UPDATE: Why financial bubbles aren't always bad things
By Jon Hilsenrath
What do we know now about bubbles?
In an interview with The Wall Street Journal in 2002, Charles Kindleberger, a retired Massachusetts Institute of Technology economics professor and author of the book "Manias, Panics and Crashes," confessed to feeling a sense of schadenfreude for having predicted the technology bubble that burst two years earlier. His next worry, the 91-year-old economist said, was housing.
"If I was 30 years younger," he said, "I'd write a small book on Fannie Mae(FNMA) and Freddie Mac."(FMCC)
Kindleberger would die a year later, the world seeming to have learned nothing about the financial bubbles he documented, dating all the way back to a boom and bust in Dutch tulips--yes, flower bulbs--in 1636. Within four years of his death, the U.S. housing market would come crashing down and the government would bail out Fannie and Freddie, the two housing-finance giants, among many other financial institutions caught up in the crisis.
With the crash, Kindleberger's fascinations with bubbles would become the obsession of regulators, central bankers, financiers and economists chastened into learning lessons from the past.
What do we know now about bubbles? Where do they come from? How can they be prevented from happening and wrecking the livelihoods of so many?
Markus Brunnermeier, an economics professor at Princeton University, has picked up the baton from Kindleberger, adding some mathematical rigor to the late MIT professor's historical explorations. As Kindleberger had surmised, bubbles tend to emerge around technological innovation--whether that be the advent of canals and railroads in the 1800s, the internet in the 1990s or credit instruments like collateralized debt obligations in the 2000s, says Brunnermeier. Uncertainty around the impact of these innovations can lead to speculation and aberrant pricing.