Identifying and Popping Bubbles is Hard

It seems like we should be able to do something to pop speculative bubbles or prevent them from happening, but the evidence suggests that this is very hard:

In the lab we can create artificial assets with known dividend streams and thus known fundamental values.  Since Vernon Smith's classic experiments (JSTOR), we know that even in these cases efficient markets fail and bubbles are common.  Bubbles occur even as uncertainty about the fundamental value diminishes (JSTOR).  We also know that once a bubble starts it's difficult to stop.  Circuit breakers and brokerage fees (transaction taxes), for example, don't do much to stop bubbles (see King, Smith, Williams, and Van Boening 1993, not online.)  Investor education doesn't help (for example telling participants about previous bubbles doesn't help). Even increasing interest rates doesn't do much to stop a bubble already in progress and may increase volatility on net. [...]

Bubbles are also less common with more experienced traders – this is one of the strongest findings.  Don't get too excited about this, however, it's experience with bubbles that counts not just trading experience.  I once asked Vernon, for example, how the lab evidence generalized to the larger economy.  In particular, I asked whether 3 bubble experiences in the lab–the number which seems to be necessary to dampen bubbles–might translate to 3 big bubbles in the real world such as the dot com, commodity and housing bubbles (rather than to experience with your run of the mill bubble in an individual stock).  He thought that this was a reasonable inference from the evidence.  Thus we may not see too many big bubbles during the trading lifetime of current market participants but experience is a very costly teacher. 

And this is assume we can identify the bubble in the first place, which poses problems of its own. And on top of both of those problems, there’s a real issue about politics. The evidence seems pretty overwhelming that we need to put our energy into trying to make a system that’s robust to bubbles, rather than one that manages to avoid them as such.