Research Topics

The Anatomy of a Pure Price-Chasing Bubble

It is widely agreed that the Nasdaq during the dot-com era 20 years ago was a full-fledged stock market bubble. Recently, the US stock market according to many metrics has become significantly more speculative and overvalued than it was at the dot-com peak 20 years ago. In both instances, a very broad subset of stocks became so highly valued that speculation in them had to be untethered from all fundamentals: the essence of what we call a “pure price-chasing bubble.”
 
This paper, drawn from a book in progress, examines the history of stock markets for comparable pure price-chasing bubbles, finding nine or so which have ever reached such a speculative extreme, with an over-the-counter market in Kuwait in the early 1980s called the “Souk al-Manakh” representing the most extreme example. Based on personal exposure to this Souk al-Manakh almost 40 years ago, we describe this anatomy and thereby make transparent the recurrent dynamics—on the way up and on the way down—of these greatest asset bubbles in human history. When one applies this framework to the current US stock market, one sees that the stock market in the US today will likely follow the disastrous path of the dot-com market.

A Micro- and Macroprudential Perspective

Bank leverage ratios have made an impressive and largely unopposed return; they are mostly used alongside risk-weighted capital requirements. The reasons for this return are manifold, and they are not limited to the fact that bank equity levels in the wake of the global financial crisis (GFC) were exceptionally thin, necessitating a string of costly bailouts. A number of other factors have been equally important; these include, among others, the world’s revulsion with debt following the GFC and the eurozone crisis, and the universal acceptance of Hyman Minsky’s insights into the nature of the financial system and its role in the real economy. The best examples of the causal link between excessive debt, asset bubbles, and financial instability are the Spanish and Irish banking crises, which resulted from nothing more sophisticated than straightforward real estate loans. Bank leverage ratios are primarily seen as a microprudential measure that intends to increase bank resilience. Yet in today’s environment of excessive liquidity due to very low interest rates and quantitative easing, bank leverage ratios should also be viewed as a key part of the macroprudential framework. In this context, this paper discusses the role of leverage ratios as both microprudential and macroprudential measures. As such, it explains the role of the leverage cycle in causing financial instability and sheds light on the impact of leverage restraints on good bank governance and allocative efficiency.

Explosion in the 1990s versus Implosion in the 2000s

Orthodox and heterodox theories of financial crises are hereby compared from a theoretical viewpoint, with emphasis on their genesis. The former view (represented by the fourth-generation models of Paul Krugman) reflects the neoclassical vision whereby turbulence is an exception; the latter insight (represented by the theories of Hyman P. Minsky) validates and extends John Maynard Keynes’s vision, since it is related to a modern financial world. The result of this theoretical exercise is that Minsky’s vision represents a superior explanation of financial crises and current events in financial systems because it considers the causes of financial crises as endogenous to the system. Crucial facts in relevant financial crises are mentioned in section 1, as an introduction; the orthodox models of financial crises are described in section 2; the heterodox models of financial crises are outlined in section 3; the main similarities and differences between orthodox and heterodox models of financial crises are identified in section 4; and conclusions based on the information provided by the previous section are outlined in section 5. References are listed at the end of the paper.