Financial bubble: description, features, interesting facts

The phenomenon of the financial bubble is of great interest to both economists and ordinary people. What is covered by this term? What are the causes and consequences of this phenomenon? What examples of modern economics most vividly illustrate this concept?

Definition of a concept

The financial bubble is also called market, price, financial or speculative. This phenomenon involves trading in large volumes of goods or securities at a price that differs from the fair market. As a rule, this situation arises when there is a rush of demand for a product accompanied by an increase in market value, or due to inaccurate statistics.

Over time, the price is adjusted to a fair level, which is accompanied by a panic of investors. Sales are activated, because of which the price is reduced even more. Thus, the financial bubble "collapses." This causes serious losses to both the owners of the goods and related persons. In some cases, the problem extends to an entire industry or financial system.

The financial bubble is an extremely harmful phenomenon for the economy. The collapse in prices leads to an irrational distribution of resources, the destruction of a significant amount of capital and economic recession.

The study of the issue

Despite the fact that the financial bubble is not an isolated phenomenon in the economy, no unified theory on this issue has been developed at the moment. There are only a few hypotheses. But even they are refuted by certain real examples of "bubbles".

The reason for the lack of knowledge of the issue is that the phenomenon is almost impossible to predict. It becomes apparent only at the stage of collapse of the bubble (that is, a sharp and significant drop in price). The change in price is usually chaotic, and therefore it cannot be unambiguously associated with a change in demand or supply.

It is very difficult (almost impossible) to predict the collapse of the bubble in the financial market. This process is accompanied by the catastrophe of the old economic model. Scientists can even predict what it will be in the future. But it is precisely the time frame for the existence of the bubble that practically cannot be predicted.

Types of Phenomenon

Scientists-economists divide modern financial bubbles into several types. Namely:

Speculative (traditional). An investor buys goods because he expects a price increase for a more profitable resale. Moreover, his forecasts are based not on objective analytical indicators, but on a one-time initial jump in value.
Rational. These are bubbles that can be measured in a specific value terms. That is, we are talking about the difference between the actual market value of the asset and the fair price, which is based on objective fundamental indicators.
Commission. These financial bubbles, pyramids and crises are caused by the discrepancy in information that customers and portfolio managers possess. Thus, the latter have the opportunity to conduct a large number of transactions to increase their commission.

Causes of the phenomenon

Many economic schools and individual scientists are studying the anatomy of the financial bubble, but there is still no consensus on the nature of this phenomenon.

There is the so-called "theory of the greater fool", according to which you can buy anything (meaning goods or financial instruments), regardless of the "quality" of this acquisition. After all, there will always be someone who considers this product valuable, and it can be resold. Thus, there is an irrational behavior of market participants. Although bubbles arise in those cases when market participants completely objectively assess the situation.

Representatives of the Austrian School of Economics believe that the bubbles swell at a high inflation rate, which is considered to be at low interest rates. This situation makes investors rely on more distant (in time) profit. Thus, the gap between investment and income is growing, and asset valuation is virtual. Also during the period of inflation there are prerequisites for an increase in wages. This leads to a temporary increase in consumption, which can become a prerequisite for the formation of a bubble.

Causes of bubbles in financial markets by Schiller

Robert James Schiller is an American economist and 2013 Nobel Laureate. In his works, he pays special attention to the study of the anatomy of the financial bubble. The scientist names such causes of this phenomenon in the financial markets:

the rapid growth of capitalism and private property;
political and cultural processes that contribute to business development;
the emergence of modern information technology;
favorable monetary policy of the state;
demographic fluctuations;
increasing public awareness of business issues;
optimistic analytical forecasts;
growth in the number of investment funds;
reduction in inflation and, as a consequence, the emergence of a "monetary illusion";
increase in trading volumes in the financial market.

Signs of the phenomenon

Studying financial bubbles in the global economy, economists have identified some general characteristics. Namely:

A sharp increase in prices in a short period of time. At the same time, the fundamental value of the product or asset remains unchanged.
Mass involvement of non-professionals in the investment process.
Purchase of financial assets in large quantities for the purpose of resale as soon as possible.
Rejection of traditional valuation techniques during the boom period.
Ignoring the bad news (in relation to the financial or commodity market) or their false interpretation as good.
The flow of funds from the real sector into financial instruments. This means that speculation has become more profitable than producing a useful product.
Growth in the number of investment companies and funds.
Deterioration of the quality of securities placed on the exchange.
The narrowness of the market.
The spread of fraud.

Faber economic bubble picture

Mark Faber is a famous Swiss billionaire, financier, analyst and publicist. As a global top investor, he is deeply interested in the issue of financial pyramids, crises and bubbles. In accordance with his findings, the picture of the economic bubble can be described as follows:

The investment mania begins, which is accompanied by uncontrolled speculation. Typically, this happens once a generation.
Until the bubble collapses, this situation can bring tremendous benefits to market players.
The stock and currency rates are sharply declining.
The volume of loans issued sharply increases.
There is an increase in construction volumes. Residential buildings, hotels, office and shopping centers, as well as transport hubs (usually airports) are being built.
It is planned to build new cities and (or) industrial zones.
National heroes are businessmen and successful participants in the stock market. Their photos are printed in magazines, on billboards, they receive state awards and titles (for example, the person of the year).
There is a firm belief that the market situation cannot worsen.
Not only professional investors, but also representatives of other professions and even housewives begin to become active on the exchange.
There is an active financing of transactions due to debts.
Significant influx of foreign investment.

Japan financial bubble

To understand the essence of the phenomenon under consideration, it is worth considering it with real examples. So, the classic and one of the most illustrative examples is the Japanese financial bubble, dated to the beginning of the 1990s.

