This blog is based on comments made by Harvard economist, David Laibson, in response to my presentation at my 55th Harvard reunion, May 22nd.
Bubbles, whether in Japanese stocks in the 1990s, tech stocks in the US in 2000, or the price of residential real estate 2005-2008, are the result of "heightened expectations" in the economy, Prof. David Laibson explained at Harvard the other day. "When the Nikkei (the Japanese stock index) got to 40,000, everyone expected it to go higher-- but instead it fell to 10,000 and "has stayed there ever since," Laibson said.
The Harvard economist, whose specialty is behavioral economics, believes prices rise from the "principle of extrapolation," which is part of the pathological sequence by which an "economy is going out of control." Laibson believes that behavioral dynamics-- that what goes up, will keep going up," is the fallacy of bubbles.
He went on to posit that people believe that "whatever the market does must be right." What they can't see is that "whatever is happening is not permanent. High prices today probably means there will be low prices in the future." Laibson blames "the regulators( I guess he means the Fed, the SEC, the Treasury) for not stopping the bubbles."
By "out of control," he referred to the price of real estate outside Las Vegas and Phoenix, Arizona, where half the people put up only a downpayment of 10% to buy raw land upon which to build their home. The fact that raw stretches of desert present an unliited, irrational opportunity for Las Vegas and Phoenix to grow in an unlimited manner. "Congestion in the cities led to higher housing prices. Then, the open areas around Las Vegas and Phoenix allowed for expansion "without limit because they were located in the middle of nothing."
Laibson seemed to indicate on May 22nd at least that he didn't think the rage for social media stocks, exemplified by the Facebook IPO, was yet a bubble going out of control..
Another commentator on my blog"The 2008 Meltdown And Whom To Blame"-- suggested that I underemphasized the notion of "panic" in the marketplace to explain the tumultuous selling of every investment asset in the fall of 2008. "Panic can shut down overnight credit in the blink of an eye, and the effect is like taking the oil out of a running engine. Paulson(Treasury Secretary at the time) and the Fed were partly responsible for the panic because of their handling of Bear Stearns and Lehman, which raised the question"who's next."
Like Laibson, this commentator(whrosen) says "Financial regulation should embody a common sense dictum of "too big to fail" means "too big to play."
