Bubble Burst: A Chapter in Financial Market History

When it comes to severe economic downturns, investors may recall periods when markets were heavily inflated. Calm yet chaotic markets that become zero. The event known as bursting bubbles has caused losses and valuable lessons for those who have experienced it.

The Mechanism of Bubbles That Must Be Understood

Market bubbles arise from a simple process but have severe negative effects: asset prices (real estate, stocks, or cryptocurrencies) soar far beyond their intrinsic value.

Behind this surge is rapid speculation, overconfidence, and the common expectation that prices will continue this way. Many investors decide without considering fundamentals, but just follow trends or avoid missing out. One day, reality hits back, and prices plummet sharply, causing asset holders to lose huge amounts of money.

Lessons from Major Crises

Subprime Mortgage Crisis 2008: When Real Estate Becomes a Puzzle

In 2008, the US faced a major crisis when the real estate market collapsed. The reason traces back to reckless mortgage lending. Loan structures were designed to allow those unable to repay to borrow anyway. Many investors bought not for living but for speculation.

Financial instruments based on these loans accelerated market growth. As property values soared, these instruments appeared valuable too. But when the loans started defaulting, the entire market system collapsed. Non-performing loans were estimated at $15 billion. The damage affected not only the US but also triggered a global financial crisis.

Asian Financial Crisis 1997: A Lesson at Home

Thailand also experienced a similar situation. During that period, Thailand had abnormally high interest rates. Real estate was booming and seemed profitable everywhere. Foreign capital flowed in.

On July 2, 1997, the baht was devalued, causing foreign debt to spike. With leverage too high to sustain, the real estate bubble burst. Borrowers couldn’t repay their debts. The economy plunged into severe recession. History teaches us that short-term borrowing for long-term investments is a recipe for disaster.

Different Types of Bubbles

In Stock Markets

Stock prices rise without reason, beyond the management, revenue, or actual assets of companies. The problem isn’t limited to individual stocks but affects exchange-traded funds (ETFs) and entire sectors.

In General Asset Markets

Beyond stocks, this phenomenon extends to real estate, Bitcoin, Litecoin, and fiat currencies. When these assets’ prices soar uncontrollably, they eventually crash hard.

Loans and Debts

Bubbles occur when consumer or business credit expands excessively. Debt instruments increase overall. Excessive lending creates danger because economic downturns can lead to widespread defaults.

Commodities

Gold, oil, industrial metals, and agricultural products sometimes jump in price uncontrollably. Heavy trading in these commodities often pushes prices beyond fair value. When demand drops or supply increases, everything collapses.

Factors That Create Bubbles

Bubbles often start from seemingly good economic conditions but swell when prices diverge from reality.

Low interest rates encourage borrowing for investment and spending. Weak economic conditions attract foreign capital. New technologies or innovative products generate excitement. Asset shortages in certain areas push prices higher.

When investors see prices rising rapidly, they rush to preserve value. Speculative demand and fear of missing out drive prices beyond reasonable levels.

Market psychology plays a crucial role: herd mentality, biases in information processing, short-term thinking—all these expand the bubble. People tend to ignore warning signs and only accept information that confirms their beliefs.

5 Stages of Bubble Formation

1. Change: Exciting new developments arrive—major technologies, record-low interest rates, or industries claiming to revolutionize everything.

2. Rising momentum: Investors flock in, fearing missing out. Capital flows in, prices soar, creating a feedback loop that fuels further demand.

3. Overconfidence: Investors believe prices will keep rising. Wisdom seems to have left the scene. Confidence reaches levels that are unsustainable, but no one fully understands.

4. The tipping point: Some investors realize it’s not sustainable. They start selling. Prices plateau or decline slightly, creating a stable but fragile situation.

5. Panic: More people recognize the overvaluation. A wave of panic selling ensues. Everyone tries to exit, prices fall sharply, and the bubble bursts—ending the cycle.

Strategies to Protect Yourself

Review your reasons: Before investing, ask yourself: Am I investing because I truly understand this asset or just because I fear missing out? Have I studied it thoroughly or just followed others?

Diversify: Don’t concentrate your investments. Spread your money across different assets, sectors, and regions. This is the most basic protection.

Control speculation: When a bubble is expanding, speculative assets are the first to crash. If you suspect a bubble, limit exposure to such assets.

Invest gradually: Instead of investing all at once, buy in small portions over time. This helps avoid buying at the peak and reduces the impact of price volatility.

Hold cash: Keep cash reserves to give yourself options. If a bubble bursts and prices fall, you have funds to buy at lower prices, while others may need to sell out of necessity.

Study the market: The best defense is knowledge. Follow news, analyze data, and research thoroughly before making decisions.

Final Thoughts

Bubble bursting is an inevitable phenomenon in market cycles. It results from the divergence of prices and intrinsic value, driven by speculation, overconfidence, and crowd psychology.

Initially, bubbles form as demand outpaces supply, with prices rising due to scarcity. Investors believe values will keep climbing, but this belief is unsustainable. Eventually, awareness of overvaluation spreads, and selling begins—starting from a few and spreading to many. Prices then fall sharply, and the bubble deflates completely.

This process is driven by multiple factors working together, not just one. It’s not under anyone’s sole control. Therefore, protecting oneself is easier through diversification, education, maintaining composure, and risk management than trying to predict or control market bubbles. These strategies help survive when the bubble bursts.