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The Three Bubbles

By Brian | March 27, 2009 | Share on Facebook

Jeff Porten posted a very cool graph, in that it provides a nice perspective on how the market has performed in the last ten years, relative to the sixty years before that. This illuminating tidbit finally kicked my butt into gear and got me to draw (and post) the graph I’ve been visualizing in my head for months now:

The blue line represents the NASDAQ composite from 1993-2003 (Source)
The red line represents average home prices in the US from 1999-2008 (Source)
The green line represents crude oil prices 2006-2008 (Source)

I’ve used different scales for each line so that the peaks are roughly even, in order to illustrate my point, which is this: we’ve had three economic bubbles in the last ten years; they are getting closer together, and they’re completing faster each time. Before we rush ahead with new laws and government regulations, we need to answer several very difficult questions:

These are not easy questions to answer. Most policies that accomplish one will not accomplish the others (in various combinations). Also, when we’re in the tail-end of a bubble, the bubbles seem like horrible things that we’d like to avoid in the future. When we’re in the beginning of one, though, we call it “unparalleled economic growth,” and it’s generally seen as a good thing (in particular, the kind of good thing that wins elections).

I don’t necessarily have answers to these questions, but at least Jeff and I are now tied at one cool stock market graph apiece. And that’s gotta count for something…

Doesn’t it?

Topics: Money Talk | 8 Comments »

8 Responses to “The Three Bubbles”

  1. Ilya says at March 28th, 2009 at 5:39 am :
    Very cool, Brian, but I would argue that the shape of the housing line contradicts your statement about completing faster. It looks to be a longer bubble than the NASDAQ one, and with less dramatic fall off from the peak. Accounting for the fact that housing data lags by a few quarters, the bubble burst is not “over” yet, at least in the same sense in which you deem the NASDAQ bubble over by ’03.

    I don’t have a clear idea whether this observation affects your proposition in any way, though.

  2. Brian says at March 29th, 2009 at 11:21 pm :
    Good point, Ilya. Now might be a good time to point out that I stretched the X-Axis on the right side of the curve as well (otherwise, the graph wasn’t very readable).

    The Nasdaq went from it’s peak to it’s trough in roughly three years. The housing market took a much slower road to reach it’s peak, but then dropped almost 50% of it’s value in roughly 18 months. And, while some are saying we’ve found a bottom, we obviously won’t know for sure for another year or two.

    Oil’s decline also went past the edge of the graph (dropping another ~40% in 2009) – the data source I had stopped at 12/08.

    Bottom line: this isn’t a perfect geometric progression by any means. A deeper analysis (some of which I wrote about here), can show a “follow the money” correlation between the three events which, when coupled with this graph, speaks more clearly to the path our economy has taken in the last 10 years. When we move past the punitive and sensational reactions to this crisis and start talking about revised regulations, knowledge of these events will prove eminently useful.

  3. Jeff Porten says at March 30th, 2009 at 1:36 am :
    You skipped over what strikes me as the key question: does this many bubbles, in such a short period of time, indicate that something in systemically wrong with how we’re running our economy?

    You can probably guess my answer, and naturally I have a post simmering about it. Your thoughts?

  4. Brian says at March 30th, 2009 at 9:59 am :
    I suspect we’d agree, but for different reasons.

    My personal belief is that bubbles are nothing new, except that we used to call them “economic cycles.” I believe that technology has greased the wheels of commerce to such a degree that a market move which used to take weeks or months to complete can now happen in days or hours, given the almost universal access to global markets and the almost free cost of transacting trades that we enjoy today.

    That’s what I meant when I spoke about revised regulations. The equity markets have “curbs,” which stop trading when it gets out of control and allow emotions to drain before financial ruin ensues. The derviatives markets have no such controls. And since the derivatives markets act as capacity boosts for non-speculative markets (like mortgages), rapid changes in their health can severely impact our economy outside of the financial sector. Hence the need for new regulation.

