Overheating in Credit Markets

What causes bubbles in certain credit instruments? Two alternate, but not mutually exclusive, views explain such overheating: The first, a “primitive preferences and beliefs view,” says investors’ often irrational perceptions play a large role. For example, consider how investor optimism inflated the 1990s dot-com bubble. The second, an “institutions, agency and incentives view,” argues that financial agents within banks, funds and insurance companies affect credit decisions, exploit regulatory weaknesses and find loopholes to boost their profits. According to this view, three elements drive credit-markets overheating...