The Ideas Factory: So, bubbles anyone?

The Ideas Factory: So, bubbles anyone?: What causes a bubble? And by bubble I mean a financial one. One of my favorite books, Manias and Panics (and some other word, I can’t rem...

So, bubbles anyone?

What causes a bubble? And by bubble I mean a financial one. One of my favorite books, Manias and Panics (and some other word, I can’t remember what it was) by Charles Kindleberger, an Economic historian at MIT said that perhaps when newer technologies come around, there is a tendency to end overpricing newer assets, as nobody knows what the inherent value is. When the South Sea company trading at the London Stock Exchange ended up falling from a massive cliff, it was because the concept of stock trading was somewhat new. Similarly a bubble occurred when new tech companies came along. Setting aside new economy BS going around that time, it could be seen that people and media hyped in a romantic sense what the changing technology could bring about. With housing I am not really that sure. And in any case Kindleberger didn’t stay alive to see the bursting of this bubble. So can’t really a deadman what his opinion was (would be?) about the housing bubble.

The key thing though is that bubbles do end up occurring in a common occurrence. Just take a look at the current shale boom happening. It is a bubble. Oil companies involved with it are issuing rosy guidance for the future, while under stressing the fact that the yield of a horizontal oil well keeps goes down by 40% - 50%; bottom line? They just have to keep drilling more and more and more just to breakeven. And guess what? Shale oil is spread out over miles of land. So it is more of a hit and trial game. Yeah right, the US is going to achieve the 18.5 millions of barrels in a self-sufficient manner.

I am an economics student in training, but the more I think about bubbles (it is amongst my favorite areas of topic) the more obvious one fact becomes- for a bubble to even exist, almost everyone has to believe in the story itself. I mean, think about it; an economy depends on what all of its constituents are thinking and believing in the first place. The people who kept believing the housing market would forever keep going more were the ones who were pushing the prices upwards. Sure, you had cheap credit available. But you wouldn’t have taken the credit in the first place if you didn’t want to buy a house in the first place. And this is why a bubble is similar to a spiral; it is sustained by people believing the story. Not enough people believed the house prices would start to collapse in the first place, that’s why you didn’t have any selling which would have kept the house prices somewhat stable. And I think that’s the key for a bubble to exist. We all like to believe that the economy is always impacted by “some other suckers”, but the truth is that you’re part of it. And collective behavior impacts the economy. The government issues guidelines but the buying and selling is done by us. And by us I mean you, me, my roommate. And when something ends up being believed in by pretty much everyone, of course you’re going to have a “bubble”.

That’s one of the reasons I somewhat find it hard to believe that the stock market is in a bubble. The mere fact that so many people are talking about it, somewhat hints that there isn’t one.

But there is one in oil and gas. And I am going shopping once it bursts. After all I missed my would-be Christmas in 2008.

The Not So Mysterious World of Money

Before anything, let's make one thing clear, I love finance. I guess it's an offshoot to my natural love for economics. That being clear let's get on. 

What the hell is finance? Most of the people think Wall Street was full of geniuses who knew how make money from nothing. Of course this definition changed after 2008 (but the Street still attracts people from all over, Goldman Sachs' COO said the bank receives 21000 applications for its internships). People still think somehow that world of finance is alien to them. It is only natural to think of something like that when you don't have a clue as to what the hell is going on. Similar to how people think MIT students can literally fix anything from a rocket to an iPod (http://mitadmissions.org/blogs/entry/mit_brings_you_unwanted_attent)

But it shouldn't be so. Finance and money are some of the most intuitive things I have ever come across. It's just that some fancy name keeps people from naturally guessing what's going on. And by finance I am not referring to those things that only people from MIT can understand like derivatives (they are still easy, but not so intuitive). What's a long position, short position, futures, P/E, Price to book et cetera. All these are some of the most intuitive things you'll ever come across. And help you realize finance wasn't and isn't some voodoo magic that only people in Wall sTREET control over or something. 

Okay, what the hell is a long position. 

Its the single most common strategy people use to make money off the stock market anywhere in the world. It means you are buying some stocks and holding on to them and hoping to sell them when the stock price goes up. When someone says I am long on XYZ, it simply means they have a bought a certain stock and are hoping that the price will go up so that they can make some money. 

Now what's a short position? It's literally the opposite to long position. Now let's say that in 2008 Lehman Brothers was going to fall. And being the heartless bastard you are, you wanted to make money off it. It turns out many of us are heartless and have invented a strategy to make money off even when the price of something falls. The way it works it simple. You borrow, say 1000 shares of Lehman at a price of $100 per share. You borrow and not buy. Right after borrowing it, you immediately sell the 1000 shares on the market for a total of $1,000,000 (1000*$100=$1,000,000). And then Lehman goes bankrupt and suddenly the price of one share is $10. At this time you buy 1000 shares at the price of $10, which is a total of $100,000. You return the 1000 shares you had borrowed and you sit on a cool profit of $900,000. You have no obligation apart from returning the shares, as you hadn't taken any loan, taken any money or anything. All you did is borrow shares and you gave those shares back. You sold the shares for 1,000,000 and you paid the 100,000 out of this and the rest of the money was pure profit. Doesn't sound that difficult, right?

This is what attracts me the most to finance, business, and the related fields; it's all so intuitive that it's literally no less than you going "OMG that perfectly makes sense!". 

I'll try covering more of these topics in future posts. If you're interested in knowing more about any concept, feel free to drop a comment and pass along the URL to this blog. 

People, Ideas, Creativity et cetera

So what's this blog about. 

Pretty much evident from the title, this is a directory of all the ideas I have, be it from imagining how certain things can be made better, or what kind of new things can be developed. 

A little bit of info on my background. I am currently an undergrad with Economics, Maths and Computer Science as my majors. And no, before you think I am mentally dysfunctional, or have impaired social life, let me make it clear, I don't hate my life that I am punishing it by triple majoring. I really enjoy what I am studying, especially computer science, since its a relatively new subject to me. My posts are going to be ranging from finance, economics, philanthropy, to having new kinds of programs that evolve themselves and how these digital organisms can be modified and used to aid us. 

That being said, let's get it on.