
Why asset bubbles are a part of the human condition that regulation can’t cure - iamelgringo
http://www.theatlantic.com/magazine/archive/2008/12/pop-psychology/7135/1/
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pessimizer
The title is a unbelievable deceptive because, unless I missed something, all
of these experiments were done on completely unregulated toy markets.

I would be curious about what would happen if, instead of rewarding people
directly with the returns on their trades and their dividends, you gave them a
baseline salary that they can never go under, then gave them a bonus based on
a percentage the gained market value of their holdings during any particular
round, but ended their game if they ranked below 50% of the other players for
two rounds in a row then gave them severance equal to five times their
baseline salary plus their average bonus per round over the entire game.

In short, I'd be interested in how far fiduciary investment bubbles would
deviate from the bubbles produced by direct investors in these same safe
markets, and whether changing any of the variables above could bring them
closer together.

~~~
pessimizer
Wow, my first sentence was made incoherent by backediting: "The title is
unbelievably deceptive because..."

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lkrubner
If asset bubbles are part of the human condition, then why have they been so
rare? There was tulip mania in Holland in 1637. The South Sea Bubble of
1719-1721. The canal overbuilding bubble in England in the 1820s. In the USA,
there was the Florida land boom in the 1920s, ending in 1926, and then from
1926 to 1929 there was the stock market bubble. There was the Japanese real
estate bubble of the 1980s, and a similar, smaller bit of overbuilding in the
USA. Then there was the dotcom bubble in the USA stock market during the
1990s, and then the real estate boom of the 00s.

Those are the big ones.

Why were there no bubbles before 1637? In a word: government. Under a feudal
regime, people are not free to do what they want with their money, therefore
there were no bubbles. People were not free to bid up the prices of assets -
most assets are illiquid under feudal regimes. The fact that a heavy-handed
monarch can suppress markets and therefore make bubbles impossible is a fairly
strong argument toward government effectiveness in stopping bubbles. Likewise,
the lack of asset bubbles in the USA from 1932 to about 1982 also suggests the
effectiveness of government in suppressing bubbles.

Of course, one might argue that we want bubbles, that such freedom of
investment has positive consequences, or that heavy-handed government, while
creating some benefits, also imposes large costs that outweigh whatever
benefits are being offered. But that would be a separate issue.

~~~
bd_at_rivenhill
Actually, you've missed quite a few big ones, have you read Kindlebarger?

[http://www.amazon.com/Manias-Panics-Crashes-Financial-
Invest...](http://www.amazon.com/Manias-Panics-Crashes-Financial-
Investment/dp/0471467146/ref=sr_1_1?ie=UTF8&qid=1286052391&sr=8-1)

I wouldn't say that bubbles are rare at all, and it wouldn't surprise me if
there were lots of them before 1637 that just aren't well recorded. The
limited scope of trade in those days would mean that such events weren't as
disruptive as they are today.

~~~
lkrubner
I thought about also listing the panics, and I started to, but then I realized
they were off-topic. This article is about asset bubbles, not about panics.
Therefore, the crash 1825, in England, the crash of 1873, in the USA, the
crash of 1907 in the USA - all of those are off-topic.

~~~
j_baker
I suppose one could make the argument that before a panic, bank accounts are
overvalued assets.

~~~
lkrubner
That's just it, you could define it however you want, but as soon as you do,
the whole conversation falls apart. If you define all panics as asset bubbles,
then pretty soon you need a new term to mean what "asset bubble" used to mean.
I think a lot of these conversations fall apart over semantics. So I tried to
use the phrase asset bubble in something like the sense that the article above
seems to.

~~~
bd_at_rivenhill
I'm not sure what you mean when you say _If you define all panics as asset
bubbles, then pretty soon you need a new term to mean what "asset bubble" used
to mean._ "Asset bubble" must always be followed by "panic" by definition,
otherwise you're actually seeing an increase that could be called "fairly
priced" instead of "inflated." Look at the five year chart on AAPL, is it
experiencing a bubble at a P/E of around 21, or is the stock somewhere close
to a fair valuation? What about AMZN trading at a P/E of around 63? As far as
I'm concerned, there's no way to be certain of the answer to this question
until the future happens: if the stock crashes, then it was a bubble,
otherwise it was fairly priced. If you have a better answer to this question
than that, then you are either a wealthy (or soon to be wealthy) portfolio
manager, or you should seriously consider that as an occupation if making a
lot of money is your goal.

~~~
lkrubner
Yes, but not every panic is caused by an asset bubble. The panics that are
caused by asset bubbles are a subset of the of panics. There are other panics
that have other causes - both supply side shocks and demand side shocks can
lead to a panic. Thus, I left out a lot of panics, which were not caused by
asset bubbles.

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jotto
The people in their study (a group of 12, "bunch of volunteers, usually
undergraduates but sometimes businesspeople or graduate students") don't seem
like a group that would actually understand the value of their assets despite
the value being explicitly clear for purposes of this study. They should do
the study with a group of 100 financial experts and see if the results are the
same.

