely changed the nature of financial markets because they made it trivial to force all the picayune details of fraudulent accounting or bogus investment bubbles to numerically work out right down to the last decimal point. This exponentially increased the number of financial scams and bubbles, it made investing counterintuitive since investors could no longer discern whether profits were bubblicious by using common sense, and entirely new financial schemes were developed — schemes much more vulnerable to bubbles than any in the past. Viz., CDOs, “quant” investment schemes so mathematically complex that physics PhDs were hired to cook them up, and high-frequency computer trading — all operating entirely outside human control.

    Warren Buffet’s alpha since 2001 has been zero. Something in the markets changed in a fundamental way. The prince of investors couldn’t make money any more because it became impossible to figure out which investments were good or bad by examining the numbers.

    1. Thomas,

      I like metahors as much as the next person. But to equate machine guns ability to kill people more efficiently with computers printouts ability to fool people is not a compeling analogy. Just because you can make an analogy doesn’t mean its true without proof. Where is your evidence that people are more easily fooled or deluded using computers? Has there been a rise in fraud across society? If not, why not?

      Also, citing Warren Buffet’s alpha as evidence that market’s changed is absurd. If fundamental changes occurred there should be stronger statistical evidence than that. In 2001 he was 71 years old. Perhaps he worked less. Perhaps his metal powers diminished.

      Last — asserting these theories with such confidence — as if you were describing gravity — would be silly even if you had actual evidence.

  7. Newsflash: “rapidly growing asset managers” are animals which are almost completely extinct at this point, thanks to the financial crisis. All but a very small number of already largest managers just scrape and claw to remain in business at this point, as most of the industry has been decimated. As a result, the odds of rapidly growing asset managers generating bubbles have been slashed.

    Alternatively, as someone who’s been in the asset management business for a long time, I’d argue strongly than it is institutional investors’ behavior (and sometimes retail investors’ behavior) that contributes significantly to the formation of bubbles: institutions dump assets into managers – at this point very large managers – who have had good recent performance; such managers respond by scaling up existing portfolios as they receive new institutional accounts to manage. This is most definitely a pro-cyclical, potential bubble inflating, positive feedback mechanism and one that almost all institutional investors and investment consultants fail to consider, often with eventual disastrous results.

    1. bornskeptic,

      I love how people just dismiss the exhaustively researched work of major institutions! After all, you know more they do — why bother thinking?

      “All but a very small number of already largest managers just scrape and claw to remain in business ”

      In fact the industry is both growing and consolidating. The firms at the top are growing rapidly, the beneficiaries of both trends. The BIS clearly documents this. Numbers, evidence, etc.

      “institutions dump assets into managers – at this point very large managers – who have had good recent performance”

      Nope. The most successful investment firms have been passive managers. Secondarily are the large ones with their vast marketing and sales operations. I suspect what you are attempting to describe is asset class herding — described in the report — where managers and investors shift funds in those asset classes with good trailing results. That’s a commonplace phenomenon, and not sufficient to form bubbles.

  8. Fabius,

    Interesting dialogue on this one. My colleague Jeff Hooke has done some very good work that shows that investors do not realize more value from actively managed accounts than from index funds. http://allaboutalpha.com/blog/2013/08/18/fees-vs-performance-jeff-hooke-tilts-at-the-public-pension-windmill/ The BIS thesis would indicate that the performance may be even worse on a risk weighted basis as the rolling bubbles appear to increase volatility substantially over time.

    Perhaps you can solve for me a conundrum that I have had for some time. From 2009-2014 U. S. federal deficits totaled $6.25 Trillion. The Federal Reserve effectively funded about $3.5 directly through the growth of its balance sheet. Indirectly it funded much more by encouraging the banking system to load up on treasuries and agencies. Bank holdings of treasuries and agencies have increased to more than $2 Trillion since the financial crisis, an increase of $930 billion from the trough in 2008. http://www.bloomberg.com/news/articles/2014-04-27/treasuries-irresistible-to-america-s-banks-awash-in-record-cash Presumably the remaining deficits were funded by individuals, corporates, institutions and overseas investors.

    Here’s the conundrum. All of this activity has resulted in the banks holding $2.5 Trillion of reserves at the Fed, up from essentially zero at the time of the financial crisis. Under the traditional theory of money and banking, that increase in reserve holdings should support a tremendous increase in new borrowings from the banking system, but that has not happened. The economy is just trudging along in what appears to be a low inflation environment. The normal explanation is that this is a result of the sharp decline in the money multiplier. Unfortunately that explanation confuses causation with consequence and does not explain the mechanism of action that his causing the credit creation system to behave in such historically abnormal ways.

