NOTE: I have to apologize to readers for the “lack of activity” on my blog for recent weeks, as I have been traveling on the road. I have just realized that I have spent my time in ten cities over a period of thirty days (which translates to an average of three days per location). Anyway, it should not be an excuse, and I will try to make sure that I will post at least one article per week.
I have been fascinated with economic and financial crisis since my student days. Since 1990s we have been presented with almost a non-stop supply of crisis, whether it is economic crisis, currency crisis, stock market collapses, company collapses, and of late the US and global financial market crisis. One of my focus was a study whereby in perfectly “rational” environment (or rational expectation hypothesis), market players and forces which acts rationally, could potentially produce “bubble” environments and conditions, that finally precipitates into bursting of the bubbles and eventually leads to crashes and panics. The key factor here is that, it exists and happens in a fully rational and “normal” market conditions. Many events of the recent pasts somewhat confirms this hypothesis, and what scares me most, is that the crisis can and do happen not only in small and isolated scale, but it can happen in the most developed and advanced markets, and in a scale that are unprecedented in human history. In order to assist readers to understand these crises, I would like to present here an anatomy of crisis, and provide some explanations of what’s going on in the world today.
Anatomy #1: A bubble can start from anywhere, and can originate from a very “sane” environment.
The crisis, which always forms itself in form of bubble, can start and originate from any forms of sources and environment – without anyone of the player realizing that it is a bubble under the making. A construction boom, oil supply shortage, current account deficits, run up of share prices (from IPOs and others), high performance economic growth, and so on – can be and may transform into a bubble. Any of these activities are “real” activities, and does not necessarily arise out of any speculative activity. These are day-to-day economic activities of any markets or country.
Anatomy #2: In today’s economic environment, we have many players chasing the same things, and hence creates surge of activities that eventually leads to many more players entering the same market or activity, and so on, until it becomes a self feeding frenzy
One success leads to other success; this makes others to copy the success and creates more success stories, and eventually everyone follow suit on successful paths, eventually it will crowd the whole market place; and it is only “rational” for everyone to follow this same paths. Successful property projects, leads to creation of many other projects, and until a point where everyone is copying the same thing and we can see massive projects being undertaken. In the beginning, the sizes are moderate, but with early successes, the sizes started to grow into many folds, and even can be gargantuan in terms of scale and size.
Anatomy #3: In a “boom” environment, almost everyone makes money, and it creates a mantra that “anything is possible” or “can do” attitudes and belief. It seems that no one will lose.
A simple example of this is the stock market: when a bull market is underway, all share prices went up, irregardless of the actual performance of the company. Good performer will drag up share prices of mediocre companies, and even laggards also have their fair share of price increase. Stories can be manufactured, any news can be turned into positive news, because everyone wants to hear “only” those stories, and all other “bad news and stories” are just being buried or ignored. Anyone who goes against the trends is seen as losers. Nobody wants to be labeled as such, and hence the whole crowd will move like a herd into one direction: upward valuations.
Anatomy #4: Most of the players believe that the end is still far away, and there are still a lot of rooms for upward movements, therefore, nobody should stop what they are doing. Despite of any calls for slowdown, everyone believe that they are different, and what they are doing are perfectly sound and will not fail. Furthermore, everyone also believes that they are different than others; therefore, history may not apply to them.
Continuous success (and the absence of any major failures), creates hubris. Without realizing, a self feeding triumphs and victories are already in the making, and create a very supportive environment for things to continue unabated. It is just like people who are at a drinking party, when everyone is already drunk; nobody knows how to keep counts of glasses of drinks consumed, and for that matter, nobody cares. People who are drunk with success will continue to be drunk and beginning to lose all their senses.
Anatomy #5: In the middle of the boom, fear somehow started to creep in; people started to have many jitters, and many are started to look for the exit doors, but somehow, nobody really makes the dash for the exit, because there is a bigger fear imbued in them: fear of exiting too early. They also believe that if anything happen, they will have sufficient time to exit, earlier than many others. This will keep everyone in the game for a while longer.
An example of this is fund managers: while the shares are still on the rise, they worried about their performance in comparison with other fund managers. Similarly, they are under pressure from their board and investors to maintain and keep the high level of performance that they have been delivering for the past periods. Exiting “too early” will makes them looks like a fool (and may even cause them to lose their job). Therefore, nobody dares to take the bold move: that is to get out. In any case, they already built in some “safety or hedging mechanism” to protect their positions.
Anatomy #6: Finally, the bubble burst. The reason for the bubble to burst can be due to almost “anything”. The “cloud of fear” has actually been gathering its force until a stage whereby it is no longer tenable, it just need any size of needle to prick the bubble.
After a long while, the psychology of fear has run so deep (consciously or unconsciously), such that the reverse of the conditions that supports the markets holds true: any bad news will be exaggerated, any rumors can be taken as factual, any good news will be taken with skepticism, and so on. Therefore, there is no longer any need of rational reason for the bubble to burst. It is just like the herd of buffaloes in the African safari; even movement of the grass can be taken as a lion attack, and can cause the whole herd to run.
Anatomy #7: The longer the bubble survives, the bigger the downfall will be. Since the size of the bubbles can be so large, and even grow into a gargantuan size: today’s bubble can be a real monster. Given it size, the bursting of the bubbles can even cause systemic chaos and havoc, and may even pull innocent bystanders who have little to do with the bubble itself.
This is exactly what happen in the current US banking and financial crisis: the bubbles survives at least for more than a decade; and it grew into tens of trillions of dollars, and eventually when it burst, it cripple the whole world banking systems, and eventually will pull down the whole economy, and hence will affect everyone from Wall street to the Main street.
Anatomy #8: The bubble started from the “real sector” of the economy, it creeps into the “financial sector” of the economy, and then when it finally burst, will damage the “real sector” of the economy.
The recent example of the bubble is the US housing industry: whereby the housing booms in US started in the 1990s. The boom helps many people to become homeowners, which are essentially good for the economy. To keep the whole boom continue, the financial sector keeps pumping in capital into the system, until it reach to a level that “too much” money being pumped into the system. This is further helped by the recent “financial innovations” which creates so many papers (CDOs, sub-prime papers etc), which keeps the process to continue. When it finally burst, the whole banking system came to a standstill, the housing starts drop to almost zero, foreclosures becoming the order of the day, many innocent people suffers, and finally even bringing the whole world economy down and affected all other sectors of the real economy.
Anatomy #9: The whole process of a new bubble, boom and bust, will repeat itself again; albeit in another form, and in another area.
Human being has a very short memory; a bust destroys many old players, they go out business, and most will move on with their lives doing totally different thing than what they used to do before. As a new boom being created, it will bring a new set of players, who are may have nothing to do with the old boom and bust. The whole process as per Anatomy #1 will start all over again.
Anatomy #10: Human being never learns.
In this sense, we are not much different than animals, except that our activities are under a much more sophisticated environment, and in a much more convoluted manner.