One of the causes of the recent financial meltdown was a bubble in the value of housing assets that emerged over a number of years. Some people saw this while it was happening, but could do little to impact things. When the bubble burst, institutions and individuals suffered tremendous damage that is still hurting people today.
An important question is this: can asset bubbles be spotted earlier, and, if so, can measures be taken that can minimize the impact of these bubbles? Sendhil Mullainathan of Harvard Business School thinks to the answers to both questions is yes. In one of the 10 Breakthrough Ideas discussed in the current issue of Harvard Business Review, Mullainathan postulates that, as structural engineers can design buildings to withstand much of the force of earthquakes, a well-designed system can help absorb and dampen the negative effects of asset bubbles.
He proposes an “early warning system” composed of a committee that could look at markets and see when contrarian views are underrepresented (according to Mullainathan, this happens often during bubbles – investors betting against the prevailing views are eventually chased from the market as prices rise inexorably). By publicizing this situation, and even, perhaps, placing counter bets, the early warning committee can help dampen prices and keep bubbles from overinflating.
I have a lot of questions on this approach – for one, wouldn’t investors create political pressure for such a public group betting against price rises? But, nonetheless, Mullainathan’s proposal deserves careful study. Because anyone who’s lived through this last bubble (John Paulson excepted) doesn’t want to relive it.
(Photo by Viking_79 via Flickr creative commons)
If you’d like to make yourself nervous, you need to peruse this photo essay from 
