The Anatomy of a Bubble
Recalling the Lessons of Recent Financial History
The dictionary defines a bubble as “something that lacks firmness, solidity, or reality.” Within the context of the economy, a bubble represents short-term financial gain that comes on suddenly, grows uncontrollably, and pops unexpectedly.
The world has a long history of financial bubbles, and they have all been equally sudden, sometimes illogical, and almost always devastating to those lured by their obscured view of reality. There was the Mississippi Bubble, the South Sea Bubble, the Bull Market Bubble of the late 1920’s, the Japanese Bubble, and the Dot Com Bubble. Each defied economic theory and in many cases, challenged simple common sense.
And of course, who can forget the recent Housing Bubble? As America entered the 21st century, home prices had gradually started to climb. They ticked up slowly at first and then as quickly as you could say “New Listing,” they rocketed to levels never seen before. Americans no longer just bought a new home, they now engaged in zero down, speculative buying, back-up offers, contingencies, and all out bidding wars. By 2001 we were in a full, fledged housing bubble that stretched and grew … consuming real estate markets like the last outposts of a Wild West land grab.
Fueled by lax underwriting, loose refinancing requirements, and an abundance of easy money … home prices soared! Some home owners up-sized, others cashed out, others re-financed, and still others pulled out equity as frequently as visits to the corner ATM.
The Housing Bubble peaked early in 2006 and like all bubbles, it began to lose air. It softened, withered and continued deflating for the better part of six years. Many that joined in the sudsy fray were left with negative equity, collapsing credit lines, adjusting mortgage rates, soaring debt, and completely unsustainable property valuations. Suddenly foreclosures, defaults and short-sales were the norm as entire communities slipped under water. The ghost towns of the 19th century copper boom … were no match for the dead zones of the 2008 Housing Bubble.
The crisis not only impacted home values but also hit the mortgage markets, the credit markets, construction, manufacturing, wholesalers, retailers, home builders, contractors, and realtors. Perhaps more disconcerting is that the real estate bubble undermined the traditional role of home ownership as a key retirement asset for millions of Americans. The idyllic white picket fence and finely trimmed lawns of the American psyche were replaced by stark Bank Owned and Foreclosure signs imprinting countless yards where children once played.
During this last bubble, a new phrase was coined called “Bubblenomics.” It is what occurs when passion overtakes reason, hype overrides common sense, and fast gains trump long-standing economic theory. The current stock market surge is a prime example.
Wall Street is in a large and tenuous bubble. It is one that we will talk about long after it withers away. With bloated portfolios, surging gains, ballooning IRA accounts, and the posting of daily records from the Dow, it’s a tough conversation to have. But real bubbles are never realized until after they burst leaving their gritty residue all over your life, your home, your savings, and your retirement.
And as the current bubble continues to expand, history tells us that it will necessarily contract. History also tells us that the greatest stores of wealth are forged by those that find and hold intrinsic value in the face of speculation and frenzy. Lear Capital has been helping customers do precisely that for over 15 years.