20 Jul 2011
Notes from Economist debate:
Definition of a tech bubble: rapid valuation inflation which exceeds company fundamental values (profit expectations aren't in sync the financial reality of the security) followed by a crash in value.
Four phases of bubbles: Stealth, awareness, mania, blow-off.
Stealth: New industry segments are invested in which generate real profit and value. Early investors who "understand" how the new markets could result in "off the cart" revenues and profits increase their investments. These people help build the high-profile companies of the bubble but always cash out before the world enters the next phase since they understand the game being played and move on to find the next thing instead.
Awareness: Later investors and different kinds of middle men (brokers, salespeople) start to notice and bring investment money resulting in higher prices. When valuations start going to the roof (i.e. Facebook going from $10 billion to $50 billion in the same year) the mantra "this time - everything is different" is inevitably preached. Everything in this phase is about keeping the bubble alive and making it bigger.
Mania: The public jumps in with their money for the "investment opportunity of a lifetime". More money leads to even higher prices pushing IPO valuations to insane levels. The goal is to maximize the bubble using investments from people who aren't domain experts by showing them how early investors in this phase are making extraordinary amounts of money as the bubble grows. The process repeats until the bubble pops and the result is basically a wealth redistribution, transferring value from "marks" to "smart money" and "promotors" (see the chart above).
Warren Buffet on the housing bubble:
The only way you get a bubble is when a very high percentage of the population buys into some originally sound premise...that becomes distorted as time passes and people forget the original sound premise and start focusing solely on the price action. People overwhelmingly came to believe that house prices could not fall significantly. And since [property] was the biggest asset class in the country and it was the easiest class to borrow against it created, you know, probably the biggest bubble in our history.