So why do bubbles happen? Haven't we seen this before? There was the dot-com bubble in 2000, and the tech bubble followed. Then everyone started investing in the real estate market. The real estate has real value, the real estate is a real investment, the market won't burst, land prices always go up. Yeah, let's buy more real estate! Oh yeah, let's buy a house so huge I don't know what to do with it. Let's buy a house so huge I got no money left. Because hey - I can sell it 2 years later, and the bigger the house, the bigger the profit.
So let's dig a little deeper. It's one thing to think you can afford a house which is too big for your own good, and quite another to actually go ahead with the purchase and having the ability to pull it off. Here the average deluded consumer got the help from the institutions and people around him. Banks willingly lent him money for a purchase he couldn't afford. Friends told him his house prices would rise, and that theirs have already risen. Newspapers told him about the housing boom, and how it's such a hot investment these days, everybody's doing it, why don't you? Get on the bandwagon! Cash in on the craze!
The fundamental reason bubbles arise is people are too optimistic for their own good. They don't see or they don't wanna see failure, either of people around them or their own. They think things are always going to improve and when they hesitate, they're easily convinced by other people. In my experience, there are a lot more optimists in this world than there are pessimists. This happy-go-lucky attitude does wonders for a bubble, because everyone is affected.
- The person who wants to buy a huge house realizes he can buy it now, even though he cannot afford it. He doesn't really know what he's doing, or if he can make it, but he's easily persuaded by his optimistic friends and the bank that's giving him the loan so easily despite his bad credit history. Everything is gonna be alright...
- The bank employee / loan officer overlooks the buyer's credit history for the same exact reason. He is an optimistic too. He doesn't need to check too hard. If he hesitates, his colleague or his competitor is going to extend the sub-prime loan, and make a couple of thousand in commission on the sale. Why shouldn't it be him? Everything is gonna be alright...
- The bank's CEO sees his loan officers making bad sub-prime loans but he won't stop them. It'll be fine. The other banks have made similar loans, and their stock price has gone up big time. Why should he miss out? Everything is gonna be alright...
- Even the regulators turn a blind eye on the bad lending practices. The economy based on maxed-out credit cards and defaulted house loans keeps zooming on, the construction industry is driving the rest of the economy, unemployment is low, the dollar is high. What could go wrong? Mr. Greenspan is praised for his supervision of the superb invincible powerhouse of the American economy. His ego is on the line too, he's an optimist, everything's gonna be alright...
- Once in a while a pessimist or a realist raises his head above the crowd and says something like "What are you guys doing? The real value of the house has nothing to do with what you're paying! The prices can't rise forever, etc."
- But nobody wants to listen. "Why you gotta be such a downer, Mr. Pessimist! Can't you just be happy like the rest of us. You're always crying wolf!" And so the pessimists voices drown in the sea of happiness, as everyone appears to be getting richer at the same time, with no consequences. Solid judgement gets dismissed as doomsday predictions. Everything is gonna be alright...
Even as the bubble is bursting, the markets are refusing to believe it. They're still optimistic. It's only a few bad apples, it's only one bank, it's only some states, it's only the American economy, it's only the dollar that's tanking.
KAPANG - And then the bubble bursts...
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