Behind bubbles

Did you know that, as recently as 1997, the majority of economists (PDF) were convinced that stock bubbles were impossible? As the New York Times explains, the thinking of that more innocent time was that:

In an efficient market, all relevant public information is reflected in the price of an asset. Prices cannot be too high or too low; they must be just right.

Bubbles were considered a theoretical impossibility. If a stock's price exceeded its fundamental value, rational investors would sell the shares they own as well as sell the stock short - betting that the price will fall - therefore putting pressure on the price to fall. As long as knowledgeable, rational investors had enough funds to "attack" a bubble by short selling, even the presence of irrational investors would not permit prices to stray from their fundamental values for long.

Well, the dot-com implosion proved otherwise. But economists are still struggling to explain why bubbles happen.