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

Proceedings of APFA7 (Applications of Physics in Financial Analysis), Conference

CCSS Working Paper No. CCSS-09-003

53 Pages Posted: 27 Apr 2010

See all articles by Didier Sornette

Didier Sornette

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC); Swiss Finance Institute

Ryan Woodard

ETH Zurich

Multiple version iconThere are 2 versions of this paper

Date Written: May 2, 2009

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 and mutual 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.

Keywords: Financial crisis, bubbles, real estate bubble, derivatives, super-exponential

JEL Classification: G01, G17, O16

Suggested Citation

Sornette, Didier and Woodard, Ryan, Financial Bubbles, Real Estate Bubbles, Derivative Bubbles, and the Financial and Economic Crisis (May 2, 2009). Proceedings of APFA7 (Applications of Physics in Financial Analysis), Conference . Available at SSRN: https://ssrn.com/abstract=1596024 or http://dx.doi.org/10.2139/ssrn.1596024

Didier Sornette (Contact Author)

ETH Zürich - Department of Management, Technology, and Economics (D-MTEC) ( email )

Scheuchzerstrasse 7
Zurich, ZURICH CH-8092
Switzerland
41446328917 (Phone)
41446321914 (Fax)

HOME PAGE: http://www.er.ethz.ch/

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Ryan Woodard

ETH Zurich ( email )

Department of Management, Technology and Economics
Kreuzplatz 5
8032 Zurich, CH-1015
Switzerland
+41 44 632 83 79 (Phone)
+41 44 632 19 14 (Fax)

HOME PAGE: http://www.er.ethz.ch/

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