Calverley when bubbles burst; surviving the financial fallout (2009)

Praise for BUBBLES “Financial bubbles have always exercised a fascination over academics and financial journalists Business economists can make their reputation by spotting them in time But in truth relatively little is known about what generates bubbles, what causes the eventual bust, what damage bubbles can do, and how they can be prevented Most importantly, are we in one now? In this book, John Calverley explores this subject in considerable depth, using an analytic approach but writing in a style accessible to the interested layman Calverley belongs to the school that believes bubbles are recognisable, dangerous and preventable He has a number of policy recommendations, many of which will prove controversial Not everyone will agree with all aspects of his diagnosis or prescription But it is hard to dispute that this book addresses an important and so far poorly understood topic.” Sir Andrew Crockett, President, J P Morgan Chase International and former General Manager, Bank of International Settlements, 1999–2003 “This is a must read for anyone considering investing in housing or stocks as well as market practitioners wishing to glean insights into how the herd can behave.” Gerry Celaya, Chief Strategist, Redtower Research “This is an indispensable book for everyone, investors and students alike, who wants to understand how bubbles arise—and to avoid being caught out by the next one.” Roger Bootle, Capital Economics “This book offers a timely warning Around the world real estate prices have been rising strongly as home-buyers take advantage of low mortgage rates But if home price increases turn out to be a bubble, the consequences for many recent buyers as well as for the economy as a whole could be severe.” Ranga Chand, international economist and financial author, Ottawa “There is no more controversial question that what to about the housing bubble, whether you are a buyer, a seller, a renter or a central bank governor John Calverley has compiled a primer for all, tackling the many difficult questions logically and informatively He is to be commended for making some very constructive proposals for what looks like a problematic future.” Alex Erskine, Chief Economist, Australian Securities & Investments Commission and former head of Asian research for a leading global bank “A clearly written analysis that deftly uses statistical data to reveal the nature of bubble/bust cycles and offers insights on how to deal with them.” Tadashi Nakamae, Nakamae International Economic Research “Calverley has written a book for our times: when growth is fuelled by asset bubbles and central bankers held hostage by the fear of their collapse He brings a global view and the lessons of economic history to diagnose the problem, to develop new ideas for policy makers and to provide sound advice for investors.” Dr DeAnne Julius CBE Chairman of Chatham House and former MPC member “If you are worried about your future, read this book with care If you’re not, read and take heed This is high quality, X rated stuff, not for the faint-hearted, written with great clarity and balance Essential reading on any public financial education course.” Richard O’Brien, Partner, Outsights WHEN BUBBLES BURST SURVIVING THE FINANCIAL FALLOUT JOHN P CALVERLEY First published by Nicholas Brealey Publishing in 2009 3–5 Spafield Street 20 Park Plaza, Suite 1115A Clerkenwell, London Boston EC1R 4QB MA 02110, USA Tel: +44 (0)20 7239 0360 Tel: 888 BREALEY Fax: +44 (0)20 7239 0370 Fax: (617) 523 3708 www.nicholasbrealey.com First edition published as Bubbles and How to Survive Them in 2004 © John P Calverley, 2004, 2009 ISBN 978-1-85788-523-1 British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording and/or otherwise without the prior written permission of the publishers This book may not be lent, resold, hired out or otherwise disposed of by way of trade in any form, binding or cover other than that in which it is published, without