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Author: warrl Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 464959  
Subject: Re: katinga Date: 10/7/2012 3:54 PM
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rcl But the next time is not going to be different there are no laws that we can past that will end the bubbles and crashes. The best we should hope for is to cut back on the level of damage.

When a large number of normally-rational people make the same stupid mistake at the same time (which is the direct cause of investment bubbles), look into why it did not seem stupid. Most likely they were responding to incorrect information - that either (a) came from a very highly credible source so they believed it, or (b) had the weight of law behind it, so those who didn't believe it would be punished for acting accordingly and/or rewarded for acting contrary to their beliefs. Or (c) a combination of the above.

Who is that credible can vary and is subject to fads; but the bigger your government is, the more likely that it's involved somehow. Fashion fads come from Paris not Podunk. Who has the weight of law behind them - by definition government is involved somehow, details vary.

In the recent housing bubble, lenders could plainly see that certain potential borrowers were high-risk and should not be lent money. But the government stepped in and said "We decree that they are low-risk and you WILL lend them money or we will punish you." Meanwhile the GSEs stepped in and said "We will buy those loans from you, so now they ARE low-risk." And the lenders lent the money. The GSEs (and others) bundled these loans and told the world "These respectable lending institutions wouldn't make high-risk loans, and with this bundling we've reduced the risk even further because even if one loan defaults it doesn't mean others are likely to." And people believed that even though in major economic swings loan defaults often DO correlate - if a factory shuts down and one now-unemployed factory worker can't pay his mortgage, there's a good chance that others like him will also be unable to pay their mortgages.
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