Irrational Exuberance

The title of this post is from a famous speech made by Alan Greenspan in 1996, which was followed by a crash of the stock markets etc. In that speech, he said that he pointed out that ‘irrational exuberance could lead to unduly escalated asset values’.

This, in a normal market would mean that a correction would be due. When prices (such as stock prices) rose too high, they would not reflect the true underlying value of the businesses they represent. Market makers should be able to spot this and start selling over priced assets, thus correcting the valuations to the right level. If the asset values had risen too high, then of course the fall would be harder – also known as a crash.

This (as he pointed out) is not worrisome if it does not affect the real economy – ‘production, jobs and price stability’. And warned of the complexity of the interactions of the asset markets and the (real) economy.

That mini-bust came and went. And then it was exuberant again.

After a while, irrationally so. We gave up on pure rationality, gave in to our fear and greed and went along for the ride.

We bought and bought and bought. We bought houses we did not need. We bought goods we could not pay for. We bought stocks just because some-one gave us a tip. We bought credit. We bought the hope of an unbounded future. We bought recklessness and untempered faith.

And some of us, funds, bought stuff that had been sold on before, just in new packaging. Bank A has a package of mortgages – solid as houses – lets buy that! Look here, Bank B has a package of credit card debt that they don’t know what to do with – we’ll take two! Cheap, recycled (must be good for earth (huh?)!) bundles of unreasonable borrowing – shall we have that too, dear?

It was all working so well. Everybody was doing something, rushing around looking busy. The cake would surely rise, and keep rising and then we’d have a party.

There were a few people, I’m sure who looked around themselves and said,”this is madness, it can’t last”. Some remebered their thrifty grandparents but their lessons seemed so irrelevant to the times. There were those who looked at the buy-to-let market in the UK and realised that the boom was over, but then there were many more new naive entrants to this market who did not have a clue, who carried on buying. Others looked at the stock markets, and then at the fundamental values of the companies and said to themselves, “This is like the dot-com bubble, it cannot last”. And watched the prices rise again, regretted the missed opportunity for profit and joined in again. And so we rose and floated away into the sunset.

Till night fell. And we were too far out to turn back safely.

Some of us will sink, will not survive. Others will find islands and turn into Robinson Crusoe. Others will build new boats and paddle slowly back. Some will find a ride on other people’s boats. And then, some will create opportunities along the way.

We need to decide which of these we want to be.


(c) meetasengupta


2 responses to “Irrational Exuberance

  1. Nice writing style. I look forward to reading more in the future.

  2. Smita Purushottam

    A great “tutorial” on the why and how of the credit collapse, I am sending it to some students who wanted good reading material on the current crisis.

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