    It appears to me that the Fed’s actions are equivalent to a helicopter drop of almost $4.5 Trillion of dollar bills that got spent once and just disintegrated rather than being recycled into the economy. Notwithstanding the remonstrations of the gold bugs, the money creation has not resulted in massive consumer price inflation (though there has been tremendous inflation in financial asset). So the open question is what has changed? Is it regulatory fiat with the banks? Is it overleveraging? Is it that we have exported our liquidity and inflation into the developing economies? Or is it just a matter of economic lags between inflation in the financial economy and the impact on the real economy?

    1. John,

      You raise many good points. Time and space limitations prevent a full reply, but here are two points.

      (1) “that shows that investors do not realize more value from actively managed accounts than from index funds.”

      Oh, yes. Lots of evidence showing this. Here’s a current report by Josh Brown about the massive underperformance of active managers in 2014, and the evaporation of alpha. The management industry is growing due to its sales and marketing — not risk-adjusted performance after fees. Lots of implications, which I plan to write about soon. In brief, its an industry ripe for disruption — and a massive collapse of employment and profits.

      (2) “that increase in reserve holdings should support a tremendous increase in new borrowings from the banking system, but that has not happened.”

      Adjusted reserve are up ~$2.7T since the crash, while Fed assets have risen $3.5T. So 3/4 of the money the Fed created at the banks has been redeposited by the banks at the Fed. These reserves are hot money, ready to power a massive increase in loans. But there’s little net demand for loans. You can lead people to the bank, but cannot make them borrow if they don’t see growth (e.g., opportunities for investment, or growing income with which to pay off the loans).

      So Say’s Law — production creates demand — doesn’t apply to credit. Hence the failure of conservatives’ insanely confident predictions of immediate inflation.

      The Fed staff knows that these idle reserves are dynamite. Should loan demand spike, the Fed must take fast drastic action to prevent an inflationary expansion of the money supply. But that’s a scenario, a potential future problem. Slow growth and possible deflation or recession are the looming dangers.

    2. “You can lead people to the bank, but cannot make them borrow if they don’t see growth (e.g., opportunities for investment, or growing income with which to pay off the loans).”

      I think something more is going on here. The chart at http://www.businessinsider.com/payments-tech-companies-move-into-lending-2015-2 seems to be mislabeled, but is very instructive. Small business lending at the banks has collapsed. Companies are flocking to alternative lenders such as OnDeck, CAN Capital and Merchant Cash and Capital to fund billions of dollars of their liquidity needs at historically very high interest rates. Clearly there is demand for credit in the system, but the banks don’t offer products to meet that demand.

    3. John,

      I don’t understand your point.

      This lending — in the graph — is pocket change in a $16 trillion economy.

      The overall numbers are shown in the Fed’s Flow of Funds statements. Net private sector loan growth stopped for several years after the crash, then resumed — but only slowly.

      Also, cash borrowing (I lend to you, outside the fractional reserve banking system) does not expand the money supply, and can not boost inflation.

    4. My point with regard to the small business borrowing data is exactly your point. The non-bank lenders do not have money creation power. The fact that the banks are not lending to the small business borrowers (and I have observed that this applies to many businesses larger than the micro credits shown in the chart) means that the lower end of the market, which much data shows to be responsible for a high percentage of job creation, is not participating in the traditional money multiplier game. This has a big dampening impact on growth.

    5. We’ll have to disagree on this one. I’m working with multiple companies in what I call the New Finance industry that have been growing at a 100% compound annual rate, providing very expensive credit to deal with credit demands not being met by the banking system. I don’t disagree that demand for credit is down as compared with the top of the bubble, but demand in the lower end of the market significantly exceeds what the banks are providing.

    6. John,

      There are always parts of the small business market that are capital constrained. But there is considerable evidence that the overall funding available to small biz is greater than any previous time. Not only is the traditional bank lending channel wide open, but new channels are open on unprecedented scale: venture capital, junk bond, crowdsourcing, etc.

      I would need to see some numbers suggesting that this is significant constraint today to this $16T economy.