the prior consent of the publishers Printed in the UK by Clays Ltd, St Ives plc The data, facts and examples used in this text are believed to be correct at the time of publication but their accuracy and reliability cannot be guaranteed Although the author expresses a view on the likely future investment performance of certain investment instruments, this should not be taken as an incitement or a recommendation to deal in any of them, nor is it to be regarded as investment advice or as a financial promotion or advertisement Individuals should consider their investment position in relation to their own circumstances with the benefit of professional advice No responsibility is assumed by the author or the publisher or Standard Chartered plc for investment or any other decisions taken on the basis of views expressed in this book CONTENTS Foreword Preface Introduction: Why Bubbles Matter vii ix PART I BUBBLES AND THE ECONOMY An Anatomy of Bubbles The Great Depression Japan and the Specter of Deflation The 1990s Stock Bubble and Reflation 11 26 42 57 PART II THE HOUSING BUBBLE The Worldwide Boom Britain’s Bubble Bursts US Bubble and Bust The Financial Crisis and Household Debt 71 73 84 97 107 PART III ORIGINS AND SOLUTIONS The Pathology of Bubbles 10 Valuing Markets Sensibly 11 New Policy Approaches 12 Strategies for Investors Final Thoughts: After the Housing Bust 123 125 139 161 183 197 Notes Index 215 229 FOREWORD W hen Bubbles and How to Survive Them was published in 2004, I wrote in the foreword that there could hardly ever have been a more timely book Asset price volatility, and especially the movement of house prices, had moved to centre stage in the economy Since then, of course, we have experienced a massive global financial crisis and major economies have moved into recession As predicted in that book, house prices have fallen sharply as the bubble burst A central theme of the current book remains that asset price bubbles make the economy, and the financial system, potentially unstable In this regard, John Calverley continues to address one of the key issues and risks of the day, and argues persuasively of the danger of periods of excessive debt accumulation and a serious risk that house prices could fall yet further Many of the predictions that Calverley made in the first book have come to pass with a vengeance In particular, the author has extended the analysis to incorporate powerful insights into the nature, causes and consequences of the global financial crisis and brings the analysis up to date to the end of 2008 In doing so, he shows perceptively how the financial and real sectors of the economy interact and how, in particular, the housing bubble, driven by debt, lies at the centre of the crisis The author argues that, while there is a danger of deflation in the near term, the policy responses could produce a period of elevated inflation further down the road He points to the experience of ultra low interest rates in 2001–4 following the collapse of the stock market bubble, sowing the seeds of the house price bubble While recognizing that the policy response in the current crisis is likely to be tighter regulation, the analysis argues the case for better, rather than necessarily more, regulation in the future In a carefully chronicled tour de force, which is written in a wonderfully clear and engaging style, John Calverley has produced a powerful vii When Bubbles Burst insight into some of the many myths that surround this subject, and most especially the housing market The author gives us some fascinating insights from behavioural finance and in particular into how markets can lose touch with reality This book is the best and most penetrating analysis of asset price bubbles, and how they have contributed to the global financial crisis, that is available in a highly readable narrative Everyone has an interest in this subject and Calverley has produced a book that can be easily read by both technicians in the subject and the layperson This book deserves