1、 assets can affect the so-called fundamentals. The most widely travelled are those which involve the use of leverageboth debt and equity leveraging. These pathways deserve a lot more research.My two propositions focus attention on the reflexive feedback loops that characterize financial markets. The
2、re are two kinds of feedback: negative and positive. Negative feedback is self-correcting; positive feedback is self-reinforcing. Thus, negative feedback sets up a tendency toward equilibrium, while positive feedback produces dynamic disequilibrium. Positive feedback loops are more interesting becau
3、se they can cause big moves, both in market prices and in the underlying fundamentals. A positive feedback process that runs its full course is initially self reinforcing, but eventually it is liable to reach a climax or reversal point, after which it becomes self reinforcing in the opposite directi
4、on. But positive feedback processes do not necessarily run their full course; they may be aborted at any time by negative feedback.* * *I have developed a theory about boom-bust processes, or bubbles, along these lines. Every bubble has two components: an underlying trend that prevails in reality an
5、d a misconception relating to that trend. A boom-bust process is set in motion when a trend and a misconception positively reinforce each other. The process is liable to be tested by negative feedback along the way. If the trend is strong enough to survive the test, both the trend and the misconcept
6、ion will be further reinforced. Eventually, market expectations become so far removed from reality that people are forced to recognize that a misconception is involved. A twilight period ensues during which doubts grow, and more people loose faith, but the prevailing trend is sustained by inertia. A
7、s Chuck Prince, former head of Citigroup said: we must continue dancing until the music stops. Eventually a point is reached when the trend is reversed; it then becomes self reinforcing in the opposite direction. C h a r t To go back to my original example, the conglomerate boom of the late 1960s: t
8、he underlying trend is represented by earnings per share, the expectations relating to that trend by stock prices. Conglomerates improved their earnings per share by acquiring other companies. Inflated expectations allowed them to improve their earnings performance, but eventually reality could not
9、keep up with expectations. After a twilight period the price trend was reversed. All the problems that had been swept under the carpet surfaced, and earnings collapsed. As the president of one of the conglomerates, Ogden Corporation, told me at the time: I have no audience to play to.Typically, bubb
10、les have an asymmetric shape. The boom is long and drawn out: slow to start, it accelerates gradually until it flattens out during the twilight period. The bust is short and steep because it is reinforced by the forced liquidation of unsound positions. Disillusionment turns into panic, reaching its
11、climax in a financial crisis.Bubbles that conform to this pattern go through distinct stages: inception; a period of acceleration, interrupted and reinforced by successful tests; a twilight period; and the reversal point or climax, followed by acceleration on the downside culminating in a financial
12、crisis. The length and strength of each stage is unpredictable, but there is an internal logic to the sequence of stages. So the sequence is predictablebut even that can be terminated by government intervention or some other form of negative feedback.The simplest case is a real estate boom. The tren
13、d that precipitates it is that credit becomes cheaper and more easily available; the misconception that turns the trend into a bubble is that the value of the collateral is independent of the availability of credit. As a matter of fact, the relationship between the availability of credit and the val
14、ue of the collateral is reflexive. When credit becomes cheaper and more easily available, activity picks up and real estate values rise. There are fewer defaults, credit performance improves, and lending standards are relaxed. So at the height of the boom, the amount of credit involved is at its max
15、imum and a reversal precipitates forced liquidation, depressing real estate values.Yet, the misconception continues to recur in various guises. The international banking crisis of 1982 revolved around sovereign debt where no collateral is involved. The creditworthiness of the sovereign borrowers was
16、 measured by various debt ratios, like debt to GDP or debt service to exports. These ratios were considered objective criteria, while in fact they were reflexive. When the recycling of petrodollars in the 1970s increased the flow of credit to countries like Brazil, their debt ratios improved, encour
17、aging further inflows and starting a bubble.* * *Not all bubbles involve the extension of credit; some are based on equity leveraging. The best example is, of course, the Internet bubble of the late 1990s. When Alan Greenspan spoke about irrational exuberance in 1996 he misrepresented bubbles. When I see a bubble forming I rush in to buy, adding fuel to the fire. That is not irrational. And that is why we need regulators to counteract the market when a bubble is threatening to grow too bi
