What caused the bubbles?

The first signs the dot-com bubble was going to crash came from the companies themselves: many reported enormous losses and some even folded within months of their offering.  In 1999 there were 457 IPOs, most of which were technology and internet related. Looking at those IPOs in more detail shows, of the 457, 117 doubled in price on their first day of trading. In 2001 there were a mere 76 IPOs and none of them doubled on their first day of trading. The Nasdaq Composite lost 78% of its value during the dot com crash as it fell from 5046.86 to 1114.11.

Following the bursting of the dot-com bubble and the recession of the early 2000s, the Federal Reserve in the USA kept short-term interest rates low for an extended period. At this same time there was a global savings glut, as developing and commodity producing countries accumulated large financial reserves. Global interest rates fell to record lows as these surplus savings were invested. This, however, lead us to our next bubble, as investors became frustrated with low returns; they began to look for higher returns and therefore assuming more risky investments. For a number of years, global financial markets went through a period which became known as the “Great Moderation”, called as such because of the above-average returns and below-average volatility by a variety of asset classes.

Rising house prices led to extensive property speculation, and also fuelled excessive consumer spending as people started to see their homes as “piggy banks” that they could take cash out from at any time to fuel discretionary spending. As house prices rocketed many home-owners “stretched” to make their mortgage payments and the possibility of a collapse grew.

When the long held idea that house prices do not decline turned out to be incorrect, prices on mortgage-backed securities plunged, creating a domino effect with large losses for banks and other financial institutions. We reached the climax of our housing bubble in September 2008 with the bankruptcy and ultimate collapse of Lehman Brothers Bank in the United States.  This housing bubble caused markets to crash, the S&P 500 fell 57% from its high in October 2007 of 1576 to a low in March 2009 of 676.

However we shouldn’t feel too bad, the Oracle of Omaha has this bubble “the granddaddy of all bubbles”. Yet the question remains, where does the global economy go from here? Do we need to just accept bubbles and be willing to ride the rollercoaster? What do we need to look out of to prepare ourselves for the next bubble? And most importantly what is our next bubble?