to be very widely read and to have the success of Bubbles and How to Survive Them David T Llewellyn Professor of Money and Banking, Loughborough University, and Visiting Professor at the CASS Business School (London), Swiss Finance Institute (Zurich), and the Vienna University of Economics and Business viii PREFACE B eginning in 2007, the world economy was rocked by a series of financial crises that reached a crescendo with the bankruptcy of Lehman Brothers in September 2008 There followed a near meltdown of the banking system as banks lost confidence in lending to each other or to all but the most creditworthy of borrowers As fears grew, governments were forced into a huge bailout of the system, injecting capital into banks and insurance companies and providing guarantees for depositors But this did not prevent a vicious process of “deleveraging” as banks, hedge funds, and investors sold assets to pay down debt Stock markets crashed and the world economy slowed abruptly amid fears of the worst economic downturn since the Second World War Meanwhile, house prices continued their vertiginous decline, with the US, UK, Spain, and Ireland leading the way The primary cause of the catastrophe was the US housing bubble This was the successor to the 1990s stocks bubble and both were part of an expansion of credit that inflated the price of most risky assets Near the end there were notable bubbles too in commodity prices, particularly oil, and even in contemporary art prices History shows that it is the nature of any bubble, but particularly in real estate, that it creates a “bubble mentality”: a belief that prices cannot go down and that borrowing or lending on the security of houses is a safe investment It was this belief, both driver of and driven by the credit bubble, which inflated house prices to extraordinary highs When they crashed back down, the world financial system and the world economy were standing underneath The results of the bust are still playing out When bubbles burst they usually overshoot on the downside and, I suspect, we shall see house prices weak for several years, with falls in many countries of 30–50 percent The economic downturn looks set to be severe, taking unemployment up sharply Meanwhile, many people’s retirement plans, whether ix When Bubbles Burst Peter Garber, “Famous first bubbles,” Journal of Economic Perspectives, Vol 4, No 2, pp 35–54 One of the earliest books on bubbles was Charles MacKay, Extraordinary Popular Delusions and the Madness of Crowds, 1841 Daniel Kahneman and Amos Tversky, “Prospect theory: An analysis of decision under risk,” Econometrica, 263–91, 1979 G B Northcraft and M A Neale, “Experts, amateurs, and real estate: An anchoring-and-adjustment prespective on property pricing decisions,” Organizational Behaviour and Human Decision Processes, Vol 39, pp 84–97, 1987 Robert J Shiller, “Human behaviour and the efficiency of the financial system,” in John B Taylor and Michael Woodford (eds), Handbook of Macroeconomics, Elsevier, 1999 Gary Belsky and Thomas Gilovich, Why Smart People Make Big Money Mistakes and How to Correct Them: Lessons from the New Science of Behavioral Economics, Simon and Schuster, 2000 D Ebrlich, I Guttman, P Schoenbach, and J Mills, “Postdecision exposure to relevant information,” Journal of Abnormal and Social Psychology, Vol 67, pp 382–94, 1957 10 Shiller, op cit 11 Didier Sornette, Why Stock Markets Crash: Critical Events in Complex Financial Systems, Princeton University Press, 2003 For Professor Sornette’s latest views on the markets see his website, www.ess.ucla.edu/faculty/sornette As of early 2004 he was expecting renewed weakness in US stocks and saw a bubble in UK housing, though not in the US For a popular introduction to the subject see Malcolm Gladwell, The Tipping Point, Abacus, 2000 12 George Soros, one of the most successful investors of all time, developed the concept of “reflexivity,” where changes in a market price feed back into the market itself George Soros, The Alchemy of