Financial Bubbles Explained

[snousle]

This article in the Atlantic explains, at last, something I have had a sense of but couldn't articulate myself. Here, Henry Blodget explains why Wall Street investors and others acted, on an individual level, in an entirely rational way in creating both the tech and housing bubbles. The key part of his account involves the tension between business risk and investment risk, which are not the same thing. As he says, being bearish and wrong is at least as risky as being bullish and wrong. The pressure to go out on a limb and take on unsustainable risk in a rising market is, on a collective level, impossible for institutions to overcome.

This article is very satisfying because it does not rely on calling anyone "stupid". (Doing so, IMHO, is to forfeit real understanding in favor of self-serving judgmentalism.) Instead it explores the motivations and uncertainties of everyone involved and shows that they all had good reasons for acting as they did. His conclusion is that bubbles are not anomalies, but are instead a permanent part of the financial landscape that we should expect to see every few decades.

This is the best single article I've read on the subject so far.

Comments

[kevynjacobs.livejournal.com]

Very thought-provoking.

His assertion that economic bubbles have always been with us, and will always be with us, is one of the best arguments I have heard for NOT privatizing vital services -- such as retirement income (like Social Security), pensions, and well as health care -- into free market investments. Those who argue in favour of such privatizations clearly do not recognize that things don't always go up.

[snousle.livejournal.com]

Privatizing social security is the worst idea ever - it would end up being pure crony capitalism. Can you imagine the corruption invited by a mandatory trillion-dollar infusion into the private sector by people who have no idea what to do with it?

[stivalineri.livejournal.com]

What I got out of the article is that human beings no matter how intelligent or well educated still act like monkeys. I think laissez faire capitalism is just as DOA as communism, we need socialism now, like Naomi Wolf says, the Center needs to move to the Left.

[kevynjacobs.livejournal.com]

> human beings no matter how intelligent or well educated still act like monkeys

DING DING DING DING DING!
We have a winner!

Now, lets set up an economic system that takes this into account, and does not assume that all economic actors are rational!

[gloeden.livejournal.com]

You can get a very nice background and understanding from Charles Kindleberger's book "Manias, Crashes, and Panics".
Dry in spots, but he covers the waterfront nicely.

[backrubbear.livejournal.com]

This article reinforces what I might call "the car salesman effect".

The guy selling you your car doesn't care about any particular feature or misfeature of your car beyond what he needs to do in order to close his deal. He's not going to point out poor fuel mileage or a poor safety rating or that the company may be teetering on bankruptcy. He's going to point out cup holders and stereo systems and comfort.

Objective risk analysis is hard, especially for a discipline you may not follow. Even for something as "simple" as a mortgage, a lot of people bought into the ARM mess. I can't understand how anyone in their right mind would do that:
- You save a small amount of money on your mortgage each month.
- The bet is you can refinance (which depends on your financial state and house value) a few years down the road.
- You can sell the house and move. This depends on there being someone who wants to buy your house at whatever value.

The car salesmen are going to tell you, "you'll be able to refinance." "Housing prices always go up." "There's enough mobility in the market that people will want to buy."

Except when there isn't.