Incentives Align To Create Bubbles

from the blame-game-not-necessary dept

In the latest financial crisis, we've seen even more focus on casting blame than following most financial crises. It may be because of the sheer size of the mess this time, and it may be because the events that led up to this mess are a lot more difficult to understand than in the past -- and may even feel more nefarious. However, the deeper you look into the crisis, the harder it is to directly assign blame for the majority of the mess. Yes, there were scammers and fraud on the margins, but for the most part, everyone was doing things in a way that makes sense. This, among other things, is a key point brought out by Henry Blodget's article in The Atlantic about why these types of collapses happen so often. Basically, there is some amount of irrationality in the system, but over time, as more and more people seem to be making money against the irrationality, more and more explanations are made for why that irrationality is actually rational. And since the irrational activity goes on for so long, it becomes nearly impossible for most people to really believe that things are so irrational. So, it's not that there's anyone who did anything wrong that needs to be blamed, so much as we need to blame ourselves, for not taking enough time to recognize that what seems irrational in the beginning actually is irrational.

Of course, along those lines, it's important to realize that, as painful as market corrections like this are going to be, the end result is often beneficial. During the bubble period, lots of money gets thrown at certain things (infrastructure or products) that post-bubble are available for quite a discount. Bubbles help build up new institutions, and even if the original investments get washed away, something good often comes out of them in the end. It may not be clear yet how this financial crisis will eventually work out, but now is a decent time to be looking for opportunity in the carnage rather than worrying about who to blame.
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Filed Under: blame, bubbles, incentives


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  1. identicon
    Kiba, 24 Dec 2008 @ 12:07am

    Broken Window Fallacy

    Please don't get on the bandwagon that bubbles are good because they provide such and such benefit. Bubbles are just that, malinvestment. It is better if the investment were aimed at something sustainable over the long run.

    Also, I like to point out that the feds make funny money by the virtue of printing them like crazy. This have an effect of fooling investors no matter how smart they are as price signals get distorted. Bubbles will keep happening over and over again because of the fed's control over the banking system. Whether or not that bubbles will cease to happen when we embraced free banking while also abandoning the fiat money system remained to be seen. What is certain is that the regulations of the banking system has not prevent these business cycles or perhaps is the cause of business cycles. See the Austrian Business Cycle Theory.

    Keep in mind that loss are an important part of capitalism as much as profit. Failure of a whole of bunch of firms is the free market's way of flushing out bad allocation of resources and begun the process of allocating resources to firms that actually generate wealth.

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