Boom and Bust

Quinn and Turner, both financial historians at Queen's University Belfast, examined bubbles across three centuries and proposed a framework for understanding when they occur.

Their framework is the bubble triangle, drawn from the fire triangle. Three conditions must be present. Marketability means the ease with which an asset can be bought and sold, which includes the existence of exchanges, low denominations, the removal of transfer restrictions and the availability of the asset to new buyers. Money and credit means abundant capital seeking returns and, particularly, the availability of borrowing to buy the asset. Speculation means a substantial number of participants buying to resell rather than to hold. All three must be present, and then a spark ignites them, which the authors identify as either technological innovation or government policy.

The case studies run from the South Sea and Mississippi episodes of 1720, through the British railway mania of the 1840s, the Australian land boom, the 1920s American market, the Japanese bubble, the dot-com episode, the subprime housing bubble, and the Chinese equity episodes of 2007 and 2015. In each they identify the three components and the spark, and they document how marketability was increased in each case, frequently by a deliberate change in rules.

Their most useful analytical contribution is on consequences. They argue that bubbles differ substantially in their aftermath, and that the damage depends on whether the asset was bought with borrowed money and on whether banks were exposed. Bubbles in assets bought with equity, including the dot-com episode, produced comparatively little economic damage; bubbles financed by bank credit, including the housing bubbles, produced severe damage.

They also argue that some bubbles are socially useful, since the railway mania left a railway network and the technology bubbles left infrastructure.

The framework is descriptive rather than predictive, since the three conditions are frequently present without a bubble following. The historical work is solid and the leverage distinction is the practically important finding.