At the start of the sustained rise in equity prices, stock dividend yields exceeded the yields on Treasury bonds and this was perceived as normal, partly reflecting the searing experience of the Great Depression. Instead, corporate earnings rose relatively steadily, supporting dividend growth. This observation led investors to bid up stock prices and push down dividend yields and this proved – more or less – sustainable. Even today, the yield on the S&P 500 index is below the 10-year Treasury note yield. 6  BIS Review 43/2010  tools available might include limiting loan-to-value ratios, limiting debt service-to-income ratios or increasing the taxes on housing transactions. Several Asian and some European countries have used such tools to limit speculative real estate activity, apparently with some success, although the counterfactual cannot be known by definition. 10 To limit a subprime lending boom, the authorities might wish to enforce strict underwriting practices, including verifying purchasers’ incomes and enforcing rigorous appraisal valuations. Increasing the ability of investors to short the assets in question might also be helpful. In terms of macroprudential tools, I’d also include tools that influence how the financial system operates and functions. Such tools might include supervisory measures that set liquidity and capital requirements for financial institutions and other intermediaries. They might also include tools that try to limit the overall buildup of leverage in the financial system. For the equity market, macroprudential tools might include margin rules for cash, options, futures and equity over-the-counter derivatives.
The next step is for the policymaker to evaluate what tools might be available to curb the imbalances that have been identified. The idiosyncratic nature of the innovations and belief systems associated with particular bubbles implies that the tools used to respond to each bubble will likely have to be different and tailored to the features of the particular bubble in question. 7  See Eli Ofek and Matthew Richards. 2003. “Dotcom Mania: The Rise and Fall of Internet Stock Prices.” Journal of Finance LVIII, no. 3 (June): 1113–37. BIS Review 43/2010  5  Finally, the policymaker needs to conduct a careful cost-benefit analysis, weighing how successful a particular policy might be in restraining the rise in asset prices versus how costly it would be to remain passive, letting the bubble grow and then potentially burst disruptively. Many factors will affect the outcome of this analysis including the magnitude of the potential asset bubble and whether the potential asset bubble is occurring in the equity or debt markets. In this analysis, the policymaker is likely to find that compared with equity market bubbles, credit market bubbles are more prone to generate higher costs when they burst. Thus, the benefits of preventing credit bubbles from forming and collapsing are likely to be higher. Credit bubbles that burst threaten the stability of the financial system much more directly than equity bubbles. 8 That is because much of the debt is held by banks and securities dealers that are highly leveraged.