Finance, John Wiley, 1994 CHAPTER 10 R Balvers, Y Wu, and E Gilliland, “Mean reversion across national stock markets and parametric contrarian investment strategies,” 222 Notes Journal of Finance, No 55, pp 745–72, 2000 Campbell and Shiller, “Mean reversion in stock prices,” Journal of Financial Economics, Vol 22, 1988, pp 27–59 Robert Shiller, Irrational Exuberance, Princeton University Press, 2000 It is true that US stocks did not fall very much during the 1990 recession but showed more of a sideways pattern Allowing for inflation, however, stocks were flat between August 1987 and February 1991 And the investor in bonds or cash would have still been ahead until 1993 Note that there have also been some occasions when the PE ratio was above 20 times because earnings were depressed by an economic slowdown and investors were expecting a rebound, for example 1992–3 and 2003 James K Glassman and Kevin A Hassett, DOW 36000: The New Strategy for Profiting from the Coming Rise in the Stock Market, Times Books, 1999 For an introduction see John Calverley, Investors Guide to Economic Fundamentals, John Wiley, 2003 Elroy Dimson, Paul Marsh, and Mike Staunton, Millennium Book II: 101 Years of Investment Returns, London Business School and ABN AMRO 2001 Robert D Arnott and Peter L Bernstein, “What risk premium is normal?,” AIMR, March/April 2002, pp 75–8, contains a rigorous examination of this argument US corporate bonds (and those of many other countries) are assigned ratings by the major ratings agencies (including Moodys, Standard and Poors, and Fitch) Government bonds as well as very good private-sector risks are rated AAA, then risk progressively rises through AA, A, to BBB–, all of which are rated as “investment grade.” From BB+ down through B is rated speculative grade Standard and Poors, Rating Performance 2001, February 2002 10 I have ignored the interest lost if the bonds default early in the 10year period If we take the extreme case where the 5.3 percent cumulative default occurred the day after the portfolio was purchased, then the loss of interest would reduce the advantage somewhat, with the amount depending on the overall level of interest 223 When Bubbles Burst rates At percent interest rates the loss would be a further 2.4 percent 11 R Mehra and E C Prescott, “The equity risk premium: A puzzle,” Journal of Monetary Economics, Vol 15, 1985, pp 145–61 12 Data for housing are much more difficult to assess than those for stocks In principle, housing is believed to depreciate by 1–2 percent per annum To some extent depreciation is captured in my figures for annual costs as the interior of the property is refurbished But in many countries older buildings are discounted just because they are old In Europe, of course, the reverse is often true Another complication is that it is not clear to what extent house price indices are able to compensate for improvements in the quality of housing over time, for example the provision of central heating or air conditioning, so this further muddies the waters CHAPTER 11 This is of course not at all what free market economists would prescribe and some have been critical, both of the willingness to respond to stock market weakness with ultra-low rates and the tolerance of a bubble in house prices But it is probably inevitable that governments will try to avoid big falls in asset prices, which makes it all the more relevant that they should also consider ways to limit the upside The Bank for International Settlements has taken a leading role in exploring these issues See for instance Claudio Borio and Philip Lowe, Asset Prices, Financial and Monetary Stability: Exploring the Nexus, BIS Working Paper No 114, July 2002 and Claudio Borio and William White, Whither Monetary and Financial Stability? The Implications of Evolving Policy Regimes, BIS Working Paper No 147, February 2004 The BIS Annual Report, published each Spring, and the BIS Quarterly Review also regularly explore these themes Cecchetti claims, however, that the Fed did