Liquidity Causes Bubbles

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A shitty app called Meerkat is raising money at a $50M valuation. Perhaps the only thing keeping it from being priced at a billion is the fact that the herd can’t come charging in. Restricted demand.

A market bubble needs a propagating mechanism, a process by which new investors are attracted into the market to keep the price momentum going (on the way up) and existing investors are induced to flee (on the way down). [1]

Liquidity also results in burst bubbles. As long as no one can sell anything, the price will never go down. In an illiquid market, Meerkat will sit on its last-traded price forever. I’m not sure if that’s a good thing, but in theory that means the bubble doesn’t pop.

Aswath Damodaran is a little late to the Hate-on-Mark-Cuban game, but he makes a very important point: Mark Cuban became a billionaire by creating a crappy internet company in the 90s. Broadcast.com was a negative-profit company that put local radio stations on the internet, and Yahoo bought it for $5.7B at the height of the dot-com bubble.

Mark Cuban thinks this tech bubble is worse than the last one only because he’s not profiting off the excesses this time.

If Cuban is serious about staying out of bubbles, he should look at the largest investment in his portfolio, which is in a market where prices have soared, good sense has been abandoned and there is very little liquidity. In a market where the Los Angeles Clippers are priced at $2 billion and the Atlanta Hawks could fetch a billion, the Dallas Mavericks should go for more, right?

This bubble is even better than the dot-com bubble.
This bubble is even better than the dot-com bubble.

References:
1. Illiquidity and Bubbles in Private Share Markets: Testing Mark Cuban’s thesis! –Aswath Damodaran

2. Caginalp, Gunduz and Porter, David and Smith, Vernon L., Overreaction, Momentum, Liquidity, and Price Bubbles in Laboratory and Field Asset Markets. Journal of Psychology and Financial Markets, No. 1, pp. 24-48, 2000. –SSRN

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