The WSJ has a fascinating article on the economics of bubbles and why it might be rational to support a bubble until it bursts:
Bubbles often keep inflating despite cautions such as Mr. Greenspan's famous warning of "irrational exuberance." Tech stocks rose for more than three years after he said that, in late 1996. Markus Brunnermeier, 39, thinks he understands why this happens.
Growing up near Munich, Germany, he expected to become a carpenter like his father. A building slump dissuaded him, and after stints in a tax office and the army he enrolled at the University of Regensburg.
He had struggled to understand why West Germany, where he lived, was so much more prosperous than East Germany. At Regensburg, he came across the work of Friedrich Hayek, the Nobel prize-winning Austrian economist known for a spirited defense of free-market capitalism. Mr. Hayek noted that while East Germany's government set prices, in the west the market set them -- and provided information about supply and demand that helped the economy adjust.Inspired by Mr. Hayek's work, Mr. Brunnermeier studied economics. But in the 1990s, soaring tech stocks made him skeptical of the quality of information that prices convey. As a graduate student at the London School of Economics, he wrote a survey of research on bubbles and crashes that turned into a book.
Under the Hayek view, bubbles don't make sense. As soon as some group of traders irrationally pushes prices way up, more-rational traders should take advantage of the mispricing by selling -- bringing prices back down. But the tech boom reinforced an oft-quoted warning from John Maynard Keynes: "The market can stay irrational longer than you can stay solvent."
So investors who spot the bubble attack only if each is confident that other skeptics are on board. In work done with Mr. Abreu, Mr. Brunnermeier concluded that if all the rational investors could agree to bet against the bubble, they could make big profits. But if they can't coordinate, it's risky for any one of them to bet against a bubble. So it makes sense to ride it up and then get out quickly as soon as the bubble's existence becomes common knowledge.
Read the whole thing.
Hat-tip: Tyler Cowen
- Log in to post comments
It's also rational for all of the people who influence a market but don't hold a direct stake. Instead their income is based on sales volume (brokers, investment bankers, etc), or on maintaining the good will of the actual players in the market (analysts). For those people, calling the pop a bit too early would decrease their income compared to that of brokers and analysts who kept their mouths shut and kept everyone happy until the bubble burst. Privately planning for the burst would be the best bet for them, though then there would be ethical implications.
This behavior sounds a bit to me like some of the information that is coming out about how bacteria and bacterial colonies coordinate their actions by various mechanisms of quorum sensing.
The bacteria spread a chemical message that allows the particular bacteria to tell if it has enough population weight to be effective.
Bearish traders wait for the news of the bubble to become accepted and this acceptance to become common knowledge before they place their bets against teh bubble.
The bears, like a minority bacterial colony, would face losses if they get too active too soon. So both wait until they are sure their compatriots, or those sharing their opinion, are in place in sufficient numbers to shift the balance in their favor. Lowering their risk while maximizing their benefit.