5 Steps of a Bubble

Go Lean Commentary

What have we learned?

LB 1The Great Recession of 2008 – 2009 has come and gone – though many Caribbean member-states are still reeling from this crisis. The book Go Lean…Caribbean serves as a roadmap for the introduction and implementation of the technocratic Caribbean Union Trade Federation (CU); it declares that a crisis is a terrible thing to waste – quoting famed American Economist Paul Romer.

A popular leadership principle dictates a methodical progression as follows, identified as the 5-L’s:


The CU will assume the leadership role of exploring the opportunities presented as a result of this recent crisis. This leadership starts with the need to study/learn from the 2008 financial crisis, with the goal of minimizing future crisis or at least mitigating their effects. But 2008 is not the only crisis for Caribbean consideration, we also contend with an annual hurricane season. This subject is not an academic pursuit, but rather turn-by-turn directions to elevate Caribbean life and culture. In fact, the following 3 prime directives are explored in the roadmap:

  • Optimization of the economic engines in order to grow the regional economy to $800 Billion.
  • Establishment of a security apparatus (including disaster management) to protect the resultant economic engines.
  • Improve Caribbean governance to support these engines.

All in all, the roadmap commences with the recognition that since 2008 all the Caribbean is in crisis. This acknowledgement is pronounced in the Declaration of Interdependence (Page 13) with these statements:

xxiv.   Whereas a free market economy can be induced and spurred for continuous progress, the Federation must install the controls to better manage aspects of the economy: jobs, inflation, savings rate, investments and other economic principles. Thereby attracting direct foreign investment because of the stability and vibrancy of our economy.

 xxv.   Whereas the legacy of international democracies had been imperiled due to a global financial crisis, the structure of the Federation must allow for financial stability and assurance of the Federation’s institutions. To mandate the economic vibrancy of the region, monetary and fiscal controls and policies must be incorporated as proactive and reactive measures. These measures must address threats against the financial integrity of the Federation and of the member-states.

This issue of learning from the 2008 crisis has been a consistent theme of the Go Lean blogs entries as sampled here:

a. http://www.goleancaribbean.com/blog/?p=841 – Post 2008: Having Less Babies is Bad for the Economy

b. http://www.goleancaribbean.com/blog/?p=782 – Open the Time Capsule: The Great Recession of 2008

c. http://www.goleancaribbean.com/blog/?p=709 – Post 2008 Student Debt Holds Back Many Would-be Home Buyers

d. http://www.goleancaribbean.com/blog/?p=528 – Facebook plans to provide mobile payment services and remittances

e. http://www.goleancaribbean.com/blog/?p=378 – US Federal Reserve Releases Transcripts from 2008 Meetings

f. http://www.goleancaribbean.com/blog/?p=353 – Book Review: ‘Wrong – Nine Economic Policy Disasters and What We Can Learn…’

g. http://www.goleancaribbean.com/blog/?p=235 – Post 2008 Tourism’s changing profile

The main lesson learned about the cause of the 2008 Great Recession is a poignant one: it spurned from a housing bubble.

Change has come to the Caribbean; the driver of this change is technology, globalization and climate change. From these 3 drivers, bubbles can easily inflate and deflate (burst). The Caribbean region must be astute to recognize the formation of such bubbles. Most importantly, we must apply technocratic skills to mitigate the risk of these bubbles and their eventual deflation.

The term “bubble,” in the financial context, generally refers to a situation in which the price of an asset exceeds its fundamental value by a large margin. During a bubble, prices for a financial asset or asset class are highly inflated, bearing little relation to the intrinsic value of the asset. The terms “asset price bubble,” “financial bubble” or “speculative bubble” are interchangeable, and are often shortened simply to “bubble.”

A basic characteristic of a bubble is the suspension of disbelief by most participants during the “bubble phase.” There is a failure to recognize that regular market participants and other forms of traders are engaged in a speculative exercise that is not supported by previous valuation techniques. Also, bubbles are usually identified only in retrospect, after the bubble has burst. Economist Hyman Minsky identified five stages in a typical credit cycle – displacement, boom, euphoria, profit taking and panic. Although there are various interpretations of the cycle, the general pattern of bubble activity remains fairly consistent.

1.       Displacement
A displacement occurs when investors get enamored by a new paradigm, such as an innovative new technology or interest rates that are historically low. A classic example of displacement is the decline in the federal funds rate from 6.5% in May, 2000, to 1% in June, 2003. Over this three-year period, the interest rate on 30-year fixed-rate mortgages fell by 2.5 percentage points to a historic lows of 5.21%, sowing the seeds for the housing bubble.

2.       Boom
Prices rise slowly at first, following a displacement, but then gain momentum as more and more participants enter the market, setting the stage for the boom phase. During this phase, the asset in question attracts widespread media coverage. Fear of missing out on what could be a once-in-a-lifetime opportunity spurs more speculation, drawing an increasing number of participants into the fold.