~~~
hugh3
That would be interesting. Get a bunch of sufficiently sensible people, and
give them enough time to think things through, and I doubt they'll have a
bubble.

Of course this doesn't solve the real-world bubble problem, where we have
absolutely no idea what the future payout of an asset will be.

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ianferrel
It sounds like the biggest problem with this study (and with many markets) was
that there was no way to efficiently sell short.

If it's only possible to make money when asset prices go up, some rational
individuals will buy in even when they think the price is already too high,
because until they own the asset, they can't profit from it.

~~~
ced
There's a quote that goes "Your capacity to short a market is dwarfed by the
market's ability to defy gravity".

The housing bubble began in 2002. If you had shorted it as soon as it was 10%
"too high", you would have had to wait 6 years before cashing in. The
yield/year is miserable, and meanwhile, your total net worth would have been
negative around 2006. (More likely, the bank would have forced you to "cash
out", at great loss)

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j_baker
Even if we grant the basic premise of the article (that regulation can't stop
bubbles), that still doesn't rule regulation out. After all, it still doesn't
prove that the government can't do anything to lessen the impact of a bubble.

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lzw
It sounds like that experiment is flawed, but the article doesn't go into
detail about what the participants are told. At any rate, you can't draw the
conclusion it does from that experiment as given and then extrapolate it to
the outside world.

IF you put any group of people together for an experiment, and give them
nothing else to do, they are going to trade. especially fake money because
there's no real risk. Unnecessary trading is going to result in abberant
activity.

The bubbles we've had in our economy are due specifically to government
forcing interest rates below their market level. You do that and you give
institutions the power to make free money-- buy from the government at %x,
invest it in low risk situations like mortgages at %Y and then pay back the
government in devalued currency (due to inflation) at %Z. In each of those
steps you make money...so, its a no-brainer.

If you want to stop having bubbles, remove the power to set interest rates
from the federal reserve / government. Then the market has a chance to self
regulate.

Right now the primary price signal that would keep bubbles from inflating is
being held down, and the natural bubble prevention is being short circuited.

So, it is no wonder that bubbles are happening. The sad thing is that this is
not a very controversial or difficult subject, but it is rare to find an
article in a publication like the Atlantic that seems even aware of the effect
of interest rates on interest bearing securities!

The reason that the mainstream media and government pretends like they aren't
manipulating us into bubbles is very simple: Letting interest rates operate
normally would also put a restraint on reckless government spending.

~~~
prewett
> If you want to stop having bubbles, remove the power to set interest rates
> from the federal reserve / government. Then the market has a chance to self
> regulate.

The article's assertion is that the problem is people themselves, so removing
the Federal Reserve would make no difference. Anyway, we've already done that
experiment. The Federal Reserve was not created until 1913 (as a result of the
Panic of 1907). Prior to that, the unregulated U.S. economy had regular boom-
bust cycles about every 10-20 years: The Panic of 1819, 1837, 1857, 1873,
1884, 1893, 1907.

Of those, speculation was part of the Panic of 1819, and directly responsible
for the Panic of 1837. The Panic of 1857 was caused by banks lending too much
(arguably a bubble in something). The Panic of 1893 was caused by speculation
in railroads (it sounds similar to the recent speculation in housing). The
Panic of 1907 was precipated by a failed short squeeze on United Copper,
causing a quick mini-bubble where its price doubled in a day and then halved a
few days later when it the squeeze failed. This left the Otto Heinze unable to
pay his loans that he used to buy United Copper shares, causing a chain
reaction in the banking system. The negotiations of J.P. Morgan in NY
described in the wikipedia article
(<http://en.wikipedia.org/wiki/Panic_of_1907>) sounds very reminiscent of what
happened with the banks in the Panic of 2009.

(See <http://en.wikipedia.org/wiki/Panic_of_1819>,
<http://en.wikipedia.org/wiki/Panic_of_1837>,
<http://en.wikipedia.org/wiki/Panic_of_1857>,
<http://en.wikipedia.org/wiki/Panic_of_1893>)

I think it is very clear that, left to themselves, financial markets _cannot_
regulate themselves.

I don't know if the Federal Reserve has reduced bubbles, since we had the
Panic of 1929 (too much borrowing), the 1987 Black Monday stock market crash,
the Savings and Loans bankruptcies that may have resulted from that, the dot-
com bubble of 2001, and the Panic of 2009 (housing). I'm not sure that the
Federal Reserve has reduced bubbles (that being a function of human greed),
but it has reduced the aftermath. Read how long the recession/depressions
lasted in the 1800s. I'll take the Federal Reserve.