    7. Agreed on the new channels of credit, but, as you said, there is no money multiplier there. I don’t agree with regard to the banks banks. Absent tangible collateral, small business lending from banks is far tighter than many times in the past and the small banks are slowly being merged out of existence. Not a friendly environment for entrepreneurs and i believe that has been holding back the economy more than you realize. Much of the $16 trillion comes from trade in goods imported from abroad. U. S. manufacturing is increasingly either final stage assembly or robotic production. Minimal jobs there compared with the past. Small business doesn’t have the luxury of hiring in Myanmar or Sri Lanka, so the jobs that are created in the small business sector are generally domestic. Those are the incomes that drive growth in consumer purchasing power needed to accelerate growth. I acknowledge I have no specific data on this point, just observations in the real world, so take it for what its worth.

    8. John,

      Thanks for pointing to this issue. I had read the research from the banks and Fed, which said there isn’t a problem. Other sources strongly disagree (& agree with you):

      The State of Small Business Lending: Credit Access During the Recovery and How Technology May Change the Game“, Karen G. Mills and Brayden McCarthy, Harvard Business School, 22 July 2014.

      SBA’s former chief: Small business lending hasn’t recovered — and that’s a big problem“, WaPo, 6 August 2014. Also see this WaPo story from November.

    9. “I love how people just dismiss the exhaustively researched work of major institutions! After all, you know more they do — why bother thinking? ”

      Gosh, you truly excel at making any kind of discussion maximally painful.

      In any case, I don’t at all buy the BIS premise: “I argue that the business risk of asset managers acts as strong motivation for institutional
      herding and ‘rational bubble-riding.’ ”

      They failed to make that case. Sure there are some managers who pile on to stocks (or other securities) that may be bubbles, but such will be a relatively small number, outside of managers who happen to own stocks which become bubble-like and then they take on additional capital from investors; in such cases they will amost certainly continue to buy as they scale up their existing portfolio. I have seen very few active managers who would intitiate a new bubble-like stock and many more who would avoid such. Heck, while there is ample evidence that positive price momentum stocks tend to generate positive outperformnace, there is also evidence suggesting that bubble-like stocks with increasing returns over time generate negative outpoerormance. Also, if you look at short interest levels of bubble-like stocks, you will see that there are many long/short managers who actively short such stocks even though, as the BIS article correctly points out, that can be a risky strategy.

      Contrasting passive vs. active management, it’s probably true that at least these days it’s easier to find passive strategies that hold and continue to buy bubble-like stocks if such passive vehicles have taken on increased amounts of capital over time. The IBB (Nasdaq biotech index ETF) is probably a good example of this as also is the mutual fund, Fidelity Select Biotechnology, FBIOX). Both of these have seen big asset flows over past few years, as performance has been high, clearly a positive feedback loop. What this has to do with the “business risk of asset managers” is completely unclear to me.

    10. born,

      “Sure there are some managers who pile on to stocks (or other securities) that may be bubbles, but such will be a relatively small number,”

      Wow. You don’t appear to understand what the BIS is saying. Your “rebuttal” consists of making stuff up, unlike the BIS that gives evidence and cites studies. There is not much else to say.

    11. Ok, so now I’m “making stuff up”. Thanks! Sorry, but conjectures backed up by links to academics’ arguments about this or that don’t necessarily make a for a compelling argument. I specifically took issue with the BIS paper’s arguing about asset manager motivations, something with which I have actual experience (which I realize you like to discount out of hand). But there’s plenty of other stuff in there to argue with – like their completely ignoring separate accounts on their Investment Vehicle chart on page 6, their frequent conflating of institutional investor with investment manager, their implication that the investment management industry is doing great because the largest firms are gowing, their extrapolation of assets managed by institutional investment industry to 2020 (wtf?) and overall premise that bubbles are “bad” and that they can be identified and pricked in a net positive NPV type of way with some probability. But I’m probably making all of that up too, right?

    12. bornskeptic,

      “Sorry, but conjectures backed up by links to academics’ arguments about this or that don’t necessarily make a for a compelling argument.”

      Perhaps not. But at least they can cite evidence and detailed analysis. I doubt you can do either.

    13. “But at least they can cite evidence and detailed analysis. I doubt you can do either.”
      Nice rebuttal. Stay classy, Fabius.

  9. Bornskeptic

    “Gosh, you truly excel at making any kind of discussion maximally painful.”

    Excellent comment. I’ve had the same experience with the Fabius Maximus editor.

    Sometimes it’s hard to have a discussion with him when he dismisses your legitimate points out of hand.

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