Paper: CCSS-09-003

Title: Financial Bubbles, Real Estate bubbles, Derivative Bubbles, and the Financial and Economic Crisis

Authors: D. Sornette*, R. Woodard

Abstract:

The financial crisis of 2008, which started with an initially well-defined epicenter focused on mortgage backed securities (MBS), has been cascading into a global economic recession, whose increasing severity and uncertain duration has led and is continuing to lead to massive losses and damage for billions of people. Heavy central bank interventions and government spending programs have been launched worldwide and especially in the USA and Europe, with the hope to unfreeze credit and boltster consumption. Here, we present evidence and articulate a general framework that allows one to diagnose the fundamental cause of the unfolding financial and economic crisis: the accumulation of several bubbles and their interplay and mutual reinforcement has led to an illusion of a ``perpetual money machine'' allowing financial institutions to extract wealth from an unsustainable artificial process. Taking stock of this diagnostic, we conclude that many of the interventions to address the so-called liquidity crisis and to encourage more consumption are ill-advised and even dangerous, given that precautionary reserves were not accumulated in the ``good times'' but that huge liabilities were. The most ``interesting'' present times constitute unique opportunities but also great challenges, for which we offer a few recommendations.

Keywords: Financial crisis , bubbles , real estate bubble , derivatives , super-exponential

Manuscript status: Accepted

Reference: Proceedings of APFA7 (Applications of Physics in Financial Analysis), Conference series entitled Applications of Physics in Financial Analysis focuses on the analysis of large-scale Economic data, organized by Misako Takayasu and Tsutomu Watanabe

JEL codes: G01, G17, O16
PACS numbers:

Local copy of the paper: CCSS-09-003.pdf

Submission date: 02-05-2009