Remember when one of the hot Fed buzzwords of 2014 was “macro-prudential regulation”, a phrase which was supposed to mean that the Fed can centrally plan every asst price, as well as catch asset bubbles in the making and prick them, also leading to such hilarious contraptions as the “Bubblebusters” – the Fed’s own committee To “Avoid Asset Bubbles.” The phrase has since quietly disappeared. And thanks to a new IMF White Paper we may know the reason why.
According to IMF researcher Brad Jones, who wrote “Asset Bubbles: Re-thinking Policy for the Age of Asset Management“, the “business risk of asset managers acts as strong motivation for institutional herding and “rational bubble-riding.”
This is a critical observation, and one which suggests that the mere group think of massive asset managers is what leads to not only herding, lack of originality and the “hedge fund hotel” phenomenon, but also to recurring and ever greater asset bubbles.
As Jones further writes, “subdued leverage is not a sufficient condition for financial
stability—if systemic risk, and activity in the wider economy, is shaped
importantly by large shifts in risk premia owing to the “rational herding” motivations of asset managers.”
This also explains why “rational” asset managers no longer “hedge” but merely piggyback on each other’s ideas, and why some precursor events to bubble pops involve far less intellectual concepts such as simply demonstrating that the groupthink is wrong: such as housing can only go up, or “Lehman Brothers is fine.”Â
In short, anyone trying to answer “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” is urged to ask the guys below: not only do they no longer have any alpha creation capabilities but they mask their lack of alpha capabilities with massive beta-boosting leverage!
