Economists may be finally closing in on the reason for asset bubbles. How to pop them before they grow too large, however, is a much harder problem.
The study of bubbles has steadily gathered urgency during the past four decades as crashes became more spectacular and more damaging. The stock crash of 1987 was a wake-up call for those who had assumed that markets function efficiently; there was no obvious reason why rational investors would suddenly conclude that U.S. companies were worth 23% less than the day before. The tech bubble was even more troubling because many observers had warned of a bubble for years before the crash, to no avail. The same thing happened with the housing bubble, only when that one burst it took the real economy with it — as tends to happen when rapid asset-price declines are combined with high levels of debt.