Have we hit another bubble?

Tracking stocks in newspaper.

TEXT OF STORY

Tess Vigeland: Happy Financial Literacy Month everyone! So how are you celebrating? Brushing up on the basics of compound interest, maybe? Doing the math on your emergency fund? Or perhaps, you're taking a couple of hours to review and re-balance your portfolio?

If you've been watching the Dow more closely than we generally recommend on this show, you know it topped 11,000 this week. The meteoric rise from one year ago is setting off warning bells in some quarters and talk of another bubble.

So we asked Marketplace's Mitchell Hartman to look into it.


Mitchell Hartman: When I was a junior at Swarthmore College, economic history professor Bob Duplessis taught me everything I know about bubbles.

Bob Duplessis: As I remember, you used to sit there with a little hint of puzzlement.

Puzzlement, maybe because I couldn't understand how the titans of capitalism -- 17th-century tulip merchants or 20th-century investment bankers -- could follow a pipe dream of ever-rising prices to disaster.

Duplessis: There are actually a number of positions about what a bubble is. We don't actually know what lessons ought to be learned.

David Blitzer of Standard & Poor's says while bubbles are hard to identify and prevent, they all have one thing in common -- a new idea.

David Blitzer: Something starts to get things going, called "displacement." It might be the stories of the mid-1990s -- it's a new economy, the Internet will solve all the problems in the world. It might be very low interest rates, and the idea that you gotta buy a house, because home prices never go down.

Back in the housing boom, that new idea drove Michael Russell of Minneapolis -- and millions like him -- to invest in property that was going up 10, 20 percent a year. It was property they couldn't afford, so they borrowed to the hilt to get in the door.

Michael Russell: I bought my house three years ago for $183,000, which at the time -- you know, it was 2007 -- really was not out of the question.

Now, the house across the street from me a year ago sold on foreclosure for about $37,000.

Russell's now trying to sell. He told me comparable homes in the neighborhood are going for 30 percent below what he paid. He anticipates selling for tens of thousands less than he owes on the mortgages.

But while it's obvious now that prices were massively inflated, Blitzer says it wasn't so obvious then.

Blitzer: After the fact, looking back, all the insanities become clear. But in the midst of it, we all get caught up in the excitement, and the euphoria and the mania, and it does look rational.

In fact, jumping in can be rational -- and very profitable, says Duplessis. It's called the "Greater fools theory."

Duplessis: You know that you're being a fool, as it were, to engage in the market, because the price is clearly out of whack with fundamentals. On the other hand, you count on there being a quote "greater fool" who will buy it at a yet more inflated price.

And here's another thing, even though prices seem out of whack, they might not be.

Duplessis: It's often difficult to know whether in fact this is a bubble, that these assets are overvalued or whether perhaps this is an understandable price increase.

Because there really is something new under the sun -- railroads, for instance, or the Internet. But that's the exception, says Dean Baker. He's with the Center for Economic and Policy Research and was also a student of my old Swarthmore prof, so I guess he wasn't as perplexed as I was.

Dean Baker: When you see a sharp departure in fundamentals with something fundamental, like housing or stocks, that should always raise clear questions, because these are big markets, and it's not that often that we get a whole new world.

Baker was one of the few economists who warned that the housing boom was a bubble. But he doesn't blame home buyers who piled in; they really did risk missing out. He blames fellow economists.

Baker: The people I really blame in this story are people like myself, economists. When they should have been yelling at the top of their lungs, raising warning flags, saying, "This can't go on. It's going to end badly," they were doing the opposite. We're supposed to be the experts and the experts totally blew it.

With that ringing endorsement, let's go back to our original question: Might the recent run-up in stocks be another bubble?

David Blitzer has looked at some key measures of market fundamentals.

Blitzer: They're a little bit high but they're not outrageously high. Unfortunately for investors, one probably has to keep watching them for the next six months or something to get a better signal as to whether we're bubbling or just recovering.

[Sound of bubble blowing then popping]

Still puzzled, I'm Mitchell Hartman for Marketplace Money.


Tess Vigeland: Mitchell's not the only guy who's still puzzled. And at least he has an excuse, he's just, you know, a reporter. But apparently some of the bank executives who helped inflate the housing bubble are still shaking their heads. They whined to a congressional panel this week that they still don't understand how their decisions to give mortgages to people who couldn't afford them could possibly have gotten all of us into such a ginormous mess.

Former Washington Mutual CEO Kerry Killinger told the panel that the government seized WAMU in September 2008 because it wanted to save even bigger banks. Some WAMU offices, by the way, are accused of cutting and pasting fake names onto borrowers' bank statements.

About the author

Mitchell Hartman is the senior reporter for Marketplace’s Entrepreneurship Desk and also covers employment.

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