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The Bubble Bursts


Eric Janszen, “The Next Bubble: Priming the Markets for Tomorrow’s Big Crash,” Harper’s, February 2008.

“Our economy is in serious trouble,” writes Eric Janszen in the cover story for the February Harper’s. “Both the production-consumption sector and the FIRE [finance, insurance and real estate] sector know that a debt-inflation Armageddon is nigh, and both are praying for a timely miracle, a new bubble to keep the economy from slipping into a depression.” A well-known venture capitalist, Janszen is the founder and owner of His is hardly the only voice on the markets today invoking apocalyptic notes. In the December issue of Vanity Fair (“The Economic Consequences of Mr. Bush”), my Columbia colleague Joseph Stiglitz makes equally dire forecasts. George W. Bush, he says, will soon outstrip Herbert Hoover for the unwanted designation of worst presidential economic steward in modern American history. Whereas the Stiglitz piece focuses on the major macroeconomic indicators, however, Janszen pulls in for a close-up view of the bubble cycle which, he argued, has come to mark the American economy.

What’s a Bubble?

We all know about this phenomenon from high school history. In the beginning, of course, was “Tulip mania,” the obsession the Dutch had with the tulip trade in the first four decades of the seventeenth century. Since the Netherlands in this era was pioneering the introduction of pre-capitalist high finance, it only stands to reason that they would also have first experienced the bubble phenomenon. Owning and propagating tulips was of course a matter for the leisure class, and the matter was developed into an industry that moved on ridiculous paths, but also providing the footprint for an emerging commodities market (futures contracts, for instance, were developed in conjunction with the tulip trade). At one point the varietal “Semper Augustus” drew a bid of 6,000 florins for a bulb (at a time when a middle class burgher subsisted on 150 florins a year). The prices were delusional, out of proportion to a realistic long-term market. A crash was inevitable. It came in 1637.

And other bubbles came and went. The South Sea bubble of 1720, for instance, which led Britain to start the process of regulating the financial services industry. The Crédit Mobilier scandal of 1872.

A financial bubble 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—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.

But the word “bubble” itself is something of a misnomer. “It confuses cause with effect. A better, if ungainly, descriptor would be ‘asset-price hyperinflation’—the 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, seen only when the fog rolls away.” Exactly, just keep that magnificent “Semper Augustus” tulip in mind. A British sailor happened by the warehouse in which it was stored and mistook it for an onion, so he peeled and ate it.

Of course, in recent times, the pace of “bubbles” has picked up considerably.

Nowadays 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.

They are essential to the rhythm of American business, Janszen argues:

There will and must be many more such booms, for without them the economy of the United States can no longer function. The bubble cycle has replaced the business cycle.

Inside the Bubble Machine
There is a familiar cycle to this process in the United States, and Janszen calls it part of our new faith-based financial world. It always starts with an idea. Indeed, a good idea. But it quickly gets hyped into sometime far beyond its short-term potential. It captured the imagination of the masses. Think of the dot-com bubble.

Deregulation had built the church, and seed money was needed to grow the flock. The mechanics of financing vary with each bubble, but what matters is that the system be able to support astronomical flows of funds and generate trillions of dollars’ worth of new securities.

And of course, the regulators might have held the excesses in check. And the media might also have proven an effective break—exposing the rising financial soufflé to a little bit of skepticism. But America’s media? Our Congress? Think again.

The media stood by cheering, carrying breathless profiles of Wunderkinder in their early twenties who had just made their first hundred million dollars; business publications grew thick with advertisements. The media barely questioned the fine points of the new theology. Skeptics were occasionally interviewed by journalists, but in general the public was exposed to constant reiterations of the one true faith. Government stood back—after all, there was little incentive for lawmakers to intervene.

So every bubble machine knows its end. “In a bubble, fictitious value goes away when market participants lose faith in the religion—when their false beliefs are destroyed as quickly as they had been formed.”

The Subprime Crisis
The latest bubble to pop, with potentially calamitous results, is the subprime mortgage market.

The U.S. mortgage crisis has been labeled a “subprime mortgage crisis,” but subprime mortgages were only a sideshow that appeared late, as the housing-bubble credit machine ran out of creditworthy borrowers. The main event was the hyperinflation of home prices. Risks are embedded in price and lurk as defaults. Even after the faith that supported a bubble recedes, false beliefs continue to obscure cause and effect as the crisis unfolds. . .

The housing bubble has left us in dire shape, worse than after the technology-stock bubble, when the Federal Reserve Funds Rate was 6 percent, the dollar was at a multi-decade peak, the federal government was running a surplus, and tax rates were relatively high, making reflation—interest-rate cuts, dollar depreciation, increased government spending, and tax cuts—relatively painless. Now the Funds Rate is only 4.5 percent, the dollar is at multi-decade lows, the federal budget is in deficit, and tax cuts are still in effect. The chronic trade deficit, the sudden depreciation of our currency, and the lack of foreign buyers willing to purchase its debt will require the United States government to print new money simply to fund its own operations and pay its 22 million employees.

So the prognosis is clear. What’s the fix? Seriously, who would think there’s an easy one. There isn’t. But the market and its genies are so predictable, says Janszen. They know of only one possible fix: the next bubble.

There are a number of plausible candidates for the next bubble, but only a few meet all the criteria. Health care must expand to meet the needs of the aging baby boomers, but there is as yet no enabling government legislation to make way for a health-care bubble; the same holds true of the pharmaceutical industry, which could hyperinflate only if the Food and Drug Administration was gutted of its power. A second technology boom—under the rubric “Web 2.0”—is based on improvements to existing technology rather than any new discovery. The capital-intensive biotechnology industry will not inflate, as it requires too much specialized intelligence.

There is one industry that fits the bill: alternative energy, the development of more energy-efficient products, along with viable alternatives to oil, including wind, solar, and geothermal power, along with the use of nuclear energy to produce sustainable oil substitutes, such as liquefied hydrogen from water. Indeed, the next bubble is already being branded.

No this is not investment advice. Rather the opposite. Let’s call it a cautionary tale unlikely to be heeded. George W. Bush has long been tagged the “Bubble Boy” president because of the lengths employed by his handlers to keep the public at a safe distance. Now, of course, the label may take on a different meaning.

Which brings us back to those Dutch tulip vendors. Can it be any coincidence that the first bubble in our historical cycle started on that powerful market that did so much to put Europe on the path to capitalism, tolerance and prosperity? There was punishment for excesses, but then the worldly wise managed always to stay ahead of the popular crazes, exploiting them, building wealth off of them, but avoiding financial ruin. Perhaps deep in the folds of those Calvinist brains was some residual contempt for the vanity of it all, a recognition, as Calvin wrote, of the necessity that thorns would be found among those roses. The stumble and failure of markets is inevitable and provides no reason for shame. The good entrepreneur knows to pick himself up and plow ahead. But he also knows to learn from his adverse experiences. And that’s the point on which America in the age of Bush is proving lamentably dense.

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