If asset prices have been driven up to unsustainable levels that do not correspond to the underlying fundamentals, we are faced with a special kind of problem. We know from experience that speculative asset price bubbles eventually burst. When they do, collateral values will fall and balance sheets deteriorate, potentially threatening the stability of the banking system. To avoid this kind of development, the central bank needs to closely monitor the potential for excessive credit growth and the possibility of asset price bubbles building up. It seems that historically the forming of speculative price bubbles has been closely linked to an excessive expansion of credit. But we need to operationalise both the concept “excessive” and the difficult concept of an asset’s “fundamental value”. As history has shown us, judging to what extent rising asset prices reflect strong fundamentals, rather than the “irrational exuberance” of investors, is easier said than done. Nevertheless, certain important risks related to asset prices need careful watching in today’s world. The first risk is that imprudent lending could fuel unwarranted asset price increases - as so often in the past. Although there is little evidence to date of a general lowering of credit standards, credit growth has been very rapid and loans to finance equity purchases have risen sharply in some countries. BIS Review 65/2000  4  Ensuring that investors are not sheltered from the consequences of their sometimes misguided investments is important for maintaining prudent lending standards.
Whereas the value of the UK  5  Foreign reserves held by EME central banks as a whole are about 60% (close to $ trillion) higher than needed for conventional precautionary reasons to cover short-term external debt. 6  Morgan Stanley, "Sovereign Wealth Funds and Bond and Equity Prices", 31 May 2007. 7  That said, the assets held by sovereign wealth funds are highly concentrated, with around 70% of total assets held by the five largest funds. So the largest sovereign wealth funds could have an impact on some markets especially smaller ones such as other EMEs. 8  Also, a number of central banks from countries with large current account deficits have been willing throughout the current liquidity crisis to lend to international banks, including UK ones, at longer, three-to-twelve month, maturities. BIS Review 31/2008  3  market for public debt securities is only 3.3% of the global market, UK equities account for 7½% of the value of global equities. The rapid growth in sovereign wealth funds is also a fillip for London as a leading international financial centre. SWFs and transparency The main doubts concern their objectives and how far their investments will be driven only by financial returns. Public sector owners might have other objectives including national political interests, such as, accessing military technology, controlling strategic resources or markets, and influencing public opinion. 9 There are often complaints that sovereign wealth funds lack transparency. Decoded, this is a request for reassurance about their investment policies.