Wednesday, February 09, 2005


Welcome to the Bubble Blog. The purpose of this blog is to share insight, analysis, data, and commentary about investment bubbles in order to make better business decisions during these complex market dynamics.

Bubbles occur all the time. They are not aberrations to normal economic functioning. They are normal. Since the 1960s there has hardly been a year where a bubble has not occurred somewhere. Some are big, some are small. They are the driving force of innovation, and change - the fuel that finances creative destruction.

The really big ones do so at terrific cost and risk. The costs are faced primarily by those who are left hodling the bag when bubbles crash. The risks can affect the entire global economy. The last 15 years has seen bubbles that have rocked the world economy (Asian Miracle turned Asian Economic Crisis, Russian Debt Crisis, Long-Term Capital Management, Argentina, the Internet), each time nearly bringing the globe to an economic crisis.

While bubbles are more frequent than we typically realize, they may also be accelerating due to the speed of global capital movements and the pace off innovation.

This blog is dedicated to improving our insight during these period of sweaping transformation so that we can manage them more effectively.

Bubbles Today

There are a lot of bubbles out there today. Top of the list are:
real estate,
hedge funds,
US debt,

What else is out there? What about little bubblets?

Search wars (Yahoo, Google, Microsoft, etc...) ?
Blogging ?
Cell phone games ?

Tuesday, February 08, 2005

Bubbles of the Past

We tend to think bubbles are rare "once in a life time events," but the truth is bubbles occur all the time. Since the 1960s there has hardly been a year where there has not been a bubble somewhere:
Late 1990s –2000 Internet bubble
Early 1990s – 1997 Asian Tigers, opening market, directed lending
Mid 1990s – 1997 Russian Debt
Mid 1990s Long Term Capital Management (1)
Mid 1990s China opening market, privatizing
Early 1990s Biotechnology
1980s Japan stock market, real estate
1982 – October 18, 1987 US Stock market
Early 1980s Personal Computers and related hardware, software in US
1980s and Early 1990s Real Estate Banking Crisis, S&L, others banking crises
Late 1970s-1980 OPEC 1979 price rise in oil
Late 1970s -1982 Third world syndicate bank loans
Mid 1970s REITs, office buildings, tankers, Boeing 747s
1960s-1970s Go-Go years, Nifty-Fifty (1,2, 3), technology companies (“onics”), color television
1920s-1929 Stock market, radio, autos, telephone
Late 1910s – 1921 Postwar boom, stocks, ships, commodities
Early 1900s – Oct 1907 Coffee, Union Pacific
Early 1890s - May 1893 Silver, Gold
1840s – 1945 British Railway mania II
1840s – 1850s US Railway mania
1830s – 1936 British Railway mania I
1820s Latin American bonds, mines, cotton in England
Late 1790s – 1810s Various waves in commodities, securities in England, Hamburg
1790s Canal mania
1770s East India Company in Amsterdam. Canals, turnpikes in Britain
1770s Commodities in Amsterdam
1720s South Sea Company, company stock in England
Late 1600s East India company, new companies, lotteries, in England
1630 Tulipmania in Dutch Republic, real estate, canals

Monday, February 07, 2005

5.5 Myths About Bubbles

Myth 1: Bubbles are rare aberrations to normal rational and efficient economic functioning.

Reality: Bubbles occur all the time. They are not aberrations to normal economic functioning. They are normal. Since the 1960s there has hardly been a year where a bubble has not occurred somewhere. Today, we swimming in bubbles see: China, hedge funds, real estate, US debt, nano-technology.

Myth 2: Bubbles are just “irrational exuberance” seizing the whole market.

Reality: Exuberance plays a role but its just one part of the story. There are both rational and irrational aspects to bubbles. They are based primarily on a cascade of bad investment decisions that follow some classic patterns throughout history fueled by 4 things: 1) distorted information and analysis that appears to justify inflated valuations for many; 2) distorted competitive marketplace that force everyone to play the game in order to earn competitive returns in a hot bubble market; 3) distorted allocation of capital that over-saturate investment opportunities; 4) easy access to money deteriorates sound business decision making leading to waste, bad business, lower return on capital and in the end a crash.

Myth 3: Bubbles are a big Ponzi scheme in which savvy investors take advantage of naïve investors who are consumed by enthusiasm and do not understand what their investments.

Reality: A lot of naïve investors do fall pray to savvy investors, but a lot of savvy investors get sucked in too. There are 3 types of investors regardless of how savvy they are: Believers, switchers and speculators. Believers truly have faith that they are making good investment decisions because they have a “vision” of the future of some new technology or market opportunity. Often the long-term potential of this vision is correct. What they tend to get wrong is how long it takes for this vision to become reality and where profits can actually be derived. As bubbles last for years, many investors switch from being skeptical and staying out of the market to investing. Some do this because they are converted and become believers. Others capitulate, they are forced to invest because in order to meet competitive returns in bubble markets they have to play the game. Speculators are timing the market and trying locate the fools who will hang on to inflated assets longer than they will.

