Friday, March 20, 2009

Anatomy of a Bubble by Louis Evan Palmer

Since no-one seems to know the mechanics of a bubble to the extent that it can be prevented or even agrees that bubbles exist and should be prevented, this article is not trespassing into an experts-only credentialed speech zone (another of the myriad ways to shut people up).

The initial insight in naming this type of phenomenon a "bubble" shows that it's regarded as a temporary unsustainable thing, something that's attractive but under pressure. No-one expects it to last, only long enough to make money.

Thus, it is clear that there is a psychological element to it - untempered optimism and greed. It is future-oriented and faith-based - my tomorrow is ensured, yours not so much. It discourages critical thought. It censors and self-censors. Nay-sayers come under hostile feedback attacks - who is willing to stand in front of the steam-roller?

Another essential ingredient is a lack of effective oversight and control. People will plead ignorance or benign neglect. Innovation will obfuscate the ritualistically diligent - those who don't really want to dig and pursue and explain, only to appear so in a court at a later date. For innovation, read racket, gimmick. Most of it a dressed-up Con 101.

Bubbles also need fuel and their fuel is personal riches. Fee-based transactions, outrageous compensation formulas, profits rule and overrule. Regimes where churn itself is the engine, the trade is the asset.

They also require capital. But not normal capital flows, they need excess capital to survive. It is their oxygen. As always, excess capital leads to over-investment and asset inflation. Typically, a reservoir of value feeds the early stages of the bubble. This generates the early winners and, as every casino knows, you need them to rope in the hordes of suckers to follow.

Another aspect of bubbles is the creation of unreal capital which is usually part of the innovation. These are sold as "instruments" or "packages" or other similarly-named products. But if you examine them carefully they are not tied to anything directly.

Like other rackets, bubbles always have a time-pressure element to them and only pay out to the few. They have much in common with a shell game - the movement, the lack of knowledge, the misdirection. But this is malevolent game which uses leglisation and policy and enjoins others in the mesh. It deliberately entwines itself across sectors and countries and currencies - partly to hid its dealings, partly to spread the culpability and increase the gain. Getting 100 people to pay for the same thing is more profitable than having only 1 person paying for it.

We can nip these destructive criminal enterprises in the bud. There are telltale marks. The postulate is that every bubble has a precursor, close to it in time and technique, displaced in location and industry. The precursor is smaller but it provides evidence of the susceptibility of the environment to this phenomenon. Also, look for people making a lot of money - that's the easiest method. We can tax certain types of speculative transactions. We can strictly control or outlaw certain classes of financial instruments or transactions. How was an entire shadow banking system allowed to exist? We must pay attention to the laws & policies being enacted from the perspective of beating the system. We should always be within one remove of an asset, ideally a tangible asset.

Bubbles are destructive and to be prevented. We know how to do it. Their existence proves massive corruption in the system. So we have two problems here.

Anatomy of a Bubble, Louis Evan Palmer, The Way It Can Be,
Copyright 2009 Louis Evan Palmer lives in Ontario Canada. His short stories have appeared in numerous publications.