For those of us who invest our money outside the lab, this research carries two implications.
First, beware of markets with too much cash chasing too few good deals. When the Federal Reserve cuts interest rates, it effectively frees up more cash to buy financial instruments. When lenders lower down-payment requirements, they do the same for the housing market. All that cash encourages investment mistakes.
Second, big changes can turn even experienced traders into ignorant novices. Those changes could be the rise of new industries like the dot-coms of the 1990s or new derivative securities created by slicing up and repackaging mortgages. I asked the Caltech economist Charles Plott, one of the pioneers of experimental economics, whether the recent financial crisis might have come from this kind of inexperience. “I think that’s a good thesis,” he said. With so many new instruments, “it could be that the inexperienced heads are not people but the organizations themselves. The organizations haven’t learned how to deal with the risk or identify the risk or understand the risk.”
Here the bubble experiments meet up with another large body of experimental research, first developed by Plott and his collaborators. This work explores how speculative markets can pool information from lots of people (“the wisdom of crowds”) and arrive at accurate predictions—for example, who’s going to win the presidency or the World Series. These markets work, Plott explains, because people with good information rush in early, leading prices to reflect what they know and setting a trajectory that others follow. “It’s a kind of cascade, a good cascade, just what should happen,” he says. But sometimes the process “can go bananas” and create a bubble, usually when good information is scarce and people follow leaders who don’t in fact know much.
That may be what happened on Wall Street, Plott suggests. “Now we have new instruments. We have ‘leaders,’ who one would ordinarily think know something, getting in there very aggressively and everybody cuing on them—as they have done in the past, and as markets should. But in this case, there might be a bubble.” And when you have a bubble, you will get a crash.
"Regulation does not work" is not the take home message I got from the article. I would say the take home message is that bubbles will always occur, period. Looking at history, bubbles have always occurred. But the difference between a good bubble (tech bubble) and this recent bubble is lack of regulation. Good things like a well developed internet come out of a well played bubble and bad things come out of a deregulated bubble. Deregulated bubbles will tend towards a Ponzi scheme type of ending where too many people own worthless paper.
So lets bring back regulation, throw people in jail when they break the regulations, and lets fire up a new bubble. I will dub it the green technology bubble and as stated in the article only the early investors make all the money. Today is the day to invest.
Loc: Sunnyvale, CA mostly
Sure, but a provocative title/headline sucks people in .
Realistic margin requirements, commodity delivery requirements and a whole host of regs that have been removed and lead to the current crisis would help, of course. But, real investors are concerned with value, and speculators care about price without regard or cognizance of value.
I still don't think they've learned their lesson, though - The financial guys, the pacemakers of this current mess, still haven't called out that latest Ponzi scheme FUBAR for what it is, a hedge fund Ponzi scheme. But hey, if you want a steal on yachts, Ferraris, or flawless 10 carat diamond, or Palm Beach mansion, there's a fire sale going on right now since everybody's sellin not buyin , but too bad for those suckers that pooled their money.
Yeah, you got it right - Peak oil popped those bubbles, and until they get a grip on that, they really don't have a grip on anything. Then, if they clue in, then there's the rest of the stuff of declining economy and value transformation from other declining resources (well, a peak demand/supply shortfall).
It's just simple math, really, but they're overly focused on a lot of the wrong numbers.
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