    My current fear is a regulation that focuses more on the more public, but less important, areas of executive compensation and other administrative expenses, without addressing this very real problem.

  5. Jeff Porten says at April 2nd, 2009 at 9:54 pm :
    Do you think there’s a method of taming the worst excesses of various bubbles, aside from our current method of sometimes closing the barn door after the cow’s escaped? I’m noting that the curbs you seem to agree needing now were once in place, before they were removed. I’m not sanguine about a system based upon, “Wait until all hell breaks loose, then scramble to fix it in a panic.” Which seems to be how we do things.

  6. Brian says at April 3rd, 2009 at 9:47 am :
    To my knowledge, the curbs I’m describing have never been in place in the derivatives markets, principally because the volume on these markets was so low as to never need them.

    As to your comment about “wait until all hell breaks loose, then scramble,” I agree that too much of our government runs this way, but market curbs are actually the exact opposite. They are akin to tranquilizing the cow when she kicks the barn doors open, so people have enough time to close them.

    This is why I point to them as one way (among many) to tame the worst excesses of bubbles. When emotions run high, the markets tend to discount supply or demand, causing huge spikes or huge drops. Slowing down trading (while, some may argue, limiting the rights of people to spend their money the way they want to) allows cooler heads to prevail and, assuming it’s enforced properly, shouldn’t provide anyone with an arbitrage advantage.

    My other recommendation (not that anyone’s asking me, of course…) is to find a way to limit speculation in markets where speculation has drastic downstream effects. The “cow has left the barn” in the mortgage market, but there are most certainly others out there.

    A stable asset (like a house) should not appreciate or depreciate in value so rapidly, and wouldn’t if there was a limit to how much speculation one could do (both on the buyer’s side – buying multiple investment properties and then “flipping” them for profit, and the seller’s side – avoiding regulatory reserve requirements by securitizing ~100% of the loans written).

  7. Jeff Porten says at April 4th, 2009 at 12:45 am :
    I think I wasn’t clear — my point is that the only effective curbs we have are the ones that we came up with after all hell broke loose. You’ve got one set passed during the Great Depression, another after the crash of 1987, etc. It’s not that the derivatives market was too small to need them — it’s that until it hits the fan, there’s zero political willpower to proactively set any.

    This seems to me to be a prescription for constant booms and busts in a market designed around innovative products — by definition, innovation won’t get any regulatory scrutiny until after the fact. (And the point is not the market cycles are bad — the point is that extremely violent market cycles are bad.)

  8. Brian says at April 5th, 2009 at 1:22 am :
    I see your point. The issue here, of course, is putting in curbs before they’re needed, which means passing regulations that have no effect on the everyday market at the time of their passage.

    Here’s a crazy example to illustrate my point:

    Let’s say I proposed that we regulate the amount of milk any given entity (individual or institution) can buy. How about no more than 10% of the current national supply. Do you think I’d get any votes? Or would I get thrown out of Congress for being loony?

    It sounds crazy because the market for milk is an ownership market (i.e., people who spend money on milk expect to receive and use milk), not a speculator’s market (people buying milk in hopes of selling it for a higher price later on). A consumer would never consider buying 10% of the nation’s milk supply, and so dairy farmers can expect relatively stable prices for their products (barring environmental disaster or somesuch event) . However, if someone figures out a way to “securitize” milk, and speculators begin to see it as a valuable commodity, then they may bid up the price of milk to a point where those on the borderline of malnutrition or starvation could go over the edge.

    Still sounds crazy, I know, but people felt the same way about homes in the 1980s. And about oil futures in the mid 2000s. Derivatives markets were a bit different, in that they were always, technically speaking, speculative, but the volumes were so low as to make curbs a ridiculous discussion.

    My point: slowing down the markets would identify the need for these curbs before things got very out of control, and would allow us to react (so the cow would have one hoof out the barn door, but could still be salvegable).


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