Asset bubbles and the inevitable financial crises that follow are not a modern phenomenon, but have been around since at least Tulip Mania in 1624 – 1637. Interestingly enough, Mark Twain’s quip that “History does not repeat itself, but it does rhyme” equally applies to the various crises. The underlying causes can be generalised as unjustifiable increases in asset prices as a result of the expansion of relatively cheap credit, inflated asset prices, and the notion that this time it would all be different. The subsequent bubble is generally caused by the shifting balance of demand and supply and, more importantly, the instability of the supply of credit followed by panic selling of assets for which there are no buyers.

Price movements associated with asset bubbles are usually not directly related to the underlying value of the asset but at least for a considerable part due to the build up of investor demand. Investor decisions are not solely based on facts but are influenced by other elements such as herd behaviour, limitations of the human mind to deal with increased complexity, and the limited time available to reach an investment decision may result in irrational purchase and sale decisions which are not fully thought through. The responses of politicians tend to echo those of the general public, and are generally euphoric in times when prices are up. Comparing the two most significant crises in recent history, we see that in the immediate aftermath of the Stock Market Crash of 1929 some remarks were made about the foolishness of investors, but attention was later turned to resolving the issues underpinning the crisis and the implementation of a wide range of measures. In the wake of the banking crisis of 2008, the current state of mind is still largely one of apportioning blame, although this is likely to change as emotional responses will make way to more analytical reviews.

In both cases, additional regulation was devised and implemented, some likely to be more effective than others, and some will be reversed again over time. The Glass-Steagall Act of 1933, for example, was eventually repealed in 1999 and replaced by new legislation, significantly loosening the original requirements. The Securities and Exchange Acts of 1933 and 1934, on the other hand, have been amended over time, but are still largely in place. The current crisis has resulted in new legislation as well as the development of global regulations. Similar to the 1930s however, there is one thing the current regulations do not address which is how to regulate liquidity in the market. After all, as long as all is well, parties will be happy to lend to each other, only to withdraw all credit once the trust falls out of the market.

Dr Natalie Schoon, CFA