obvious once they ’ ve burst. ) in a bubble, asset prices become disconnected from reasonable expectations of the future earnings of those assets. markets fail to get prices right. this mis - pricing gets reinforced and exaggerated by herd behaviour, or irrational exuberance. investors convince themselves that someone else will pay even higher prices for the assets in future. in the case of commercial buildings in the 1980s, the pace of construction was frantic, as supply rose to meet the high demand which was manifesting itself in high prices. anyone who was around at that time can remember the cranes that cluttered the skylines of our major cities. while prices for industrial properties also rose sharply in the 1980s, construction of new industrial buildings was actually fairly steady during this period. the bubble that occurred in the mid 1980s was not limited to business property. the se40 share market index doubled in one year and then halved in the following year, after the crash. nor was the bubble limited to new zealand ; it occurred in other countries too, notably in the us. figure 3 industrial property prices and the cpi annual percent change the bubble burst in late 1987 when the us share market crashed. it suddenly became obvious that asset prices had been out of line with economic fundamentals. we had witnessed a sustained period of misplaced investment, with the returns from this investment proving to be low. misdirecting resources in this manner can be very costly for the economy. the consequences for new zealand were serious. some companies went bankrupt and the economy went into a recession. it didn ’ t recover from this recession until 1992. in terms of the loss of output relative to potential output, this recession was probably new zealand ’ s second worst of the twentieth century. when the recovery did arrive, it was strong. manufacturing, much of which had been restructured and was running under new ownership and management, began to thrive. for a number of years we had double digit percentage growth in manufactured export volumes. consequently, the demand for industrial property rose sharply. in the newly deregulated environment of the labour market, employment growth was strong, and unemployment began a steady decline. the growth in service sector employment increased the demand for commercial property. the asian crisis and the drought of 1997 slowed demand for both industrial and commercial properties. but prices have lifted again in recent years, fuelled by the economic growth stemming from all the factors i mentioned earlier. in general, these recent rises do not appear to be cause for concern. as i see

any form of on - site examination of banks. these distinguishing features continue to apply under the new supervisory framework. in late 1991 we commenced a major review of our banking supervision arrangements. the review was motivated by a number of concerns. probably the main reason for commencing the review was a concern that conventional approaches to banking supervision generally make insufficient use of market disciplines as a means of promoting a sound and efficient financial system. we believed that there was considerable scope to use market disciplines to promote systemic stability. in particular, we wished to provide the market with a greater capacity to hold the directors and management to account for the sound management of their bank. and we wanted to improve the market ’ s ability to make well informed decisions as to which banks they would do business with. as i note later in this address, we concluded that the introduction of a well focused and comprehensive disclosure regime would go a long way towards achieving these objectives. another factor which led us to review our banking supervision arrangements was a concern at the compliance costs and regulatory distortions which can be associated with conventional approaches to banking supervision. this concern reflects our view that banking supervisors tend to have strong incentives to promote a stable financial system, without always having appropriate regard to the compliance costs and regulatory distortions to which supervision and prudential regulation can give rise. we were also concerned at the taxpayer risk involved in the traditional approach to banking supervision. although this risk is present regardless of the form banking supervision takes, it is likely to be greater where the banking supervisor, and only the banking supervisor, has regular access to financial information on a bank. it is also likely to be greater the more intensive the supervision process is. we wanted to explore ways of reducing the risk of the government being called upon to rescue a bank in distress. finally, we recognised that conventional banking supervision can only go so far in promoting a sound banking system. there are inherent limitations in the extent to which prudential regulation and supervision, even supervision which includes on - site examinations, can minimise the incidence of bank distress and failure. this is evidenced by the fact that countries with intensive supervisory regimes have not been immune from serious episodes of financial distress. indeed, we were concerned that banking supervision could even be increasing the risk of bank failure or distress, by potentially reducing the incentives for bank directors and managers to make their own considered judgements about what constitutes prudent behaviour. the new approach to banking supervision in new zealand in the light of these concerns, and following a lengthy period