appone

'The Crash of 2008 and What It Means' by George Soros

“ If the market believes that the long-run interest rate is 1%, the
present value perpetuity of the stream of rent income is $1,680,000.”


Why I agree with your conclusion, your first word explains exactly why “irrationality “ is at the base of bubble building.
It all hinges on the “IF” part. The irrational behavior is in believing such nonsense (as interest rates will stay at 1%).
The “fair” value analysis only applies in a theoretical vacuum or in an “irrational” bubble, as the main ingredient has to be the belief part.
IF the market can believe that “long-run” interest rates will be 1% the market also believe that prices will only go up for the “long-run”. Thus they behave “irrationally”.


On Jul 12 11:11 PM Arthur Hau wrote:

> I don't know why people still think that a bubble is necessarily
> built by people's irrationality or some sort of disequilibrium in
> the financial market.
>
> When you have a prolonged period of low interest rate, the so-called
> real estate market bubble (similarly stock market bubble) is actually
> RATIONAL!
>
> Suppose you have an apartment that can be rented out at $1,400 a
> month and hence $16,800 a year.
>
> If the market believes that the long-run interest rate is 1%, the
> present value perpetuity of the stream of rent income is $1,680,000.
> That is the apartment's "fair" value is about $1,680,000.
>
> If the market believes that the long-run interest rate is 5%, the
> present value perpetuity of the same stream of rent income is worth
> only $336,000. That is the apartment's "fair" value is only about
> $336,000.
>
> If the Fed keeps the interest rate low for a long while, any so-called
> bubble is only the result of rational computation from some FIN 101
> theory in finance.
>
> Mr. Greenspan correctly contained the internet bubble by flushing
> the stock market with liquidity and low interest rate. However, he
> did not have any exit plan. The right time for raising the interest
> rate steadily back from 1% to 5% should have been the period of 2003-2006.
> Instead, it waited until Dr. Bernanke finally realized that there
> was a possible bubble. Bernanke tried to correct the bubble by raising
> the interest rate, but It was already too late!
>
> The U.S. should have a minor bubble burst in 2006, instead of a major
> bubble burst in 2008. Thanks to Mr. Greenspan, a small financial
> crisis had turned into a financial tsunami.
>
> Now, the interest rate is back to historical low. Is there an exit
> plan? The real estate prices in NYC was down but not by a sufficient
> amount. What will happen when the interest rate rises again?
>
> Monetary policy can only contain a bubble, not correct it. You want
> the bust to go away? You better improve the productivity of the economy.
> Promoting speculative activity by lowering interest rate further
> won't work!