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David's Macro Blog

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Tag: boom and bust

British humor we can all understand.

Somehow this seems to explain the situation better than CNBC. Why is that?

Can good economic times last forever? Is it impossible to have “stable” economic growth?

This is the argument presented in Barry Ritholtz’s post: Galbraith: Financial Stability Creates Instability

Here are the essential points of the article.

  • When the economy is good for a long time, people then think the good times will continue indefinitely so they take extra risk (e.g. debt).
  • This additional risk eventually sows the seeds of the end of the economic expansionary period.

For example, during the 2000 real estate bubble, housing prices were thought to only go up, therefore the logical conclusion was for everyone to buy as much real estate as possible (by using financial leverage or debt) since this was an easy road to wealth.

Of course this speculation led to massive over construction of residential and commercial real estate. The resulting overcapacity caused falling prices which, as we now know, completely destroyed our financial system and the economy.

Interestingly, classically accepted econimics says that the economy can remain in a steady state – yet it never does, does it?  Ritholtz’s article explains what really happens.

Key Quotes

McCulley was referring to economist Hyman Minsky’s concept that long periods of stability cause people to take on ever more debt and ever more risk, leading to a gigantic meltdown.

Systemically-speaking, the Ponzi phase is one of risky behavior crowding out prudent behavior in a world free of regulatory controls. If risky behavior is temporarily rewarded with profit and this temporary period is long enough, then risky behavior wins and drives out good behavior.

Think we’ll remember this during the next bubble?

Related Posts

Classical economics teaches that an economy, if properly managed, will remain in a state of equilibrium. This is because economists assume a perfect market place with rational actors who maximize their returns through their uniform access to all information.

As we know, the REAL world is much different from economic equations.

Instead, the real world economy moves through market cycles. These market cycles fluctuate between boom and bust as the market participants move through cycles of fear and greed and all sentiments in between.

The past 10 years have seen some amazing bubbles which were not sustainable because the asset prices got out of line with the underlying fundamentals supporting the market.

Let’s review the bubbles in our recent memory.

2000 Nasdaq index over 5000 – 9 years later the index is still off 60% from its peak.

2007 Real Estate Bubble – In just 2 years some markets are off 60% and the average is off 30%.

2008 Oil Price – The price per barrel peaked around $150 but then fell to under $40 in less than 2 years.

2009 US Treasuries??? If the future holds inflation then this may be just as large as the 2007 real estate bubble. However, if we continue with deflation, then maybe current yields are the new normal.

So, what bubble are we in now?

Please comment below and let me know what you think.

You might also like these posts on similar topics:

Historically we often think of a recession as a sharp drop in economic output followed by a sharp rise. This is called the “V-shaped” recovery. The current “Great Recession” had a sharp downturn but so far no recovery after 18 months, and most talk is of an “L-shaped” or “U-shaped” rebound.

Why is this?

There’s an excellent post on Calculated Risk blog (one of my favorites) about economic growth engines that typically pull us out of recession with a sharp upward swing in activity.

The top two economic growth engines are residential investment and personal consumption expenditures.

Since we’ve had the largest residential real estate bubble in history and massive over-consumption, both due to very loose credit, these two growth engines are NOT poised to restart economic growth anytime soon.

In fact, just the opposite is true. Any recovery will be held in check by the massively overbuilt inventory of residential real estate and the inability of consumers to tap savings and credit to purchase consumer goods at the level needed to “stimulate the economy”.

Thus, while it looks like we avoided the Great Depression II, we’ll probalby remain in the Great Recession I for some time.

What do you think? Whether you agree or disagree, please add your comment below and show me you’re alive!

Was the great real estate bubble of 2000 – 2007 preventable?

Who won and who lost?

Why weren’t the inevitable crash and current historic recession preventable or predictable by the best the brightest among us?

The following video from CNBC’s “House of Cards” (ht – Alan Sun) contains interviews with people in all parts of the real estate food chain: from borrowers to loan officers to lenders to wall street bankers to hedge fund operators to bond ratings analysts.

Wall Street will create what they can sell until there are no more buyers. This generates seemingly safe fee income which boosts quarterly profits and of course also produces undeserved multi-million dollar bonuses.

It is hard to believe now, but the banker’s financial models predicted 6% to 8% annual housing price increases forever into the future. How was this sustainable when household income wasn’t rising and probably wouldn’t rise much with global wage arbitrage? Many of the people on the front lines of this historic boom were young home buyers, recent MBA grads at Wall Street firms, etc. They had never known a down real estate market. It couldn’t even occur to them from experience that real estate goes anywhere but up in price.

The boom couldn’t start without Wall Street securitizing loans and selling them off to investors (many of them overseas). What type of WS culture creates an environment where there is strong incentive to sell what the market will buy and book a trading profit or fee income? No one had any incentive to stop the lucrative money train.
– Home buyers bought more house than they could afford.
– Loan officers originated more loans and earned significant income for basically just helping borrowers fill out a form (loan app).
– Wall Street bankers generated massive bonuses for themselves and quarterly profits for their firms.
– Rating agencies earned more fees rating mortgage backed securities (MBS) as AAA.

Isn’t it startling that nowhere was a fundamental issue like a borrower’s ability to service a loan and pay on time for 30 years ever discussed or considered?
The economic boom was NOT about fundamental value creation but solely a product of easy credit. Housing prices historically rise about 1% a year in line with increases in household income. They will revert to the mean over time. Essentially, there is no new economy or new economics. When we hear that in the MSM (mainstream media), look for the unsustainable bubble and prepare for it to end.

Why couldn’t Alan Greenspan, our economic “maestro”, our foremost authority on finance, interest rates and a stable economy, have warned us about the unsustainable boom and subsequent global economic collapse? He didn’t see the bubble. To make matters worse, he says:
“there is no doubt that somewhere in the future, we’ll have this conversation again. It will not be for quite a period of time, but it will occur because the flaws in human nature are such that we cannot change that, it does not work.”

Will you remember that all booms go bust?

Will you remember that what cannot go on forever must end?

Will you remember what your parents taught you? Just because everyone is doing it, doesn’t mean you have to do it too.

If history is any guide, almost all of us will forget what we learned by the time the next boom starts. Scary thought, isn’t it?