Friday, January 29, 2010

There's No Such Thing as Bubbles

The New Yorker 1/13/2010 "Interview with Eugene Fama"



小弟姓黑名貓 said...

How is subprime not a bubble? Lending standard hit bottom where some loan borrowers were given the option of paying nothing at all and rollback the interest payment on principal. And most of the subprime loans had a "honeymoon" period where the rate was offering at discount rate.

Clearly (maybe with a little hindsight), those home owners were given loans they couldn't afford and it was just a matter of time they default. So I find it bizarre that Fama claims it was some kind of macroeconomic depression that made subprime borrowers unable to repay their loan rather than those people genuinely couldn't pay the loans.

CCLu said...

1. Using leverage is a common practice in modern finance. Without that, the world can hardly move forward. What those home owners used was just that.

2. They were over-stretched, we can see that in the hindsight. That being said, we cannot tell for sure back then when or where the bubble will burst.

3. To claim something a bubble, we need a publicly recognizable standard of the fundamental value. Sadly, we don't.

4. What we call a "bubble" is just different perspectives of risk and people's different willingness to take that risk.

5. If it takes a crystal ball to identify a bubble, then its existence is up to debate.

Real world question:

Is there a bubble in China? We see inefficient or even bad loans accumulating in Chinese banks in the past year and we see outrageous prices of commercial and residential buildings in big cities. Are they bubbles? If the answer is positive, when will they burst?

Professor Fama just took a rigorous definition of bubbles and needless to say they are hard to identify before they burst. We speculate, we have doubts, but we cannot be sure. Sometimes those bad situations just straightened out themselves. For those which did not, they were bubbles we saw.

小弟姓黑名貓 said...

1. I agree with that partially. For people who borrow money for trade schools, graduate schools or houses on genuinely non-speculative sense, yes, leveraging is common sense and benefits borrowers. However, when people borrow money to buy Tulip bulbs in 17th century Netherlands or to buy birds in Taiwan in 1960s then it was quite obvious whoever lent loans to those speculators were idiots. Subprime home owners really were not that different from Tulip bulb or birds buyers and I think it is wrong to put those Subprime borrowers in the same sense as genuine loan borrowers.

3. I agree with that. However, there are probably no objective methods to judge the value of Tulip bulbs or birds, but I think we can all agree they were bubbles.

As of the possibility of housing bubbles in China, I am just an econ undergraduate so you will definitely have more knowledge than me, but I am thinking:

i. Is the growth rate of housing price atrociously outgrow income growth rate?

ii. Does the rate of new houses sold significantly overmatch the rate of migration in those areas?

iii. Do banks fanatically increase bad loans?

Certainly there are more meaningful indicators of speculators' mania. If all these indicators all sending bad signals, then I think it is quite evident there is going to be a bubble.

I think only small amount of intelligent investors can identify bubbles and no one can pinpoint the exact moment when the bubbles are going to burst. Those who did made a fortune on credit default swaps. Nevertheless, just because only a handful of investors can identify the bubble and Fama can't does not mean there is no such thing as a bubble. It just means bubbles are hard to identify.