Irrational Exuberance

Synopsis

Why the irrational exuberance of investors hasn't disappeared since the financial crisis

In this revised, updated, and expanded edition of his New York Times bestseller, Nobel Prize-winning economist Robert Shiller, who warned of both the tech and housing bubbles, cautions that signs of irrational exuberance among investors have only increased since the 2008-9 financial crisis. With high stock and bond prices and the rising cost of housing, the post-subprime boom may well turn out to be another illustration of Shiller's influential argument that psychologically driven volatility is an inherent characteristic of all asset markets. In other words, Irrational Exuberance is as relevant as ever. Previous editions covered the stock and housing markets-and famously predicted their crashes. This edition expands its coverage to include the bond market, so that the book now addresses all of the major investment markets. It also includes updated data throughout, as well as Shiller's 2013 Nobel Prize lecture, which places the book in broader context. In addition to diagnosing the causes of asset bubbles, Irrational Exuberance recommends urgent policy changes to lessen their likelihood and severity-and suggests ways that individuals can decrease their risk before the next bubble bursts. No one whose future depends on a retirement account, a house, or other investments can afford not to read this book.

Summary

Chapter 1: The Seven Signs of Exuberance

* Signs of excessive optimism and irrational behavior in the stock market include: extraordinary popular interest, new era thinking, dangerously low interest rates, comfortable liquidity, overconfidence, exponential frenzy, and a fractured market.
* Example: In the 1920s, the "Florida land boom" exemplified these signs, with rampant speculation driven by low interest rates and a perception that real estate prices would continue to rise indefinitely.

Chapter 2: The Bubbles in History

* Historically, financial bubbles have been common, dating back to the Dutch tulip bulb mania in the 17th century.
* Example: The Japanese equity market bubble of the 1980s involved extreme speculation and irrational valuations, leading to a dramatic market crash in 1990.

Chapter 3: The Dot-Com Bubble

* The dot-com bubble of the late 1990s was characterized by excessive investment in internet-related companies, often with little regard for earnings or profitability.
* Example: During the height of the bubble in early 2000, the internet retailer Pets.com had a market capitalization exceeding $250 million despite never turning a profit.

Chapter 4: The Greenspan Conundrum

* Federal Reserve Chairman Alan Greenspan was widely praised for his handling of the economy in the 1990s, but his policies also contributed to the dot-com bubble.
* Example: Greenspan's decision to keep interest rates low during the late 1990s provided ample liquidity that fueled speculative investment.

Chapter 5: The Real World Consequences

* Financial bubbles can have devastating economic consequences, including job losses, bankruptcies, and recessions.
* Example: The collapse of the dot-com bubble in 2000 led to significant losses for investors and companies, and contributed to the U.S. recession of early 2001.

Chapter 6: Reversing the Tide

* Dealing with financial bubbles requires a concerted effort by central banks, regulators, and investors.
* Example: In 2000, the Federal Reserve raised interest rates aggressively in an attempt to curb speculation and prevent a further escalation of the dot-com bubble.

Chapter 7: The Lessons of History

* Past financial bubbles provide valuable lessons for understanding how to identify and prevent future excesses.
* Example: The historical pattern of bubbles suggests that periods of irrational exuberance are inevitably followed by periods of correction and market decline.

Chapter 8: The Future of Exuberance

* While financial bubbles are unlikely to disappear entirely, investors can learn from history to minimize their risk.
* Example: Diversifying investments and avoiding excessive speculation can help reduce the potential impact of bubbles.

Chapter 9: The New Era

* Shiller argues that the early 21st century ushered in a new era of financial instability, characterized by increasing globalization and financial complexity.
* Example: The subprime mortgage crisis of 2008, which led to the Great Recession, exemplified the risks associated with financial innovations and systemic interconnectedness.