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Posted: April 27, 2009

Bursting bubbles

After tech stocks and housing, what’s next?

Mike Cote

A few things are certain in life: death, taxes and financial bubbles, be they tech stocks, subprime mortgages or beanie babies.

A panel that convened in Denver on Monday as part of the annual convention of the Society of American Business Writers and Editors pondered how to look for the next financial bubble and who to blame for the one that fueled the biggest financial meltdown since the Great Depression.

Up until the 1990s, housing prices roughly kept pace with inflation for a hundred years. So it shouldn’t have been difficult to determine that something was amiss when they radically diverged from that trend, said Dean Baker, co-director of the Center for Economic Policy and Research.

“That should really raised some alarm bells,” said Baker, who noted that apartment owners facing high vacancy rates converted them to condos, which were selling briskly, another sign that there was a problem with the fundamentals.

Baker blamed the media for failing to adequately warn investors, and also said former Federal Reserve Chairman Alan Greenspan should have seen it coming.

Not that anyone would have paid much attention. Panelists noted that those who warned about potential disaster from subprime mortgages and derivatives faced ridicule.

“Within any bubble there are always a few wise sages who warn that the bubbles exist,” but they are always drowned out, said Kevin Blakely, president and CEO of Risk Management Association.

“True bubbles are driven by the herd. It takes the momentum of the group to sustain them,” Blakely said. “Bubbles are very similar to Ponzi schemes. The only difference is one is legal and one is not.”

Blakely also noted that financial memories are very short and alluded to the “rule of 38s,” that anyone who is 38 or younger has never experienced a serious financial downturn.

Like Baker, Blakely said the fundamentals should have been clear: “Most everything usually reverts back to the norm. If something’s value extends far beyond its norm, you should be worried about it.”

There’s no way to prevent bubbles from happening, Blakely said, but there are ways to mitigate them, saying financial institutions and regulators need to pay better attention.

He alluded to the green energy industry, citing “the environment,” as one potential bubble.

Lynn Turner, former chief accountant for the Securities and Exchange Commission, said one clue to the impending collapse was when people earning “ninja levels” – no income, no jobs, no assets – were qualifying for homes. And data showed they were almost immediately going into default.

“Investors get in this notion of suspended disbelief and start ignoring the basic fundamentals,” Turner said.

Business journalists get carried away with writing about stars, he said, comparing them to Washington press corps afraid to alienate their sources.

“When you make your source more important than your news story, you’re doing a disservice to the public,” Turner said.

Allan Sloan, senior editor-at-large for Fortune magazine, said there are a couple of phrases that should sound alarm bells for journalists: “This time it’s different” and “You don’t understand.”

“You need to be awake. You need to be alert,” said Sloan, adding that it comes down to common sense.

“All you need is a three-function calculator. You don’t need spreadsheets. You don’t need a regression analysis. Nobody reads that crap anyway,” he said.

Sloan said he’s been writing for several years now that the biggest current bubble is with treasury securities, and joked that he hasn’t been right about it yet.

“There is the illusion of safety. The Treasury and Fed are moving Heaven and Earth to drive down treasury rates,” he said, as the government tries to keep mortgage rates down.

I’m not saying they’re wrong to do this, but you have to recognize what they’re doing … The United States cannot keep selling its dollars to the world to get out of its own problem.

Moderator Al Lewis, columnist for Dow Jones Newswires, cited the network capacity swaps in the late ’90s that telecom companies like Denver-based Qwest Communications and Broomfield-based Level 3 Communications booked as revenue to demonstrate growth to investors as an example of a noted local financial bubble.

But his favorite bubble: Beanie Babies.

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Mike Cote is the former editor of ColoradoBiz. E-mail him at mcote@cobizmag.com.

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