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Avoid the next bursting investment bubble

Sign No. 2: easy credit
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Sign No. 2: easy credit

One characteristic of nearly all bubbles is the heavy use of leverage "or the use of debt vehicles to fund additional purchases on the expectation that the value will continue to rise and rise," says Rodriguez.

According Mansharamani, three dynamics of easy money can lead to bubbles.

Financial innovation: Financial institutions evolve with the times. When economic conditions are conducive to easy credit and excessive risk, products emerge that enable consumers to borrow too much money. Example: interest-only mortgage loans.

Cheap money: Low interest rates on loans make money cheap. "When I say that money is too cheaply priced, I mean that interest rates are far below where they would naturally occur if you had a freely floating interest rate model rather than one where a central banker sets the interest rates," says Mansharamani.

Moral hazard: When individuals are protected from risk, they behave differently than if they had to live with the consequences. If they can't fail, they take more risks. The same is true of financial institutions and corporations.


 

 

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