Sunday, September 4, 2011

Boombustology: Chapter 11

Asset bubbles are frequently popping up, and back down. They are easy to spot in hindsight, but we appear to lack the tools to recognize them ahead of time. Vikram Mansharamani aims to rectify that with his book, Boombustology. He applies a multi-lens approach to understanding bubbles with the aim of giving the reader the ability to identify bubbles, and thereby avoid being caught unaware.

In this chapter, the author aggregates the learnings from the previous chapter in order to develop a framework for accurately identifying bubbles while they are happening. Observers should look at the following attributes:

1) Are credit and asset prices reflexive? If credit has fueled growth in asset prices, and if creditworthiness is determined by asset prices rather than income-based affordability metrics, look out!

2) Is cheap money playing a role? Financial innovation often accompanies the build-ups during unsustainable booms, but these innovations are usually nothing more than embedded or concealed leverage. Is money so cheap that it is even available to borrowers who would otherwise be considered unworthy of credit?

3) Is there a feeling that this time it's different? New technological developments can sometimes make it seems as if prosperity will forever be present. An interesting indicator is the level of prices for trophy assets such as art and prominent architecture. For example, the world's tallest skyscrapers have tended to be built in regions which were later shown to have undergone unsustainable booms.

4) To what extent are regulations affecting supply and demand? Political activities can have unintended consequences which reduce supply and increase demand. These can lead to price instability.

5) How infected is the population? If amateur investors and popular media are interested in the asset class, it is a sign that there aren't many people left to contribute to the bubble. The bubble is thus relatively mature.

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