Bubbles, Busts, and Blame

37 Cornell Law Forum 14 (2011)

Cornell Legal Studies Research Paper No. 11-09

6 Pages Posted: 10 Apr 2011 Last revised: 4 Apr 2013

Date Written: April 8, 2011

Abstract

I argue that financial asset price bubbles and busts, such as those we have recently experienced in the mortgage and securities markets, are compatible with market efficiency, individual rationality, and even ethically unobjectionable behavior. The reason is that they constitute classic recursively self-amplifying collective action problems, the hallmark of which is the efficient aggregation of individually rational behaviors into collectively calamitous outcomes. In the present case, individuals rationally "legged the spread" between cheap borrowing costs and credit-fueled capital gains rates, neither of which market actors could affect in their individual capacities even when knowing that credit would have eventually to run out at some indefinite point in future. The upshot was a continuous series of self-reinforcing credit-fueled asset price rises, followed by a symmetrical series of hoarding-induced asset price drops once credit was exhausted. It is important to emphasize the rationality- and efficiency-compatability side of this story because prescribing a proper cure to our ills presupposes a proper diagnosis. The solution to a collective action problem, of course, is a collective agent. In the present context, that is a macroprudential financial regulator cognizant of her requisite role in tightening credit-money supplies when positive feedback loops emerge in asset markets.

Keywords: Bubbles, markets, credit, borrowing, rates

Suggested Citation

Hockett, Robert C., Bubbles, Busts, and Blame (April 8, 2011). 37 Cornell Law Forum 14 (2011); Cornell Legal Studies Research Paper No. 11-09. Available at SSRN: https://ssrn.com/abstract=1805930 or http://dx.doi.org/10.2139/ssrn.1805930

Robert C. Hockett (Contact Author)

Cornell University - Law School ( email )

Myron Taylor Hall
Cornell University
Ithaca, NY 14853-4901
United States

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