Benign Bubbles vs Mean Minsky Bubbles

Paul Krugman:

while bubbles are in general a bad thing, just how bad depends a lot on the context — in particular, whether the inflation of the bubble has been accompanied by a big increase in leverage on the part of those buying the inflated assets.

Consider the stock bubble of the late 1990s. It was crazy, and when it popped U.S. households suffered a capital loss of about $5 trillion. This was bad, and helped cause a recession. But it never rose to the level of economic catastrophe.

Similarly, the stock market crash of 1987 had almost zero impact on the economy. A decline in prices is usually a good thing, so the popping of a bubble can be beneficial. The world would be a worse place if tulips were still worth their weight in gold like they were during the great tulip bubble. The crash in oil prices in the 1980s was devastating to big exporters like the USSR and the Persian Gulf, but it was a boon the the world as a whole. The decline in housing prices should make life easier because everyone needs a home and now they are cheaper, but the artificial financial crunch due to leverage caused a much broader problem.

What was the difference? First, a lot of financial institutions — which are highly leveraged — were holding [housing] securities ... So the housing bust undermined the financial system in a way the stock bust never did.

Second, households also leveraged themselves up in the housing boom, in a way they for the most part didn’t with stocks (yes, there were people buying dotcoms on margin, but they were not typical). So the housing bust created a balance-sheet crisis for the household sector in a way that the dotcom bust didn’t.

... the bubbles we should fear are those that lead to leverage, and set us up for a Minsky moment.