Here Comes Another Bubble, and a Crash That Will Dwarf the Last One, Unless . . .

Eric Janszen recently provided some very useful historical perspective in Harper's Magazine. He begins by explaining exactly what a financial bubble is: "A huge spike in asset prices that results from a perverse self-reinforcing belief system, a fog that clouds the judgment of all but the most aware participants in the market."

Asset hyperinflation starts at a certain stage of market development under just the right conditions.

The bubble is the result of that financial madness, accurately seen only when the fog of current events rolls away. It is a market aberration manufactured by government, finance, and industry -- a shared speculative hallucination and then a crash, followed by depression.

Bubbles were once very rare, says Janszen -- one every hundred years or so was enough to motivate politicians, bearing the post-bubble ire of their newly destitute citizenry, to enact legislation that would prevent subsequent occurrences. After the dust settled from the 1720 crash of the South Sea Bubble, for instance, British Parliament passed the Bubble Act to forbid "raising or pretending to raise a transferable stock." For a century this law did much to prevent the formation of new speculative swellings, i.e. bubbles.

Nowadays, however, we barely pause between such bouts of insanity. The dot-com crash of the early 2000s should have been followed by decades of soul-searching; instead, even before the old bubble had fully deflated, a new mania began to take hold on the foundation of our long-standing American faith that the wide expansion of home ownership can produce social harmony and national economic well-being. Spurred by the actions of the Federal Reserve, financed by exotic credit derivatives (a kind of insurance policy that transfers risk to someone other than the bank or other institution that extended the credit) and debt securitization, an already massive real estate sales-and-marketing program expanded to include the desperate issuance of mortgages to the poor and feckless, compounding their troubles and ours. (more)