Why bubbles are so hard to see

Henry Blodget


Kai Ryssdal:
You know that old line about those who don't remember history being condemned to repeat it?
There's a certain element of that in the crisis du jour.

I mean, it's not like Wall Street hasn't had experience losing boatloads of other people's money before.

Former Wall Street analyst Henry Blodget writes about why Wall Street always blows it in the current edition of the Atlantic Monthly.

Good to have you with us.

Henry Blodget: Great to be here. Thank you for having me.

Ryssdal: You know a thing or two about bubbles on Wall Street. Did this one catch you off-guard?

Blodget: This one caught me less off-guard than the first one. To provide background, I was a technology analyst at Merrill Lynch and I covered Internet stocks. And I was definitely aware that it was possible that it was a bubble, and toward the end of it I thought it probably was a bubble. And yet I still managed to drag myself and my clients right off the cliff.

In the housing market I was, I would say, early in saying, Hey wait a minute, this looks very similar to what was going on in technology. And in fact, I personally made the opposite mistake in the housing bubble, which was to get out too early.

Ryssdal: But you were, and there are on Wall Street now, a bunch of people who are the smartest guys in the room. And if that's true, how come we're all so broke?

Blodget: Well, I think you see the smartest guys in the room on Wall Street make this same mistake, and I think there are a lot of reasons for that. To start with, if you go back into the boom phase of any bubble, what you'll find is that just about every constituency that is participating in the decisions that further the bubble is thrilled with the boom. So, you have a self-reinforcing cycle where it's in everyone's interest to keep it going, and it takes an incredibly rare, strong and confident voice to say, Now hey, wait a minute, we are setting the table for disaster.

Ryssdal: And arguably all those people you mentioned, they're all acting, at least in the short term, rationally right?

Blodget: The decisions that are made in bubbles are much more rational than people think in hindsight. To take it back to the level of a real estate broker, you want to sell the house. It's not really your job to say, Hey, most of these economists who are saying house prices are going to go up are wrong. I think that they're going to drop, therefore I'm not going to sell any houses. And so, in the context of that, they are rational.

Ryssdal: Post-fact though, as you look back at a bubble, is there a sense of culpability or regret on the part of some of these people, do you think?

Blodget: I think there's huge regret. For me it was, I had seen the bubble forming, I had gotten wide open in the endzone and the game-winning pass was coming down and it hit me in the chest and I dropped it. I just felt like I'd made a tremendous error. And I think a lot of people are feeling that. I'm sure Alan Greenspan is feeling that because I think if you're going to look at the single biggest factor of why this housing bubble came in, it was that he kept interest rates too low for too long. Everything is screamingly obvious in hindsight and anybody who cares about the decisions they make is going to look back with a lot of regret.

Ryssdal: The next time we're in a bubble, are we going to be smart enough to say, you know, it's not really different this time. You remember back at the turn of the century?

Blodget: I think that some people will. And a lot of the people who will say it is not different -- this is just the same thing all over again -- are going to be those of us who are still alive who went through this period. Of course, at that time, we're going to be dismissed as cranks who are now totally out of touch and we don't understand the world has changed.

But there are also a lot of smart people who are saying it is different this time and here's why it's different. I think a really important point about bubbles is that the logic of saying it's different has to be persuasive, otherwise nobody would believe it. Again, if you go back to the tech bubble, you had Alan Greenspan saying, Look, the Internet is making things different. It is creating the ability for the economy to grow faster without overheating than it ever has before. That logic is very hard to refute. Again, it takes an extreme amount of knowlege and confidence to say, You know what, that is just simply wrong.

Ryssdal: Henry Blodget, he's the editor of Silicon Alley Insider. The article we're talking about is in the current edition of the Atlantic magazine. It's called, "Why Wall Street Always Blows It."

Henry, thanks a lot.

Blodget: Thank you for having me.

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About the author

Kai Ryssdal is the host and senior editor of Marketplace, public radio’s program on business and the economy.
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Bubbles and scams seem to share many characteristics. Whether its phantom technology (the tech bubble) or fancy financial engineering (credit default swaps), the appeal and the motives are usually the same. Maybe it really isn't that complicated to understand when something is off...it's when you notice how good it feels to think you might get something for nothing. I'm in no position to second-guess Mr.Greenspan's powers of reason when it comes understanding the complexity of the market, but perhaps our grandparents did have an advantage when they listened to their gut as much or more than their head. With the current crisis, I wonder when we will finish deconstructing the details of how it happenned and begin dealing with "the disturbing forces underpinning their rise". (see The End; by Michael Lewis Dec 2008 Issue). Until we can get to the bottom of that, there's bound to many more bubbles to come.

Shorter version of why bubbles are "hard to see": greed is blinding. No stock market has ever been linear. It's always a series of peaks and valleys, some more extreme than others. When regulations lag the "innovation" of those who play with money for a living, the outcome is the same every time. BOOM!

Regarding the creation of market bubbles

My perception is that markets will naturally create bubbles. To the extent
that we expect a profit beyond that
created by a company's production or
service provided, we are speculating,
not investing. Speculation then becomes
a "pyramid scheme:" we gain a profit as
long as there is another person willing
to pay more than we did, who then looks
for a buyer willing to pay more again.
Buy low, sell high. That basic premise
leads to market bubbles and busts.

Your piece about the financial bubble was infuriating! There was no mention of the real culprits and the real cause: lending money to people who couldn't afford to pay!! That was breaking a cardinal financial rule, one that would have been obvious to our grandparents. But in this generation of "gimme,...gotta have it,...NOW!", common sense only gets in the way.

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