A lengthy but very interesting read...

Here's a very intersting anecdote that describes how an "asset bubble"
builds up and what are its consequences.

Read it even if it confuses you a bit...things will be clear as you reach the end....

ANCEDOTE -

Once there was a little island country. The land of this country was the
tiny island itself. The total money in circulation was 2 dollar as there
were only two pieces of 1 dollar coins circulating around.

1) There were 3 citizens living on this island country. A owned the land. B
and C each owned 1 dollar.

2) B decided to purchase the land from A for 1 dollar. So, A and C now each
own 1 dollar while B owned a piece of land that is worth 1 dollar.


The net asset of the country = 3 dollar.

3) C thought that since there is only one piece of land in the country and
land is non produceable asset, its value must definitely go up. So, he
borrowed 1 dollar from A and together with his own 1 dollar, he bought the
land from B for 2 dollar.

A has a loan to C of 1 dollar, so his net asset is 1 dollar.

B sold his land and got 2 dollar, so his net asset is 2 dollar.

C owned the piece of land worth 2 dollar but with his 1 dollar debt to A,
his net asset is 1 dollar.

The net asset of the country = 4 dollar.

4) A saw that the land he once owned has risen in value. He regretted
selling it. Luckily, he has a 1 dollar loan to C. He then borrowed 2 dollar
from B and and acquired the land back from C for 3 dollar. The payment is by
2 dollar cash (which he borrowed) and cancellation of the 1 dollar loan to
C.
As a result, A now owned a piece of land that is worth 3 dollar. But since
he owed B 2 dollar, his net asset is 1 dollar.

B loaned 2 dollar to A. So his net asset is 2 dollar.

C now has the 2 coins. His net asset is also 2 dollar.

The net asset of the country = 5 dollar. A bubble is building up.

(5) B saw that the value of land kept rising. He also wanted to own the
land. So he bought the land from A for 4 dollar. The payment is by borrowing
2 dollar from C and cancellation of his 2 dollar loan to A.

As a result, A has got his debt cleared and he got the 2 coins. His net
asset is 2 dollar.

B owned a piece of land that is worth 4 dollar but since he has a debt of 2
dollar with C, his net Asset is 2 dollar.

C loaned 2 dollar to B, so his net asset is 2 dollar.

The net asset of the country = 6 dollar. Even though, the country has only
one piece of land and 2 Dollar in circulation.


(6) Everybody has made money and everybody felt happy and prosperous.

(7) One day an evil wind blowed. An evil thought came to C's mind. "Hey,
what if the land price stop going up, how could B repay my loan. There is
only 2 dollar in circulation, I think after all the land that B owns is
worth at most 1 dollar only."

A also thought the same.

(8) Nobody wanted to buy land anymore. In the end, A owns the 2 dollar
coins, his net asset is 2 dollar. B owed C 2 dollar and the land he owned
which he thought worth 4 dollar is now 1 dollar. His net asset become -1
dollar.

C has a loan of 2 dollar to B. But it is a bad debt. Although his net asset
is still 2 dollar, his Heart is palpitating.

The net asset of the country = 3 dollar again.

Who has stolen the 3 dollar from the country ?
Of course, before the bubble burst B thought his land worth 4 dollar.
Actually, right before the collapse, the net asset of the country was 6
dollar in paper. his net asset is still 2 dollar, his heart is palpitating.

The net asset of the country = 3 dollar again.

(9) B had no choice but to declare bankruptcy. C as to relinquish his 2
dollar bad debt to B but in return he acquired the land which is worth 1
dollar now.

A owns the 2 coins, his net asset is 2 dollar. B is bankrupt, his net asset
is 0 dollar. ( B lost everything ) C got no choice but end up with a land
worth only 1 dollar (C lost one dollar) The net asset of the country = 3
dollar.

************ ****End of the story******* ********* ********* **

There is however a redistribution of wealth.

A is the winner, B is the loser, C is lucky that he is spared.

A few points worth noting -

(1) When a bubble is building up, the debt of individual in a country to one
another is also building up.

(2) This story of the island is a close system whereby there is no other
country and hence no foreign debt. The worth of the asset can only be
calculated using the island's own currency. Hence, there is no net loss.

(3) An overdamped system is assumed when the bubble burst, meaning the
land's value did not go down to below 1 dollar.

(4) When the bubble burst, the fellow with cash is the winner. The fellows
having the land or extending loan to others are the loser. The asset could
shrink or in worst case, they go bankrupt.

(5) If there is another citizen D either holding a dollar or another piece
of land but refrain to take part in the game. At the end of the day, he will
neither win nor lose. But he will see the value of his money or land go up
and down like a see saw.

(6) When the bubble was in the growing phase, everybody made money.

(7) If you are smart and know that you are living in a growing bubble, it is
worthwhile to borrow money (like A ) and take part in the game. But you must
know when you should change everything back to cash.

(8) Instead of land, the above applies to stocks as well.

(9) The actual worth of land or stocks depend largely on psychology.


Hiren

WHERE DID THE U.S. HOUSING BUBBLE COME FROM?:

It did not fall from the sky!.

In actuality, the American housing bubble is the crisis of the "new economy",

1)The bursting of the stock exchange bubble of the year 2000 or as we call the technology bubble, which involved, as one could expect, a particularly severe fall in investment by companies and a rapid rise in lay-offs.
But the recession did not turn into a real depression, thanks to spending by households. Enormous means were employed to achieve this. The first was an extraordinary fall in the lending rate of the American central bank.

2) A rate that was in a very short space of time brought down from 6 per cent to one per cent. Then prolonging this low rate structure to a sufficiently long period by forwarding it into the housing market and then bringing the interest rates back up to balance the stock markets and the bond markets, trying to balance the flight of funds. When the loans and the mortgages came up for renewal people noted a huge rise in payments, a gap that the Feds knew was coming but did not know how to accommodate the same for the people who bought the houses and the lenders of the housing market. This was under way for a long time in the United States, when the credit tap was turned on to the maximum, which largely facilitated mortgage credit and launched the housing bubble.

3) the cure became worse than the decease: The medicine used to nurse the stock exchange bubble became the drug of the housing bubble: they got out of one bubble only to fall into the next one, Having gotten into the newer one, the rate of indebtedness of American households shot up from 107 per cent in 2001 to 140 per cent in 2006, opening the way to the crisis of over-indebtedness which we can observe today. Can a ordinary citizen shore up the burden of such a sharp increase?

All of these are coming to haunt the U.S. Financial markets and then the housing markets, the Banking industry, the retail and the consumer industry. And if it stops there then, the Government can plan a course of action to correct this. While all of this is still yet to be contemplated and corrected, there are other factions in the world politics that are depleting the very scarce resources by their support of a war that they had no need to start and the cost of the energy which we find we are unable to support and the flight of the land usage from commodities that we use for our daily food to Corn and Ethanol production.

Did we build 'A' Bubble and then we burst it OR we keep on building bubbles and then try and burst them one at a time??!!

What I find is: "That is the price we pay for placing very highly educated people in a very powerful place. A very ordinary citizen gets taken for a bumpy roller coaster ride in this world", and what choice do we have?

I for one want to scream " Stop this world and I want to get off". But who is listening?

Freddie.