take the stock market boom into account to some extent and the argument should be about whether or not it did enough, not whether it reacted at all Stephen G Cecchetti, “What the FOMC says and does when the 224 Notes stock market booms,” RBA Annual Conference, Vol 2003-05, Reserve Bank of Australia, 2003 See for example Stephen G Cecchetti, Hans Genberg, and Sushil Wadhwani, Asset Prices in a Flexible Inflation Targeting Framework paper prepared for the conference on Asset Price Bubbles: Implications for Monetary Regulatory and International Policies, organized by the Federal Reserve Bank of Chicago and the World Bank, Chicago, April 22–24th, 2002 Also Charles Bean, Asset Prices, Financial Imbalances and Monetary Policy: Are Inflation Targets Enough?, BIS Working Paper No 140, September 2003 Charles Goodheart, “What weight should be given to asset prices in the measurement of inflation?,” The Economic Journal, June 2001, pp F335–56 John Calverley, “Spotting the next asset price bubble,” Financial Times, November 15th, 2002, p 19 Adam Seitchik, The Business, June 22–23rd, 2003, p 18 For an overview see Turbulence in Asset Markets: The Role of Micro Policies, OECD Contact Group Report, Paris, September 2002 For a discussion see Anna J Schwartz, Asset Price Inflation and Monetary Policy, NBER Working Paper No 9321, November 2002 10 Claudio Borio, Towards a Macroprudential Framework for Financial Supervision and Regulation?, BIS Working Paper No 128, February 2003 11 Fiona Mann and Ian Michael, “Dynamic provisioning: Issues and applications,” Bank of England Financial Stability Review, December 2002 12 See OECD Contact Group Report, p 23 13 Barker op cit 14 Early that year Overend Gurney, a large, long-established bank, faced difficulties with its loan portfolio when interest rates rose sharply from to percent It asked for help from the Bank of England, but was refused Over the next couple of days there were runs on banks all over London as depositors panicked and tried to withdraw their funds Several banks failed, including a number of basically solvent ones The authorities finally realized the dangers in the situation The government suspended the Bank Charter Act, which forbade 225 When Bubbles Burst the issue of new bank notes, and the Bank of England gave assurances that it would freely provide support to the banking system This broke the panic and nothing like it has been seen until 2007–8 For more details see E P Davis, Debt, Financial Fragility and Systemic Risk, Oxford University Press, 1992, p 245 CHAPTER 12 Investment Company Institute, quoted in Financial Times, October 31st, 2003 To see how rebalancing works, imagine a portfolio at the start of the year with 50 percent in stocks and 50 percent in cash and bonds During the year stocks soar 25 percent while the cash and bonds half earns just percent At the end of the year the portfolio will have 54.3 percent in stocks and only 45.7 percent in cash and bonds By selling some stocks to bring them back to a 50 percent weighting investors are in effect taking profits on the upward move and increasing their holdings of bonds Someone still adding to their portfolio each year through new savings may be able to achieve the same effect by putting the new money straight into cash and bonds rather than stocks As noted in Chapter 4, companies are under severe pressure if their pension fund is underfunded when its assets are “marked to market.” Individuals can more easily afford to take the long view Roger Bootle makes this point very eloquently in Money for Nothing, Nicholas Brealey, 2003 FINAL THOUGHTS Ben Bernanke, A View from the Federal Reserve, speech to the National Association for Business Economics, October 7th 2008 Available at www.nabe.com Luc Laeven and Fabien Valencia, Systemic Banking Crises: A New Database, IMF Working Paper Number 224, September 2008 See Table B.100, the Balance Sheet of Households and Nonprofit Organisations in Flow of Funds Accounts, US Federal Reserve, published quarterly 226 Notes