3.       Euphoria
During this phase, caution is thrown to the wind, as asset prices skyrocket. The “greater fool” theory plays out everywhere. Valuations reach extreme levels during this phase. For example, at the peak of the Japanese real estate bubble in 1989, land in Tokyo sold for as much as $139,000 per square foot, or more than 350-times the value of Manhattan property. After the bubble burst, real estate lost approximately 80% of its inflated value, while stock prices declined by 70%. Similarly, at the height of the internet bubble in March, 2000, the combined value of all technology stocks on the Nasdaq was higher than the GDP of most nations.

4.       Profit Taking
By this time, the smart money – heeding the warning signs – is generally selling out positions and taking profits. But estimating the exact time when a bubble is due to collapse can be a difficult exercise and extremely hazardous to one’s financial health because, as John Maynard Keynes put it, “the markets can stay irrational longer than you can stay solvent.” Note that it only takes a relatively minor event to prick a bubble, but once it is pricked, the bubble cannot “inflate” again.

5.       Panic
In the panic stage, asset prices reverse course and descend as rapidly as they had ascended. Investors and speculators, faced with margin calls and plunging values of their holdings, now want to liquidate them at any price. As supply overwhelms demand, asset prices slide sharply. One of the most vivid examples of global panic in financial markets occurred in October 2008, weeks after Lehman Brothers declared bankruptcy and Fannie Mae, Freddie Mac and AIG almost collapsed. The S&P 500 plunged almost 17% that month, its ninth-worst monthly performance. In that single month, global equity markets lost a staggering $9.3 trillion of 22% of their combined market capitalization.

Investopedia Online Investing Trade Journal (Retrieved June 12, 2014) http://www.investopedia.com/slide-show/5-steps-of-a-bubble/

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The Caribbean region felt the brunt of the Panic of this 2008/2009 crisis. See this news article posted on Jan 18, 2009 in USA Today, describing the full economic devastation with this title: “Caribbean islands slammed with double financial hit” – http://abcnews.go.com/Business/story?id=6677886&page=1&singlePage=true

For the Caribbean, the lessons of the above 5 Steps of a Bubble was not academic, it was real-life, affecting every man, woman and child. But still, bubbles continue to be impactful; in addition to housing market bubbles, the Caribbean must contend with post-hurricane recoveries.

The Go Lean book envisions the CU as a confederation of the 30 member-states of the Caribbean to do the heavy-lifting of empowering and elevating the Caribbean economy by creating a “single market” for the region. Many benefits are due to abound, but there must be caution not to create bubbles.

The book details the community ethos to adopt to monitor, manage and mitigate risks and the emergence of bubbles. The roadmap also details the executions of the following strategies, tactics, implementations and advocacies to guide progress in the region; (a bubble can result in “1 step forward but 2 steps backwards”):

Anecdote – Puerto Rico – The Greece of the Caribbean Page 18
Community Ethos – Consequences of Choices Lie in the Future Page 21
Community Ethos – Money Multiplier Page 22
Community Ethos – Lean Operations Page 24
Community Ethos – Return on Investments (ROI) Page 24
Community Ethos – Ways to Impact the Future Page 26
Community Ethos – Ways to Impact the Greater Good Page 37
Strategy – Agents of Change – Technology Page 57
Strategy – Agents of Change – Globalization Page 57
Strategy – Agents of Change – Climate Change Page 57
Tactical – Confederating a Non-Sovereign Union Page 63
Tactical – Fostering a Technocracy Page 64
Tactical – Growing Economy – Avoid Economic Bubbles Page 69
Tactical – Growing Economy – Trade and Globalization Page 70
Tactical – Separation of Powers – Central Bank Page 73
Tactical – Separation of Powers – Securities Regulatory Agency Page 74
Tactical – Separation of Powers – Housing and Urban Authority Page 83
Implementation – Ways to Deliver Page 109
Implementation – Ways to Better Manage Debt Page 114
Implementation – Ways to Benefit from Globalization Page 119
Planning – 10 Big Ideas Page 127
Advocacy – Ways to Grow the Economy Page 151
Advocacy – Ways to Control Inflation – Post Natural Disasters Page 153
Advocacy – Ways to Improve Housing Page 161
Advocacy – Ways to Improve for Natural Disasters Page 184
Advocacy – Ways to Foster Technology Page 197
Advocacy – Reforms for Banking Regulations Page 199
Advocacy – Ways to Impact Wall Street Page 200
Advocacy – Ways to Impact Main Street Page 201
Appendix – Controlling Inflation – Technical Details – Quick Recovery Page 320

Now is the time for all of the Caribbean, the people and governing institutions, to lean-in for the empowerments described in the book Go Lean … Caribbean. We start by understanding “bubbles”. While the 2008 Great Recession crisis originated as an American bubble, the rest of the world felt its devastating effects. This case-in-point sets the model for the CU to emulate for the Caribbean region; we need a resilient economy that can grow in “ripe” conditions, but avoid any bubble effects. Every year the region is threatened by tropical storms and hurricanes; the spending for recovery, repair and rebuilding can always create a bubble-effect. LB 4

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This has been the legacy in the past, but now the CU administration is proposed as “new guards” to shepherd the economy to avoid such pitfalls.

The CU/Go Lean roadmap is a complete solution for Caribbean elevation. Despite threats – natural disasters and economic bubbles – the region can be led to a better destination, a better place to live, work and play.

Download the book Go Lean … Caribbean – now!

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