"A Bubble Mystery"

Barkley Rosser has a post that elaborates on comments he made here to Should We Pop Bubbles?, but first some background. This is from last July:

Gradual Decline before the Crash?: Barkley Rosser says the period after the peak of a speculative bubble can often be broken into two periods, the first characterized by a gradual decline, i.e. a period of "financial distress," and a second where there is a massive panic and crash. He also says he has a model that can explain how this happens...:

Falling from the Period of Financial Distress into the Panic and Crash, by Barkley Rosser: In 1972, Hyman Minsky described the "period of financial distress," in a paper in a journal that no longer exists..., "Financial Instability: The Economics of Disaster." Charles P. Kindleberger picked up on this and followed Minsky's analysis in his famous book, Manias, Panics, and Crashes: A History of Financial Crises, the 4th edn of which appeared in 2000... The period of financial distress is a gradual decline after the peak of a speculative bubble that precedes the final and massive panic and crash, driven by the insiders having exited but the sucker outsiders hanging on hoping for a revival, but finally giving up in the final collapse. According to Appendix B of Kindleberger's 2000 edition, 37 of the 47 great historical speculative bubbles exhibited such a period before the final crash, even though all the theoretical models predict a crash immediately following the peak with no such period.

In 1991 I published the first mathematical model of such a phenomenon in my book From Catastrophe to Chaos: A General Theory of Economic Discontinuities_(Kluwer, Chap. 5)..., although nobody seems to have noticed... In 1997, I published a paper describing this model (and related matters)... This paper has never been cited. More recently I have coauthored a paper that ...[is] now under a long revise and resubmit, still waiting for an answer ... with Mauro Gallegati and Antonio Palestrini, "The Period of Financial Distress in Speculative Markets: Interacting Heterogeneous Agents and Financial Constraints" (available at my website), that lays all this out in much more up-to-date mathematical modeling.

So, why am I boring all of you with this self-citation? Well, Dean Baker is constantly claiming credit for his forecasts of doom and gloom. It looks like we might be finally reaching the big crash in the US mortgage market after a period of distress that started last August (if not earlier). I and my coauthors are the only people to have provided actually formal models of this phenomenon, beyond the verbal and historical discussions provided by the brilliant Minsky and Kindleberger (both of whom I knew...). I have been forecasting this in unpublished lectures all over the globe for years, but never have put it up into the blogosphere. So, I am claiming credit, to the extent it is due, although the basic ideas were clearly laid out earlier by Minsky and Kindleberger. ...

Here's the follow-up:

Update on the Period of Financial Distress and a Bubble Mystery, by Barkley Rosser: Nearly a year ago (7/12/08) I posted here on "Falling from the Period of Financial Distress into Panic and Crash" In that I noted my own work on this concept, which Charles Kindleberger claimed in his Manias, Panics, and Crashes has been the most common pattern of speculative bubbles and crashes (37 out of 47 bubbles listed in Appendix B of his 2000 4th edition). What is involved is for there to be a gradual decline in prices initially after the peak of a bubble, with the crash coming sometime later. The paper I cited then on this by Mauro Gallegati, Antonio Palestrini, and me ... has now been accepted for publication and is forthcoming in Macroeconomic Dynamics.

The three patterns that Kindleberger, drawing on the work of Hyman Minsky, argued we have generally seen are ones with such a period of distress as described above, ones that go up to a peak and then crash hard (which are what most theoretical models of crashes predict), and ones that go up to a peak and then decline gradually without a crash, but usually a bit faster than they went up. In the last few years I would argue we have seen all three patterns. The peak-followed-by-crash pattern looks like the oil market last year, which hit $147 per barrel last July only to fall hard to $32 per barrel by November. The more or less symmetric up-then-down-without a crash pattern looks like the US housing market, which, according to the Case-Shiller index, began rising in 1998, peaked in mid-2006, and has been going down since about the way it went up, with quite a ways to go.

Last year I had it in my mind that the global financial derivatives market smelled like a period of financial distress pattern, and now I think that it was indeed. The peak was in August 2007, when the problems in those markets first began to appear. The crash was the dramatic "Minsky moment" in mid-September 2008.

Which brings me to a fourth pattern that is somewhat mysterious, a variation on the pattern that does not have a crash. Whereas most such bubbles go down more rapidly than they went up, and some go down at about the same rate, there is one that has gone down at a much slower rate, indeed may still be in its decline. I am referring to housing in Japan. A graph of the pattern up to 2005 can be seen here. Around 2006 there was a brief cessation of the decline, but it has since resumed. In any case, that figure shows that the index rose in three years from 150 to its peak around 200, but took ten years thereafter to get back to 150, and it took 15 years from the peak in 1991 to get back down to the level it was in 1986, a clear asymmetry in the direction of going up much faster than it has gone down.

Now, according to private communication from Kindlebeger to me, this is the only major bubble in world history to exhibit such a pattern, and why it has done so remains a mystery. I saw a paper (still unpublished) some years ago that argued that it was Japanese banks manipulating the real estate market to keep the value of their most important collateral from declining too rapidly in the face of broader financial pressure that have been behind this pattern, but I have not seen that confirmed. That would suggest that the pattern has had deep implications for the broader Japanese economy. In any case, this curious decline in Japan remains a mystery (and some say that US housing prices could go down for a much longer time than many think, pointing to this strange case), but it may ultimately have to do with the Japanese wishing to preserve their broader economic system in the face of pressures to more deeply transform it.