The purpose of this paper is to show how the “system” works, why it generates bubbles, why they eventually burst, and the macroeconomic effects of bubbles. Here we apply the economic understanding of bubbles derived from the Austrian business cycle theory (ABC theory) to the current case of the housing bubble and show that this aspect of the housing crisis is the result of government failure: the inevitable failure of a government bureaucracy (i.e. the Fed) to manage the money supply and interest rates in an economically rational manner. However, the same reasoning can be applied to historical bubbles, from the Tulip mania in 17th century Holland (see French 2006) to the dot.com tech bubble of the late 1990s (see Callahan and Garrison 2003), and to future bubbles.