Myth 4: Bubble are caused by excess liquidity driven by Federal Reserve policy that sets interest rates too low.

Reality: Liquidity is a key driver of bubbles, but interest rates are not always the primary source of liquidity for bubbles. Low interest rates can help provide a ripe capital market environment for bubbles and can tip the balance for some marginal investors to put in a little more money than they would otherwise. However, while low rates do lower risks of capital, they do not eliminate risk altogether. No interest rate justifies the kinds of bad investments that occurs during bubbles such as dot.coms that never should exist, Chinese companies that are scams, condo construction in super saturated markets like South Florida. Many bubbles occurred during rising interest rates including: The bubble leading to the 1987 crash, the Go-Go years of the 1960s, personal computers in the early 1980s. The primary source of liquidity for during many sector specific bubbles is investment portfolios targeting bubble assets that rise dramatically with the bubble, reinvest their gains creating self-perpetuating capital spiral that only ends when the bubble bursts. The more important cause of bubbles is not low rates, but a cascade of bad investment decision making.

Myth 5: Bubbles are bad.

Reality: Purely speculative bubbles like the Dutch Tulip mania, certain stocks, commodities, currency, don’t produce anything and typically crash leaving more people worse off. They are bad. However, business bubbles based on new technologies like the Internet or new market regions like China, are the driving force of capitalism. They finance innovation, change and accelerate learning about new opportunities.

Myth 5.5: Bubbles are good.

Reality: Speculative bubbles tend to leave more people worse off than when they started. Even productive business bubbles have great costs and carry great risks. The costs are obvious in the form of money lost during the crash. But the risks can also have sweeping effects in the US and global economy. The last 25 years has seen bubbles that have rocked the US or world economy (LDC Debt, S&L Crisis, Asian Miracle turned Asian Economic Crisis, Russian Debt Crisis, Long-Term Capital Management, Argentina, the Internet), each time nearly bringing the globe to an economic crisis.

Sunday, February 06, 2005

Some Good Academic Papers (please add to this list)

Barber, Brad and Odean, Terrance. (2001). “The Internet and the Investor,” Journal of Economic Perspectives. (Winter) Vol. 15 Num 1 41-54

Barber, Brad and Odean, Terrance. (2000). "Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors" Journal of Finance, Vol. LV, No. 2, 773-806.

Paul A. David and Gavin Wright -- General Purpose Technologies and Surges in Productivity: Historical Reflections on the Future of the ICT Revolution.

DeLong, Bradford, Andrei Shleifer, Lawrence Summers. Robert Waldman, “Noise Trader Risk in Financial Markets,” The Journal of Political Economy, 94 (4) 703-738

DeLong, Bradford. (2002) “Macroeconomic Vulnerabilities in the Twenty-First Century Economy: A Preliminary Taxonomy” Conference Draft

Devine, Warren. (1983). “From Shafts to Wires: Historical Perspective on Electrification,” The Journal of Economic History, 43:2 (Jan) 347-372.

Gompers, Paul, and Josh Lerner. "Money Chasing Deals?: The Impact of Fund Inflows on the Valuation of Private Equity Investments." Journal of Financial Economics 55, no. 2 (February 2000): 281-325.

Gompers, Paul A., and Josh Lerner. "What Drives Venture Capital Fundraising?" Harvard Business School Working Paper Series, No. 99-079, 1999.

Haacker, Markus and Morsink, James. (2002). “You Say You Want A Revolution: Information Technology and Growth,” IMF Working Paper WP/02/70 (April)

Helpman, Elhanan and Trajtenberg, Manuel. (1994). “A Time to Sow and A Time to Reap: Growth Based on General Purpose Technologies,” NBER Working Paper 4854, (September)

Helpman, Elhanan. (1996). “Diffusion of General Purpose Technologies,” NBER Working Paper 5773, (September)

IMF World Economic Outlook, April 2003 -- Chapter 2: When Bubbles Burst PDF 355KB

IMF World Economic Outlook, September 2004 -- Chapter II. Three Current Policy Issues - The Global House Price Boom PDF 412KB

IMF World Economic Outlook, May 1998--Chapter IV. Financial Crises: Characteristics & Indicators of Vulnerability

The Myth of Asia's Miracle, Paul Krugman

Ritter, Jay and Welch, Ivo. (2002). “A Review of IPO Activity, Pricing and Allocations,” The Journal of Finance, (August).

Scharfstein, David and Jeremy Stain, “Herd Behavior and Investment,” The American Economic Review, 80 (3) 465-479