Thursday, July 27, 2006

"When the Wind Blows Hard Enough, Even Turkeys Fly" or "Temporary Religions of Convenience"

I found this to be a most excellent summary of the psychology underlying asset bubbles in general and the housing bubble in particular.
The tech stock bubble was psychologically supported by a repeat of the mass delusion of an economic New Era. The very same term was used four times in the 20th century to explain a temporary suspension of well understood principles of market pricing: in the US in the 1920s, in the US in the 1960s, in Japan in the 1980s, and in the US in the 1990s. Each New Era period ended with a repudiation of the New Era idea that a fundamental change had occurred in the way the economy and markets operate, thus explaining the enduring elevated securities prices. Why re-cycle the old New Era concept? The old New Era tale apparently works over and over again, and will no doubt work again some day.

Mass belief in the New Era myth was supported by the media, elected officials, venture capitalists, and every other institution and organization that benefited. The deluded masses got some crumbs off the New Era cake as well; the apparent free and zero risk money flowing their way as the stock market rose was surely the result of their investment acumen. And why shouldn't they partake in the benefits of the New Era that the experts in the press, and honorable and credible representatives of the US financial system's institutional representatives such as Abbey Joseph Cohen, and even the head of the US central bank, Alan Greenspan, proclaimed as the real deal. Of course, what made the illusion of a New Era possible, and pushed the value of the stock of now bankrupt to absurd levels, was a hurricane of money, first supplied by the Fed, later by the markets themselves as money was recycled via the public markets back through venture capital and back out through new IPOs. When the wind blows hard enough, even turkeys fly. asset bubble is supported by an underlying belief system, a kind of temporary religion of convenience that evolves during bubbles to explain, as in John Ciardi's children's poem, "Why the sky is green, why trees are blue/Why kittens caw, and crows mew." Faith allowed millions to suspend disbelief and put large amounts of money at risk. When a market is imbued with a misperception of risk, investors begin to lose the ability to distinguish between gambling and investing. The New Era religion even spreads to the Fed itself, in the form of the usual assertions that the masses of investors know best, even when they are in the grips of a mass delusion.

The mirage of low risk is further enhanced by the observation of market participants that speculative bubbles, even when acknowledged as such, can collapse with little consequence. The reason is that the Fed has as its primary mission to rescue the markets to prevent a knock-off collapse of the real-economy. Market participants see that the Fed has apparently succeeded at this mission over and over. It's human nature to continue to engage in risky behaviors that are repeatedly survived, whether it's free diving that results in 100 deaths per 5,000 divers per year, or investing in assets that one fully expects will certainly get pumped back up again by Keynesian monetary and fiscal policy.

Asset bubbles collapse in increments. Starting in 1999, Fed rate hikes started to lower the wind speed and a few turkeys fell to the ground. Along with bankruptcies and layoffs, as I predicted in my article, revelations of fraud -- fraud is a standard feature of all asset bubbles, including the real estate bubble -- started to chip away at investor confidence and undermine bubble mass psychology, causing many to start to lose their faith. In the atmosphere of lingering greed but growing doubt that happens at the end of an asset bubble, what economists refer to as a random exogenous event occurs that gets the inevitable panic selling started.

As in the case of all bubbles, belief in its foundations is for a while self-fulfilling. Real estate is a good example. The believers' valuation process is tautological: the value of housing is rising because prices are rising, attracting more money, causing prices to rise further.


marine_explorer said...

"...what economists refer to as a random exogenous event occurs that gets the inevitable panic selling started."

This "event" is later interpreted as the root cause, while the "investing" public's basic assumptions about manias continues on, untested. Perhaps this explains people jumping from a tech meltdown into a housing bubble?

Anonymous said...

That is a great explanation.
Thanks for finding it.
I'm wondering what is going to happen next.

fredtobik said...

What insight, markets are affected by emotions, how suprising. Definetly pulitzer material.

I guess the industries that were created during the 90's are our imagination.

Sounds like someone bought stock... or webvan.. lol

Always someone elses fautl...

Anonymous said...

I'm wondering what is going to happen next.

Remember dot-coms?
Magic: The Gathering cards?
Black & White small-press comic books?

sf jack said...

fred -

Just wondering - could you name the industries created in the 90's?

Marinite said...

No doubt he is talking about internet companies (e.g., Google, eBay, etc.), miles and miles of optical fiber cable that was laid down, etc. The industries were created, got all puffed up by the bubble, and then came crashing back down to earth in terms of valuation. But the infrastructure is still there for new companies to use and for much cheaper and some companies obviously survived the crash and are chugging along.

The same sort of thing will be said about granite countertops, stainless steel uber appliances, cherry hardwook cabinets, italian tiles, etc. Over-priced tract homes are the pets.coms of the 00's IMO. People will be able to get them for cheaper. It will just take longer than the stock markets took as houses are illiquid which sellers are now re-learning.

fredtobik said...

Jack - what marinite said.

Marinite - I am interested in your definition of a tract home.

sf jack said...

fred -

The "industries"? Is there really an internet industry? (as there's an automobile industry, or a biotech industry, or a travel & leisure industry?)

As for companies... Google is an advertising company. And probably a communications company of some kind. Albeit, both in new says.

And eBay, I can see that, it's new, bringing sellers and buyers together in a new way.

Fiber optic cables, for communicating? Boy, that really sounds like "new".


"tract house

n : one of many houses of similar design constructed together on a tract of land"

fredtobik said...


I think it is sad that the 90's are associated more with stupid people doing stupid things(buying stock), than smart people doing smart things. When people refer to that time it is all about stocks, and not about creative innovative ways to do business.

Anyway, I haven't seen any tract homes in Marin like there are in the Detroit area, or Phoenix, where every house is the same with very small subtle differences. I am still new to Marin though, always interested in learning.

sf jack said...

fred -

I definitely agree your thoughts re: late 90's.

At the same time, with regard to innovation, I have to say that some really dumb ideas must have looked good to somebody because some real crap got funded... and as we know, eventually the cream rose to the surface, so to speak.

I think I know what you mean by "tract houses" in some of those cities you mention. Maybe the excesses of "sameness" evident there were also seen here, but perhaps the "creativity" that Californians are known for having (especially in Marin!) has allowed more individualistic forms within such tracts to emerge.

A little twist here, a different touch there (either in original construction or in the meantime up to the present) and voila! A neighborhood with some character and some interesting features despite the tract "nature" of it overall.

Just a thought.