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Financial Bubbles, Real Estate bubbles, Derivative Bubbles, and the Financial and Economic Crisis

Author

Listed:
  • Didier SORNETTE

    (ETH Zurich and Swiss Finance Institute)

  • Ryan WOODARD

    (ETH Zurich)

Abstract

The financial crisis of 2008, which started with an initially well-defined epicenter focused on mortgage backed securities (MBS), has been cascading into a global economic recession, whose increasing severity and uncertain duration has led and is continuing to lead to massive losses and damage for billions of people. Heavy central bank interventions and government spending programs have been launched worldwide and especially in the USA and Europe, with the hope to unfreeze credit and boltster consumption. Here, we present evidence and articulate a general framework that allows one to diagnose the fundamental cause of the unfolding financial and economic crisis: the accumulation of several bubbles and their interplay andmutual reinforcement has led to an illusion of a “perpetual money machine” allowing financial institutions to extract wealth from an unsustainable artificial process. Taking stock of this diagnostic, we conclude that many of the interventions to address the so-called liquidity crisis and to encourage more consumption are ill-advised and even dangerous, given that precautionary reserves were not accumulated in the “good times” but that huge liabilities were. The most “interesting” present times constitute unique opportunities but also great challenges, for which we offer a few recommendations.

Suggested Citation

  • Didier SORNETTE & Ryan WOODARD, "undated". "Financial Bubbles, Real Estate bubbles, Derivative Bubbles, and the Financial and Economic Crisis," Swiss Finance Institute Research Paper Series 09-15, Swiss Finance Institute.
  • Handle: RePEc:chf:rpseri:rp0915
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    File URL: http://ssrn.com/abstract=1407608
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    Keywords

    Financial crisis; bubbles; real estate; derivatives; out-of-equilibrium; super-exponential growth; crashes; complex systems;

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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