Interesting read on economic bubbles.

I walked to Powell's Books on W. Burnside this afternoon, to take a look at a book that I had my eye on for the past week or so, "All About Technical Analysis".  My curiousity to learn about technical analysis stems from my observation of the volatility of the equity markets, and the seemingly positive move of the Dow Jones Industrials into the 9000 territory. If you were to strictly go by the economic news that trickled out between the end of the 3rd quarter last year through this quarter, it would seem odd to the average Joe that the market would surge so high.  Why, after all, wouldn't the market just simply sink into record-low territory and stay there, since for all intents and purposes, the economic news hasn't gotten better?

Well, to make a long story shorter (not short), I skipped around to a latter chapter in the book that talked about bubbles, and I thought it was too interesting to pass up writing about.  Specifically, the author points to three indicators of a bubble forming:

1. Potential future earnings is viewed as more important (less risk) than past performance.
2. Banks begin to follow this method of risk assessment, and pour money into these investments.
3. The media catches on and begins to exclaim how Average Joe is missing out on the earnings, causing the general pubic to follow suit.

We can most certainly see how this pertains to the housing bubble.  We have ratings agencies (S&P) marking derivatives higher than they should be, looking at how the rise in housing values means that future potential growth outweighs the data showing a starkly different probability.  Then we have banks (and Freddie Mac/Fannie Mae) rushing in to get in on the action, especially smaller banks that aren't able to get a piece of the bigger construction loan pie.  Then finally, we have the general public rushing in to try to cash in on the growth of the housing prices, as witnessed by the flipping of properties and the rush of people into real-estate investment.

So what?

Well, the most fascinating part of the story is how the author suggests the economy is finally rescued: By way of small businesses.  Not all small businesses will reap the gains of the recovery, but in fact, only those that are positioned to best utilize the now-cheap assets of the losers of the bubble.

That's why I just had to write this down...it's too delicious not to write it down!  It all makes perfect sense, and it just takes a good, analytical review of the players to understand who will and who won't best recover from this downtrodden economy.  I'm not about to let everyone in on the secret, as I think people need to do their own research and come to their own conclusions, but I am quite certain of who the winners will be, contrary to what Wall Street thinks.  :)