GLOBAL – An IMF working paper published this week has questioned the assumption that investors' "irrational exuberance" caused the property bubble, suggesting that rational investors were just as likely to follow bubbles and aggravate mispricing.
Claiming rational investors' activity did not necessarily help eliminate bubbles, analyst Anna Scherbina said limited liability for managers could in fact encourage investors not to trade against the bubble – which would contribute to its collapse – but with it, aggravating asset mispricing.
She cited the "compelling and sensible story" behind most bubbles.
In the case of the real estate market, the argument that securitisation would allow to diversify the idiosyncratic risk of real estate acted to limit the liability of lenders by taking the loans off their books.
But the IMF report has gone further, suggesting that bubbles are not necessarily entirely irrational.
In particular, Scherbina pointed out that rating agencies working from data that showed recent consistent price increases – albeit with faulty risk models – rationally inferred that lenders would be able to recover the assets' value.
Despite its focus on currently unfashionable rational investors, the paper nodded at behavioural economists' assumption of investor 'herding', pointing to the market's tendency to reward managers who mimic other managers' investment choices despite their better judgement via relative performance fees.
"Betting against the herd is very costly while the bubble is on the rise – the managers who cannot keep up with their peers suffer fund outflows as investors reallocate funds to the more successful managers," it said.
Although the paper stopped short of issuing recommendations, Scherbina pointed out that shorting restrictions in some markets had not helped.
"As in previous bubble periods, the market was dominated by the optimistic investors," she said.
"If there were pessimists who would have liked to short the housing market or the mortgage-backed securities, they lacked the means to do so."