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3 Bubbles That Will Shape 2009

By Morgan Housel - Updated Apr 5, 2017 at 8:00PM

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Forget housing -- these three will dictate the state of the economy next year.

It’s as reliable as the sun rising in the east: Financial bubbles burst. All of them do. Always. Usually in grand fashion. Over the years, there have been dozens and dozens of them, and every single one has ended badly. Shall we reminisce? Here are a few big ones:

  • Tulip mania
  • The South Sea bubble
  • The railroad bubble
  • The Roaring '20s
  • The 1980s buyout bubble
  • The dot-com bubble
  • The housing bubble
  • The American Idol bubble (Fun fact: More people vote for American Idol than typically vote for the winning President)

There are probably more, but you get the idea: As long as there has been an economy, there have been bubbles.

So what bubbles might underline 2009? Here are three distinct ones I can think of.

Bubble No. 1: Treasuries
As I write this, a three-month Treasury bill yields 0.005%, a 10-year note will fetch you 2.5%, and a 30-year bond will score you a spectacular 3.007%. For comparison's sake, inflation has averaged 3.42% since 1913.

If the expectation is that every other asset class will be eroded by deflation, skimpy returns on government bonds might not be a bad idea. I bet most investors would have loved to achieve "only" a 0.005% return over the past year, compared to the destruction of nearly every other asset class.

Still, the stampede into Treasuries will eventually burst. It has to. One of two factors practically guarantees this:

  • Things will get better; investors will regain an appetite for risk, and move away from Treasuries.
  • Things will get worse, prompting more bailouts and more stimulus packages, eroding faith in the dollar.

Either way, the Treasury bubble won't be fun when it bursts. Having sent the government's borrowing costs higher, Uncle Sam might have a tough time funding its trillion-dollar endeavors, and this could leave companies like Citigroup (NYSE:C), General Motors (NYSE:GM) and Ford (NYSE:F) up in the air should they come back, hats in hand, asking for more ... which, come to think of it, probably isn't a bad thing.

Bubble No. 2: Fear
Have a look at these fear indicators:                                                       

  • In January of 2007, the spread between corporate junk bonds and U.S. Treasuries was just 2.65%. Yesterday, it was more than 20%.
  • Annaly Capital (NYSE:NLY) -- which invests solely in Fannie Mae and Freddie Mac securities -- saw the spread on its investments surge from 0.67% to more than 2% over the past year, even though those investments technically became less risky after the government nationalized and guaranteed Fred and Fan.
  • Credit default swaps on Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) surged to 440 basis points last month (higher than Citigroup's at the time), meaning some assumed a Berkshire bankruptcy was a very real possibility within the next five years.

What started years ago as a bubble of optimism has morphed into a bubble of fear today. Sure, reckless speculation needs to be purged out of the system, but an economy that's unwilling to take any risk is just as bad as one that's oblivious to it.

One worry is that even financially healthy consumers will become gripped by fear, slamming their wallets shut and exacerbating an already beleaguered economy. Another is that investors' hesitation to take any risk could stifle the venture capital investments that produce the Googles (NASDAQ:GOOG) of the world, hurting our chances of staying globally competitive when we need it the most.

Let's not forget that when Franklin D. Roosevelt warned, "The only thing we have to fear is fear itself," it was in the context of factors he thought could prolong the Great Depression. And he was right.

Bubble No. 3: Distrust
In just the past week, we've been blindsided by two (really, three) big stories that could lead to a bubble of distrust:

  • Illinois Governor Rod "do I hear $500,000" Blagojevich undermining the credibility of politicians.
  • Money manager Bernard Madoff, whose self-described Ponzi scheme may have blown through $50 billion.
  • The Securities and Exchange Commission being asleep at the wheel while Madoff committed perhaps the largest financial fraud in history.

All three are pretty appalling. What's scary is that the few bad apples who make all the headlines ruin it for the honest politicians (I'm sure they exist) and credible money managers that are vital to the economy. The old saying that "capitalism is based on trust" is getting tested, and that's a scary, scary proposition. If these shady headlines keep up at this pace, one fear is that we could become a culture that dismisses even sound financial advice and refuses to accept almost everything politicians do, which certainly isn't a recipe for anything economically healthy.

This could just be a partial list, of course. Any other potential bubbles you can think of? Feel free to share your thoughts in the comment section below.

For related Foolishness:

Fool contributor Morgan Housel owns shares of Berkshire Hathaway. Annaly Capital Management is a Motley Fool Income Investor pick. Berkshire Hathaway is a Motley Fool Inside Value recommendation and a Motley Fool Stock Advisor pick. Google is a Motley Fool Rule Breakers selection. The Fool owns shares of Berkshire Hathaway and has a disclosure policy.

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Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
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Annaly Capital Management, Inc. Stock Quote
Annaly Capital Management, Inc.
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Alphabet Inc. Stock Quote
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Ford Motor Company Stock Quote
Ford Motor Company
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Citigroup Inc. Stock Quote
Citigroup Inc.
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General Motors Company
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