The return of 'irrational exuberance': the astounding similarities between the subprime housing and energy market bubbles.

• Author: Verleger, Philip K., Jr.

"Irrational exuberance" was a key contributor to the Great Recession eight years ago. Poor lending practices, combined with the investment banks' uncontrolled packaging of subprime mortgages into financial instruments bought without question by large institutions, fueled an unsustainable housing construction boom. The end of that boom followed by the financial industry nearly collapsing caused the Great Recession.

Eight years on, "irrational exuberance" has caused another economic debacle. Once again an industry confronts a prolonged period of recession or depression following several years of excessive investment funded primarily by debt. Meanwhile, the lenders and buyers of that debt are again learning a harsh lesson: that the hard assets they funded will likely never have value.

Ultimately, only the absence of myriad complex derivative securities supported by loan bundles distinguishes the oil and housing bubbles. This time is different in that respect because regulators have forced bankers to be more disciplined.

Another dissimilarity is the housing bubble will be more easily resolved than the oil bubble. The ongoing population expansion and income growth have already spurred a correction in housing after governments intervened with programs such as TARP. The oil industry faces a far more difficult recovery because innovation is driving down development and operating costs, quantitative easing is promoting accumulation of vast oil inventories, and government relief of any kind will not be forthcoming. The consequences of the oil bubble bursting, then, threaten to be more prolonged and more devastating.

That said, the similarities between the housing and oil bubbles astound. Both bubbles were stimulated by the entry of new innovators--unregulated mortgage firms in housing and frackers in oil--and the regulatory laxity that permitted their inflation beyond historic proportions. In addition, the key players in both episodes were myopic, seeing only increasing prices for the foreseeable future. This myopia led them to boost investment three times higher than historical rates. The greater investment was funded by very large increases in debt and borrowings.

The myopia on the part of participants was the most important contributor to both market collapses. In the case of housing, many key players believed housing prices would never fall. In July 2005, for example, Ben Bernanke, then chair of the Council of Economic Advisers, told a CNBC interviewer that "we've never had a decline in house prices on a nationwide basis."

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