In the second half of the 1980s, there was a rapid speculative growth in the real estate stock market, due to such factors:

At that time, the average Japanese family set aside about 30% of monthly income, which led to an excess of capital and limited demand.
The country was successful in foreign economic operations. Capital inflows caused excessive liquidity. In conjunction with the previous factor, this caused an excessive growth of deposits.
Banks invested their liquidity not in lending to production, but in exchange transactions related to real estate.
The market has low interest rates, which has led to unjustified expectations regarding further economic growth.

Over the past five years, the Nikkei stock index has quadrupled, which has doubled the cost of land. Thus, many Japanese became millionaires, judging by the value of the assets they owned, citizens began to feel successful and wealthy. Earlier, economical and unpretentious people began to spend a lot of money on image and travel. The Japanese considered other capitalist countries flawed in comparison with their dynamically developing state.

But by 1990, the bubble collapsed. The key impetus for this was the decision of the Bank of Japan to raise interest rates. In two years, the Nikkei index more than doubled, and the market value of financial assets decreased significantly. From this moment began a period of economic stagnation, the consequences of which are felt today.

First, financial speculative companies and large realtors went bankrupt. A significant decrease in land prices and securities led to an increase in bad loans in Japanese banks. This led to a reduction in investment and a further weakening of banks. By the mid-1990s, several large financial institutions filed for bankruptcy.

Another consequence of the collapse of the bubble was deflation. The country began to export more than import, which led to a significant appreciation of the national currency. People began to buy less in the expectation that prices would fall even lower. All this led to a colossal decline in production.

America's economic bubble

In 2008, one of the most widespread in the modern economy crisis occurred, which is also called the US financial bubble. The starting point is September 15, 2008, when Lehman Brothers, a leading investment bank, filed for bankruptcy. At that time, the debts of the organization amounted to 613 billion dollars. This was followed by a chain reaction, as a result of which many multinational banks and mortgage companies were also in a crisis situation.

This situation was preceded by a mortgage crisis. The government set itself the goal of making housing purchases affordable by limiting the growth of mortgage rates and lowering the requirements on the financial situation of borrowers. At the same time, many unsecured mortgage-backed securities were issued. All this led to the fact that until 2007, even poor Americans could afford luxury housing in the suburbs and several cars. But in 2007 there was a critical increase in the share of bad loans - 12%, and household debts significantly exceeded their incomes. Thus, poor Americans could not pay off their debts, and banks refused to refinance them.

Already in 2008, the crisis spread far beyond the United States. First, the banking system and the real economy of Europe suffered, and later the Asia-Pacific countries. By 2009, almost all over the world there was a rapid increase in the number of bad loans and an increase in unemployment. Governments were forced to lower key rates, partially nationalize the economy, and provide financial assistance to banks. The only country that has been virtually unaffected by the crisis is China.

Despite all efforts, the 2008 crisis could not be curbed. In 2010, a huge collapse of the economy took place. Greece suffered more than other countries. People all over the world faced impossibility to repay loans, more than 200 million workers faced unemployment.

According to experts, the US government has not learned a lesson from the 2008 economic tragedy. Experts believe that at the moment the same mistakes are made in regulating the banking sector, and therefore the crisis may recur.

Bubble called "Overhaul"

Even a simple layman who is far from the concept of financial pyramids, tickets, crises and bubbles, these problems are directly related. For example, overhaul.

In 2012, a law was passed in the Russian Federation, according to which residents of high-rise buildings are required to independently pay for future major repairs. The normative legal act entered into force in 2014. From this moment, residents pay monthly from 6.16 rubles. per sq. m, depending on the region. Transfers are made to the regional overhaul fund or to the individual account of the house.

The Russians were skeptical of this initiative, as they are sure that overhaul is the duty of the state. In addition, this is a blow to the family budget. But economists see in this initiative signs of a financial pyramid or bubble. First, citizens are required to continue to pay dues even after the overhaul is completed. Secondly, they cannot affect the timing and scope of repairs pre-determined by officials. Thirdly, in case of lack of funds, residents will be forced to make additional contributions. And given the fact that many refuse both the payments themselves and their indexation, this program will be beneficial only for those whose houses are planned to be renovated in the near future. When will the financial bubble of overhaul burst? When payers will be left with nothing.

To the complaint of the initiative group of deputies to the Prosecutor General’s Office and the Constitutional Court, an answer was received about the illegality of collecting payments for overhaul. Since payers cannot manage financial resources themselves, this initiative is unconstitutional.

Bubble Dow Jones

Many financial analysts claim that the long-term financial markets are constantly growing, not paying enough attention to the inflation factor. The study of indicators of the Dow Jones index leads to rather interesting conclusions. So, from 1900 to 1982, it is equal to zero. That is, for almost a hundred years, the US stock market has not budged. Over the 130-year history of its existence, the index has repeatedly undergone recombinations and rotations, but during the analysis in the long term it remained unchanged.

In the last century, two Dow Jones financial bubbles were seen in the US stock market. The first was swollen from 1924 to 1929. During this time, the index soared 4 times, after which a sharp drop in the market began, which stopped only by 1932, which was accompanied by a 85% decrease in the index. The recovery period continued until 1937, when the index grew four times again (but did not reach the previous maximum). For the next 16 years, the market was in a state of stagnation, from which it began to exit only in 1953.

The second bubble is dated 1994. Until 2000, the market almost tripled, after which it collapsed by 40%. From 2003 to 2007 there was a recovery, which, however, could not be fixed due to the onset of the new crisis of 2008.