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Irrational Fear and Irrational Exhuberance

A brief fairy tale

Once upon a time we had a stock market bubble. The wise old sage Alan Greenspan warned us that the demons of irrational exhuberance were fooling us into a false sense of optimism. Sadly, our leaders at the time had too much to be gained from the illusion of perpetual growth. There were taxes to be collected to pay down the budget deficit, and elections to be won.

Meanwhile, investment bankers made billions on tech IPOs. The champagne flowed and everyone partied like mad.

Eventually the bubbles in the champagne popped and everyone had a hangover. Fortunately, not the investment bankers, because they sold most of their stock to day traders, who were left holding a bunch of wothless paper, realizing they’d been had. Who then went bankrupt and had no jobs or assets left.

Then came the housing bubble. Everyone said that real estate prices, like crude oil, would never fall. It was only up. So the banks started lending money to people with no jobs or assets, assuming that those same people would sell those houses to other people without jobs or assets, at a higher price. Since this was such a safe investment, the banks transformed those mortgages into bonds and sold them to the investment bankers.

Eventually, the banks couldn’t find any other jobless asset-free people to sell $1,000,000 condos to. So people started defaulting on their mortgages. Housing prices collapsed, and investors realized that those mortgage-backed securities weren’t worth what they thought. They started dumping them like crazy at a loss.

In the end, a bunch of investment bankers were left standing around holding a bunch of worthless paper, realizing that they’d been had. So they started screaming about the irrational fear that was sweeping the market and unfairly driving prices down. Market failure, they claimed. And they proceeded to ban short selling. It’s selling that drives prices down. From now on, buying only.

Thanks for listening. The moral of this story is that irrational exhuberance and irrational fear are just flip sides of the same coin. The only difference is that in this case, the people getting burned are more politically connected. They have bigger megaphones and can scream louder about the end of the world. Neither should be bailed out.

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