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Boombustology: Spotting Financial Bubbles Before They Burst



"Asset class bubbles are by far the most important events in the life of both stock markets and economies. Boombustology is a comprehensive, informative, and entertaining look into how bubbles form, what really constitutes a bubble, and, critically, the causes and circumstances of bubbles breaking. It is essential reading for any bubbliophile."
—JEREMY GRANTHAM, Co-founder and Chief Investment Strategist, GMO

"Imaginative, accessible, and blessedly concise, Boombustology is a Baedeker for these boomy and busty times."
—JAMES GRANT,Grant's Interest Rate Observer

"If there's one thing that cleaves Wall Street's winners from its losers, it's the ability to say, 'I've seen this movie, and I know how it ends.' Vikram Mansharamani's Boombustology will entertain readers with an entire film festival of past, present, and future investment disaster flicks that will make them laugh, make them cry, and save their bacon."
—WILLIAM J. BERNSTEIN, bestselling author of The Investor's Manifesto: Preparing for Prosperity, Armageddon, and Everything in Between

"Investors are attracted to bubbles. To paraphrase Orwell, they find themselves playing with fire without even knowing that fire is hot. Vikram Mansharamani's highly readable book will set them right. It provides a sound intellectual framework for identifying bubbles before they burst. If you buy only one investment book this year, make it Boombustology."
—EDWARD CHANCELLOR, author of Devil Take the Hindmost: A History of Financial Speculation

"Through an artful and accessible melding of theoretical frameworks and historical cases, Boombustology provides the essential tools to identify and navigate the financial booms and busts that can be so hazardous to one's portfolio. Required reading for all investors."
—PAUL A. REEDER, President, PAR Capital Management

"Who is the better investor: the generalist or the expert specialist? In this spirited book, Vikram Mansharamani brings to life five famous boom-bust episodes and argues for a multidisciplinary, generalist approach. Boombustology is an engaging read for specialists and generalists alike."
—JOHN GEANAKOPLOS, James Tobin Professor of Economics at Yale University; External Professor, the Santa Fe Institute; and Partner, Ellington Capital Management

VIKRAM MANSHARAMANI is an experienced global equity investor and a Lecturer at Yale University, where he teaches a seminar called "Financial Booms and Busts." Mansharamani has a PhD and MS from the MIT Sloan School of Management, an MS in political science from the MIT Security Studies Program, and a BA from Yale University. He lives in Brookline, Massachusetts.

Foreword xi

Preface Is There a Bubble in Boom-Bust Books? xvii

Acknowledgments xxiii

Introduction The Study of Financial Extremes: One-Armed Analysts, Secrets, Mysteries 1

Secrets versus Mysteries

Different Problems Necessitate Different Approaches

Financial Booms and Busts as Mysteries

Part I Five Lenses

Chapter 1 Microeconomic Perspectives: To Equilibrium or Not? 9
"Random Walks" and Accurate Prices: The Efficient Market Hypothesis
Constant Instability and Inefficiency: The Theory of Reflexivity
Reconciling Efficiency and Reflexivity

Chapter 2 Macroeconomic Perspectives: The Impact of Debt and Deflation on Asset Markets and Prices 23
The Magnifying Power of Leverage
Collateral Rates and Debt Dynamics
Hyman Minsky’s Financial Instability Hypothesis
Debt Defl ation and Asset Prices
The Austrian Business Cycle Theory
Integrating the Macro Lenses

Chapter 3 The Psychology Lens: Homo economicus Meets Homo sapiens 45
The Study of Irrationality Is Born
Heuristics Gone Wild: How Rules of Thumb Lead Us Astray
Our Flawed Brains: Other Cognitive Issues
The Certainty of Uncertainty

Chapter 4 Political Foundations: Evaluating Property Rights, Price Mechanisms, and Political Distortions 69
Can Anyone Own Anything?
Prices: To Guide or Be Guided?
Political Distortions of Property and Price

Chapter 5 Biological Frameworks: Epidemiology and Emergence 85
Revealing the Maturity of an Unsustainable Boom
How Micro Simplicity Drives Macro Complexity
Emergent Behavior in Human Swarms
The Blind Leading the Blind

Part II Historical Case Studies

Chapter 6 Tulipomania: A Bubble in Seventeenth-Century Holland 103
The Uniqueness of Tulips
Fertile Soil for Bubble Formation
The Boombustology of Tulipomania
The Multilens Look

Chapter 7 The Great Depression: From Roaring Twenties to Yawning Thirties 117
Castles in the Sand
From Booming Twenties to Busted Thirties
The Boombustology of the Great Depression
The Multilens Look

Chapter 8 The Japanese Boom and Bust: A Credit-Fueled Bubble Economy 137
Japan(ese) as Different
An Overview of the Bubble Economy
The Boombustology of the Japanese Boom and Bust
The Multilens Look

Chapter 9 The Asian Financial Crisis: The Mirage of a Miracle 155
Boom Times in East Asia
Thailand Catches the Flu
The Boombustology of the Asian Financial Crisis
The Multilens Look

Chapter 10 The U.S. Housing Boom and Bust: The Homeowner’s Society Creates the People’s Panic 173
"Safe as Houses"
The Music Stops
The Boombustology of the U.S. Housing Boom and Bust
The Multilens Look

Part III Looking Ahead

Chapter 11 Spotting Bubbles before They Burst: A Method for Identifying Unsustainable Booms 193
Reflexivity and Self-Fulfi lling Dynamics
Leverage, Financial Innovation, and Cheap Money
Policy-Driven Distortions
Epidemics and Emergence

Chapter 12 Boombustology in Action: Is China Next? 217
Tendencies toward Equilibrium
Leverage, Cheap Money, and Potential Defl ation
Conspicuous Consumption and Overconfi dence
Rights, Moral Hazard, and Political Distortion
Consensus, Silent Leadership, and Epidemics
The Unsustainable Chinese Story

Conclusion Hedgehogs, Foxes, and the Dangers of Making Predictions 243

Notes 247

About the Author 265

Index 267