In much of the lead‐up to the Global Financial Crisis (GFC), through the 2000s, there were comments by regulators and others about potential asset price bubbles. Were these occurring, did they matter,and was there anything that the authorities could or should be doing about them? Could markets prices assets inefficiently, or was any apparent mispricing just a temporary effect, which would be remedied by the prices of the relevant class of assets returning to some fundamental value? Some countries saw this as more of an issue than others: in the USA in particular there was a reluctance to intervene, with a case against intervention set out by Bernanke (2002).
Once United States house prices peaked in 2006, and as the symptoms of the GFC became more evident during 2007 and 2008, the authorities in many affected countries began to accept that there had been problems, and that the subsequent reductions in residential property prices (and in the prices of some other classes of assets) were a salutary outcome. Lower prices for residential property would counter some of the previous froth, and allow assets prices and economies to returnto more stable levels.
There was a further set of lessons learned in from the crisis. If asset prices got out of line and there was a subsequent bust, problems could develop for the financial sector, particularly where the potentially inflated assets had been financed with debt. When asset prices fell, financial institution solvency could be seriously undermined, leading to systemic difficulties for the banking sector.
This paper was presented in July 2014 at the 19th Melbourne Money and Finance Conference (MMFC), which explored the theme Current Issues in Australian Financial Markets.
For more papers presented in the conference, please click here