Steve Blank explains the phases of a bubble and the five types of participants:
Smart Money are prescient angel investors and Venture Capitalists who started investing in social networks, consumer and mobile applications and the cloud 3, 4 or 5 years ago. They helped build these struggling ventures into the Facebooks’, Twitters’, and Zyngas’ before anyone else appreciated these companies could have hundreds of millions of users with off-the-chart revenue and profits.
In a bubble the smart money doubles down on their investment in the awareness phase, but when it starts becoming a mania — the smart money cashes out. (Really smart money recognizes it’s a bubble and bets against it.) They manage this all with knowledge of the game they’re playing, but they don’t hype it, talk about it or fan the flames. They know others will.
The Shills are the middlemen in a bubble. They profit from the boom times. They’re the mortgage brokers and real estate agents in the housing bubble, the investment bankers and technology press in the dot.com bubble. Since it’s in their interest to keep the bubble going, they’ll tell you that housing always goes up, that these bonds are guaranteed by a big bank, and that this tech stock is worth its opening price. All the stories peddled by Shills have at their heart why “it’s a new age” and why “all the old ways of measuring value are obsolete.” And why “you’ll be an idiot if you don’t jump in and reap the rewards and cash out.”
The Marks are your neighbors or parents or grandparents. They’re not domain experts. They know nothing about real estate, financial markets or tech stocks, but they don’t want to miss the ”investment opportunity of a lifetime”. They hear reassurance from the Shills and take their advice at face value, never asking or questioning the Shills financial incentives to sell you this house/mortgage/tech stock. They see others making extraordinary amounts of money at the start of the mania (just buy a condo or two and you can sell them in six months.) What no one tells the Marks is that as they’re buying, the smart money and institutional investors are quietly pulling out and selling their assets.
The True Believers don’t financially participate in the bubble like the Marks (lack of assets, timidity, or time) but they could if they would. They have no rational evidence to believe, but for them it’s a “faith-based” belief. By their numbers they give comfort to the Mark’s around them.
The Promoters are the ones who keep the bubbles inflated even when they know that the asset exceeds its fundamental value by a large margin. While Shills have no credibility, Promoters have “brand-name” credibility that makes the Marks trust them. What makes the role of the Promoter egregious is that they are a small subset of the Smart Money. They loudly tell the Marks and Shills that everything is just fine, enticing them to buy into the bubble, even as the Promoters are liquidating their own positions.
Investment banks who sold CDO’s (synthetic collateralized debt obligations,) in the financial meltdown and the mortgage lenders in the housing bubble are just two examples. Some investment banks actually bet that the very investments they were selling their customers would fail. There’s a special place in hell waiting for these guys (only because our political and financial regulatory system won’t deal with them while they’re on earth.)