At first, sentiment is neutral. As asset values increase, the market observers become increasingly optimistic, which drives prices higher in a self reinforcing cycle. Also, the perceived risk is diminished, so credit is extended and accepted in ever greater amounts.

Finally, at the peak of optimism, all the money that can go in is already in, credit is stretched to reckless levels by unworried participants who feel invulnerable. Since there is no more money to go in, the upward price movement stops.

Then some trigger occurs. In this case, it was defaults on subprime mortgages issued in 2006, some without even one payment having been made. Since all the money is in, it has only one way to flow, out.

In asset bubbles, the next phase is bad publicity and the beginnings of broad negativity, but there are still many looking for the quick soft landing. This is when the unsustainability of the bubble is exposed and instances of fraud are uncovered.

This pattern has been repeated dozens of times since the modern financial era began in Holland 500 years ago. The only element in the classic bubble that is missing from this bubble is the development of heroes who are leading the way to the new economy. What happens next is a bit variable, but the end has never been in question. It ends badly. Very badly.

It is possible that the bubble can reinflate, pushing asset prices higher for years, until it finally bursts again. It is possible it can slowly deflate over a large number of years, torturing the economy all the way down (Japan anyone?).

It is most likely to snowball downward as panicked participants run for the exits before they are bankrupted. Credit availability goes from wide open to shut, as a results of fear and diminished capital from loses.

At this phase the negativity builds until finally there is revulsion. People don’t want to have anything to do with the asset, are embarrassed to tell others they own it, won’t buy it even when it gets cheap. In fact, asset prices typically overshoot on the downside and can be a great deal for those who buck the trend and buy (e.g. Boston real estate 1992).

Nobody knows how this will unfold. This could be different from all those other times.

Point taken. While investment bubbles are hard to predict in advance, the results are not. Bubbles burst and people loose money.

Plus, how can an economist make any accurate predictions when you have a central bank acting independently and without regard for basic concepts of economics?