Eric Janszen recently provided some very useful historical perspective in Harper's Magazine.
He begins by explaining exactly what a financial bubble is:
"A huge spike in asset prices that results from a perverse
self-reinforcing belief system, a fog that clouds the judgment of all but the
most aware participants in the market."
Asset hyperinflation starts at a certain stage of market development under just the right conditions.
The bubble is the result of that financial madness, accurately seen only when the fog of current events rolls away. It is a market aberration manufactured by government, finance, and industry -- a shared speculative hallucination and then a crash, followed by depression.
Bubbles were once very rare, says Janszen -- one every hundred years or so was enough to motivate politicians, bearing the post-bubble ire of their newly destitute citizenry, to enact legislation that would prevent subsequent occurrences. After the dust settled from the 1720 crash of the South Sea Bubble, for instance, British Parliament passed the Bubble Act to forbid "raising or pretending to raise a transferable stock." For a century this law did much to prevent the formation of new speculative swellings, i.e. bubbles.
Nowadays, however, we barely pause between such bouts of insanity. The dot-com crash of the early 2000s should have been followed by decades of soul-searching; instead, even before the old bubble had fully deflated, a new mania began to take hold on the foundation of our long-standing American faith that the wide expansion of home ownership can produce social harmony and national economic well-being. Spurred by the actions of the Federal Reserve, financed by exotic credit derivatives (a kind of insurance policy that transfers risk to someone other than the bank or other institution that extended the credit) and debt securitization, an already massive real estate sales-and-marketing program expanded to include the desperate issuance of mortgages to the poor and feckless, compounding their troubles and ours.
That the Internet and housing hyperinflations transpired within a period of ten years, each creating trillions of dollars in fake wealth, is, I believe, only the beginning. There will and must be many more such booms, for without them the economy of the United States can no longer function. In America, the bubble cycle has replaced the business cycle.
Such transformations do not take place overnight. After World War I, Wall Street wrote checks to finance new companies that were trying to turn wartime inventions, such as refrigeration and radio, into consumer products. The consumers of the rising middle class were ready to buy, but lacked funds -- so the banking system accommodated them with new forms of credit, notably the installment plan. Following a brief recession in 1921, federal policy accommodated progress by keeping interest rates below the rate of inflation. Too far below. Borrowing was rampant. People began borrowing heavily in order to buy stocks. Pundits hailed a "new era" of prosperity -- until Black Tuesday, October 29, 1929.
The crash, the Great Depression, and World War II were a brutal education for government, academia, corporate America, Wall Street, and the press.