Bubbles. We’ve just been through two of them in relatively short succession: the Internet bubble of the late 1990s, and the recent housing bubble.
Why do bubbles occur? The list of explanations includes shortsightedness, sheer stupidity, and greed. The history of bubbles is a story of excessive enthuasisms—for anything from tulip bulbs to subprime mortgages.
But is there something more fundamental at work? Something more innate and psychological? It seems to me there is. It arises from who we are as humans, and in how we think and behave, individually and as social animals.
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Is it the 1930s all over again? If that were true, it would be one very good reason to panic, sell everything, and put your money in a mattress. But it turns out that the comparisons between today and the Great Depression are (mostly) bunk.
You should know by now (if you’ve been reading the papers or the blogs) that the stock market crash of 1929 did not cause the Great Depression. Instead, the Depression came about because of a flawed economic response in Washington. As the economy cooled in the early 1930s, rising bank failures led to sharp contraction in credit. Congress balanced the budget and imposed trade tariffs. The result was a downward spiral in the economy and massive unemployment. The economic collapse led to the failure of the financial system—notably, a surge in bank failures and collapsing stock prices.
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Trying to understand the global financial crisis? Confused by derivatives and default swaps and the commercial paper market?
Here are three ideas to explain it all: cheap money, surging debt, and bad credit.
Recipe for financial chaos: Take one large economy. Add cheap money—the lowest yields in 40 years. Encourage households to rack up big debts without any attention to long-term ability to repay. End result: a surge in credit card and mortgage debt, driving a consumption and housing boom in the economy. A big-screen TV, a new car, a bigger house, maybe even a vacation home—all available for “no money down” and with “low monthly payments.”
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