Bubbles

It is actually quite refreshing to be cornered by a 16 year old with a sharp mind and sharper question! I have no qualms whatsoever in saying “I really don’t know!” to any of my students. I do have issues with teachers who do not get back with an answer after looking things up.

One of my IB1s, Allie, is a truly remarkable young lady. She has that ice-pick sort of mind that goes to the heart of any matter and spends little time on peripheral issues. She sees the obvious questions to be asked that so few of us ask.

Our IB students do loooooong days and I am inclined to ease off a bit during last class. I have baked in 30 minutes of movie time on days when I know the kids will be absolutely knackered. No, we don’t watch ‘Hunger Games’ or such but such films as ‘Commanding Heights’, ‘Inside Job’ or ‘How China Fooled The World’. I’m not much fun to watch movies with – I tend to pause now and then and do diagrams. In my defence, I do make sure that we are well-armed with crisps (‘chips’ in American-ese) and Gummibears!

We were watching Inside Job, a rather scary documentary (of sorts – I mean, Matt Damon is the narrator) about greed, stupidity, ignorance, greed, deregulation, greed and greed. You get the picture; the financial crisis of 2008. The first part of the movie is about how a bubble is formed – basically how the self-fulfilling prophecy of of expectations inflates asset prices (property and/or shares) in an ever-upward spiral that isn’t ever ‘ever-upward’. That’s the second part; what happens when the bubble pops.

It was around this point where I pressed pause in order to refer the IB1s to a few clarifying points about some of the terms used (such as CDOs) and Allie cocked her head to one side, politely raised a hand and asked “Matt, why do bubbles pop? I mean, I can understand the ‘self-fulfilling prophecy’ of speculative surges that drive up the price of housing and shares, but what actually causes the bubble to burst?”

I gave my standard answer: “Well, ultimately, we run out of fools! Just imagine buying a good and selling it on to someone who is either not as smart as you or simply does not have access to the information you have. He is the ‘greater fool’ and as long as there is one more ‘greater fool waiting in the speculative line, the bubble can continue. When you run out of fools…”

Now, Allie is not one to sit still for a what actually is a lay (= non-professional) explanation. She pressed for a theory or model that would explain the process by which asset prices (of shares, property, gold for example) suddenly plummet, leaving the ‘last fools’ with huge losses.

My answer went something like this: “Well, um, hrmmmm…quite frankly, I really don’t know!” I wrote her question down on my to-do board and we went back to the film. Upon ending class I promised them an answer by next class. Then I started to look things up…

Simply put; there are a lot of suggestions but no theories really hold up completely in addressing the issue. I was quite taken aback. Somehow one assumes that great minds have put forward some sort of “…Z follows Y which is caused by X…” line of reasoning that would have broad acceptance amongst economists. Nope. No such model or theory. The range here is something like a) “All bubbles are the result of excess money supply and liquidity!” to; b) “There is no such thing as a bubble since this contradicts the efficient market hypothesis!” In between one can read about how bubbles pop when large investors – for some reason or another! – leave the market. But I have not as yet been able to find a solid line of theory that explains the general pattern of bursting speculative bubbles.

Ask your teachers! If they can help me, I’d be most appreciative.