Homer Hoyt, 100 years of Land Values in Chicago, Arno Press, 1970 (first published 1933) See Piet Eichholtz, “A Long Run House Price Index: The Herengracht Index, 1628–1973,” Real Estate Economics, Vol 25, pp 175–92, 1997, and Oyvind Eitrheim and Solveig K Erlandsen, House Prices in Norway 1819–1989, Norges Bank, Oslo, November 11, 2004 I am indebted for this insight on the 18-year cycle to Fred Harrison See his excellent book Boom Bust: House Prices, Banking and the Depression of 2010, Shepheard Welwyn, 2005 Fred’s timeline looks alarmingly close to the truth 227 INDEX 401K pension accounts 23, 63 AIG 163 Alt-A lending 5, 18, 105, 112; see also subprime mortgages anchoring 129–31 Asian Tigers bubble 1, 3, 15 asset prices deflation 50–51, 209 inflation 19¬–22, 30, 42, 73 role in Depression 39–41 Asset Valuation Committee (AVC) 170–73, 177–8, 182, 184 Australia xi, 7, 15, 17, 54, 65, 79, 83, 155, 162, 168, 173 house prices 73, 74 housing bubble 81, 188, 206 AVC (Asset Valuation Committee) 170–73, 177–8, 182, 184 bailouts, of banks and insurance companies ix, 113–14, 117, 181–2, 197–8 bank failures 36, 38–9 bank lending xii, 1, 5–7, 8, 18, 39, 45, 51, 114, 115–18, 163–4, 199 restraining 174–9 Bank of England 29, 30, 82, 87–8, 90, 96, 161–2, 168, 210 Bank of Japan 41, 44, 45, 48, 55 Basle II rules 116–17 bear markets 58, 150 Bear Stearns 6, 110–11, 112, 117, 182 behavioral finance xii, 127–34 behavioral economics xii Belgium, house prices 73 Bernanke, Ben 4, 25, 38–9, 41, 200; see also Federal Reserve bonds 55, 69, 110, 153, 155, 157, 181, 194, 200–201 private-sector 148–50 valuing 145–50 Brazil 187 bubbles anatomy of xi, 11–25 and company behaviour 23–5 Asian Tigers 1, 3, 15 Australia housing 81, 188, 206 bursting ix, 1, 7–8 causes of 26 classic cars commodities ix contemporary art ix controlling with nonmonetary measures 173–4 emerging market mining mania gold 229 When Bubbles Burst bubbles (cont.) housing x, xii, 1, 2, 7–8, 17, 25, 73–83, 159, 211, 213 housing, dangers of 76–9 housing, strategies for investors 188–9 identifying 12–18, 136–7 Impressionist painting Japan 1, 2–3, 4, 41, 42–56, 57 Netherlands housing 188 oil ix profile of 11–12 railway mania Scandinavian housing silver South Sea Bubble Spain housing 188, 206 stocks ix, x, xi, 3, 8, 23–5, 159 stocks, strategies for investors 183–8 technology mania 1, 3, 18 theories of 125–38 Tulip Mania typical characteristics of 12–18 UK housing xii, 1, 2, 81, 84–96, 161–2, 188 US housing ix, xii, 2, 4–5, 15, 18, 97–106, 188, 197–8 US housing, financing of 102–6 US housing, profile of 100–102 US stocks 2, 4, 14, 15, 16–17, 25, 56, 57–70, 161 Wall Street Crash 1, 2, 25 warning signs warnings about 168–73 why they matter 1–8 Buffett, Warren 186 Bush, President George W 4, 59 buy-to-let mortgages 17, 87 Canada xi, 2, 119–20 house prices 204 CDOs (collaterized debt obligations) 18, 106, 107–10, 111, 113 CDSs (credit default swaps) 108 CFDs (contracts for differences) 20, 177 China 49, 59, 66–7, 155, 159, 187 classic cars bubble cognitive dissonance 133 collaterized debt obligations (CDOs) 18, 106, 107–10, 111, 113 commodities bubble ix consumer expenditure deflator 30 consumer spending 5, 19¬–23, 36, 58 contemporary art bubble ix contracts for differences (CFDs) 20, 177 contrarianism 185¬–6 credit default swaps (CDSs) 108 critical state theory 135–8 current account deficit 66–7, 88, 108–9 230 Index debt deflation 50–52, 164 debt destruction 181 defined-benefits pension schemes 189–90, 201–2 defined-contribution pension schemes 201 deflation x, xi, 4, 8, 42–56, 59, 149, 194–5 and monetary policy 52–6 asset price 50–51, 209 debt 50–52, 164 influence on bubbles 50–51 deleveraging ix, deposit insurance 116, 180 Deposit Protection Fund 116 Depression, 1930s xi, 2, 4, 25, 26–41, 49, 57, 182 explanations of 37–9 deregulation 207–8 disaster magnification 133 disaster myopia 133 disinflation 156–60 displacement 11 downturn, economic ix, 7, 12, 24, 25, 31, 33, 34, 58, 114, 118, 120, 149, 155, 199–200, 201, 207 economic downturn ix, 