Wednesday, September 24, 2008

Booms and Busts

There is a lot of hand wringing about what has caused the current Wall Street meltdown. I think the explanation is very simple:

It's like the old story of the frog and hot water: throw a frog in boiling water and he will jump out immediately. But put him in cold water and slowly turn up the heat...and he will die.

Gradual unhealthy change is below the threshhold of awareness...but it can still kill you.

The US financial markets risk levels increased over the past 15 years....the illusory profits of the dot com boom bolstered by an increase in the money supply....which gradually found its way into mortgage backed securities....and to main street via riskier mortgages....household income and mortgage debt became decoupled....housing equity turned to debt....

Every boom crashes because we run out of buyers of high priced assets. The early participants keep the winnings, and the latecomers can't sell their houses, don't get the appreciation they counted on....

Law of nature, law of financial markets.

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