Nov 10, 2008
Bubbles have two components: a trend that prevails in reality and a misconception relating to that trend. In real estate, the trend consists of an increased willingness to lend and a rise in prices. The misconception is that the value of the real estate is independent of the willingness to lend. That misconception encourages bankers to become more lax in their lending practices as prices rise and defaults on mortgage payments diminish. That is how real estate bubbles are born.

Markets that are prone to bubbles should be regulated. It is impossible to prevent bubbles from forming, but it should be possible to keep them within tolerable bounds. Regulators such as the Fed, the Treasury, and the SEC must accept responsibility for preventing bubbles from growing too big. So far they have explicitly rejected that responsibility.

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