7, 12, 24, 25, 31, 33, 34, 58, 114, 118, 120, 149, 155, 199–200, 201, 207 economic growth 15, 30, 60, 96, 157 efficient markets hypothesis 125–6 emerging market mania endowment mortgages 64 equity risk premium 150–52 Estonia 162 ETFs (exchange traded funds) 20, 177 euphoria 11–12, 40, 82, 107, 115, 186 Eurozone 54, 200 exchange rates 18, 54 exchange traded funds (ETFs) 20, 177 Fannie Mae (Federal National Mortgage Corporation) 6, 103–5, 112–13, 117 Federal Home Loan Mortgage Corporation (Freddie Mac) 6, 103–5, 112–13, 117 Federal National Mortgage Corporation (Fannie Mae) 6, 103–5, 112–13, 117 Federal Reserve Board xi, xii, 3, 6, 25, 26–7, 29–30, 30–34, 36, 37, 40, 41, 56, 57, 59, 68–70, 82, 103, 112, 117, 146, 161, 165–7, 179, 199, 211 Felix, David x financial crisis xi, xii, 2, 5–7, 67, 79, 91–3, 102, 107–21, 149, 157, 159, 197–8, 207 development of 110–14 origins of 107–10 financial regulation 168–73 Financial Services Authority (FSA) 35, 169, 170 231 When Bubbles Burst Finland 23; see also Scandinavia fiscal stimulus 4, 35, 45, 48, 55, 59 Fisher, Irving 32–3 flight to quality 110 fools rallies 131 France 23, 36, 81, 83, 120 Freddie Mac (Federal Home Loan Mortgage Corporation) 6, 103–5, 112–13, 117 Friedman, Milton 32 FSA (Financial Services Authority) 35, 169, 170 Genghis Khan date test 129 Germany 23, 36, 120, 125, 180 house prices 73 gold bubble Gold Standard 30, 31, 33, 36–7, 41, 44, 58, 179 Greece 180 Greenspan, Alan xi, xii, –4, 26–7, 30, 47, 57, 68–9, 98, 100, 103, 167, 168, 171 Greenspan put 52, 163 growth, economic 15, 30, 60, 96, 157 hedge funds ix, 6, 110, 114, 177, 209 herd instinct 132–3 Hong Kong xi, 49–50, 58–9, 175–6, 178, 187 house price–earnings ratio 14, 16 house prices xii, 8, 19, 40, 155, 208 Australia 73, 74 Belgium 73 Canada 204 effect of falls on personal wealth 118–21 Europe 206–7 falls ix, xii, 79 gaps 83 Germany 73 Ireland ix Japan 73 justification for higher 79–81, 88–91 Netherlands 73 outlook for 202–7 Spain ix, 73, 74 Sweden 73 UK ix, 73, 74, 204 US ix, 6, 58, 73, 75–6, 203¬4 household debt xii, 107–21 Household Finance 110 household savings 4, 20–21, 36, 46, 64–7, 88, 102, 118–19 housing bubble x, xii, 1, 2, 7–8, 17, 25, 73–83, 159, 211, 213 Australia 81, 188, 206 Netherlands 188 Scandinavia Spain 188, 206 strategies for investors 188–9 UK xii, 1, 2, 81, 84–6, 161–2, 188 US ix, xii, 2, 4–5, 15, 18, 97–106, 188, 197–8 housing bust 7, 93–5 HSBC 110 Iceland 162, 180, 201 232 Index Impressionist painting bubble India 60, 187 Indonesia 209 inflation x, 1, 4, 21–2, 30, 33, 39, 42, 47, 48, 55, 58, 59, 80–81, 82, 84, 88, 94, 96, 97–8, 102, 120, 146, 156–60, 164–7, 181, 182, 193–5, 199–200, 201–2, 209–10 asset price 19–22, 30, 42, 73 interest rates xi–xii, 4, 6, 18, 26, 31, 34, 36, 39, 45, 52–3, 54–5, 56, 68–70, 75, 80–81, 82–3, 84–5, 88, 91–3, 94, 96, 105–6, 130, 140, 147, 157, 166–7, 181, 200 Ireland 7, 23, 81, 83, 107, 155, 180 house prices ix, 73 irrational exuberance 27, 57, 168 Italy 54 lender of last resort 12, 29, 115–16, 179–81 lending bank xii, 1, 5–7, 8, 18, 39, 45, 51, 114, 115–18, 163–4, 174–9, 199 mortgage 88, 94, 102–6, 107, 202 subprime 5–6, 17, 18, 82, 105, 110, 112, 115 leverage 212 liar loans 105; see also subprime lending liquidity 6, 12, 25, 36, 43–4, 51, 82, 112, 117, 128, 179–81 Long Term Capital Management 31, 166, 179 Japan xi, 59, 60, 66, 112, 120, 150, 178, 198 bubble x, xi, xii, 1, 2–3, 4, 41, 42–56, 57 house prices 73 JP Morgan Chase 112 Keynes, John Maynard 30 Kindleberger, Charles Kuczynski, Michael x Lehman Brothers ix, 6, 93, 113, 114, 117, 180, 182, 187, 197–8 madness of crowds 127 mania 11–12 margin lending 34–5 mark-to-market accounting rules 6, 108 mean reversion 139–45 mental accounting 128 mental framing 128–9, 132 MEW (mortgage equity withdrawal) 20, 78–9 Meyer, Larry x Millennium Bug 31, 166 Minsky, Hyman x Minsky moment x mistakes, monetary policy xi, xii, 2, 37, 40, 70, 165–7 monetary policy x, xii, 18, 21, 26, 32, 34, 35, 37–8, 52–6, 57, 233 When Bubbles Burst monetary policy (cont.) 58–9, 60, 87–8, 161–82, 207–13 alternatives to 34–5 in 1920s 30–35 in asset bust 179–81 mistakes xi, xii, 2, 37, 40, 70, 165–7 Monetary Policy Committee 96, 170 mortgage equity withdrawal (MEW) 20, 78–9 mortgage lending 88, 94, 102–6, 107, 202; see also subprime lending mortgage rates 4, 120 mortgage-backed securities 67, 87, 92, 104, 107, 113, 114 NASDAQ index 3, 18–19, 57, 60, 130–31, 167 Netherlands 23, 80, 83 house prices 73 housing bubble 188 New Century Financial 110 New Zealand 7, 65, 155 NINJA loans 105; see also subprime lending noise traders 125 Northern Rock 6, 92–3, 111, 116 oil price ix, 205¬–6 overconfidence 131–2 Overend Gurney 179 overoptimism 132 overvaluation 14–15, 67, 73–4, 83, 93, 99; see also valuation panic 12, 50–51 paradigm shift 16–17, 87 PBGC (Pension Benefit Guarantee Corporation) 62 Pension Benefit Guarantee Corporation (PBGC) 62 Pension Protection Fund 62 pensions ix–x, 1, 23, 25, 60–64, 74, 164, 189–90, 201–2 401K accounts 23, 63 defined-benefits schemes 189–90, 201–2 defined-contribution schemes 63–4 strategies for investors 189–92 pre-comping 104 price–earnings ratio 14, 33, 42, 58, 139, 140–41, 142, 143, 144, 158, 171, 184 prospect theory 127–9 railway mania rationality 125, 134–5, 138 rebalancing portfolio 186 recession xi, 4, 6, 8, 12, 15, 26, 45, 65, 84, 91–3, 94, 100, 114, 149, 150, 186–7, 197, 199–200 revulsion 12 Roaring 20s 27–30, 40 Russia 187 S&P 500 index 3, 60, 61, 155, 156, 167, 168, 171–2, 187 S&P Case-Shiller index 4, 97 Scandinavia 2, 23 housing bubble 234 Index Schwartz, Anna 32 SEC (Securities and Exchange Commission) 35 Securities and Exchange Commission (SEC) 35 securities, mortgage-backed 67, 87, 92, 104, 107, 113, 114 Shiller, Robert 140 short selling 176–7 silver bubble SIVs (special investment vehicles) 106 solvency 180–91 South Sea Bubble sovereign wealth funds 117 Spain xi, 7, 15, 23, 54, 79, 81, 107, 114, 155, 162, 175 house prices ix, 73, 74 housing bubble 188, 206 special investment vehicles (SIVs) 106 Split Capital Trusts 35 spread betting 20 stimulus, fiscal 4, 35, 45, 48, 55, 59 stock market crashes x, ix, 32–3 stocks bubble ix, x, xi, 3, 8, 23–5, 159 strategies for investors 183–8 US 2, 4, 14, 15, 16–17, 25, 56, 57–70, 161 strategies for investors xii, 8, 183–96 housing bubble 188–9 pensions 189–92 stocks bubble 183–8 stress test 195–6 subprime lending 5–6, 17, 18, 82, 105, 110, 112, 115; see also Alt-A lending, liar loans, mortgage lending, NINJA loans survivor bias 151 Sweden, house prices 73; see also Scandinavia Taiwan 178 teaser rates 105–6 technology mania 1, 13, 18 terrorist attacks, September 11th, 2001 59, 167, 179 tipping point 136 TIPs (Treasury Inflation Protected bonds) 145, 194 Tobin, James 24 Tobin’s Q 23–5 Treasure Inflation Protected bonds (TIPs) 145, 194 Tulip Mania UK xi, 2, 7, 15, 17, 23, 36, 54, 79, 80, 81, 83, 107, 155, 176 house prices ix, 73, 74, 204 housing bubble xii, 1, 2, 81, 84–6, 161–2, 188 unemployment ix, 1, 3, 22, 27, 30, 36, 45, 48, 57, 69, 75 US xi, 2, 79, 80, 83, 125 house prices ix, 6, 58, 73, 75–6, 203–4 housing bubble ix, xii, 2, 4–5, 15, 18, 97–106, 188, 197–8 235 When Bubbles Burst US (cont.) stocks bubble 2, 4, 14, 15, 16–17, 56, 57–70, 161 valuations xii, 8, 11, 14–15, 16, 24–5, 42, 57, 85, 126, 130, 138, 139–60, 153–4, 184, 186, 187; see also overvaluation wage cuts 49–50 Wall Street Crash 1, 2, 25, 33 wealth effects 19 wealth effects, calculating 22–3 WhizzPizza 24–5, 42–3 236 ... crashed back down, the world financial system and the world economy were standing underneath The results of the bust are still playing out When bubbles burst they usually overshoot on the downside... Greenspan There was another important factor, which ironically was also the outcome of past bubbles, this time the Japanese and East Asian bubbles After the bubble in Asia in the mid-1990s, business... sharply as the bubble burst A central theme of the current book remains that asset price bubbles make the economy, and the financial system, potentially unstable In this regard, John Calverley