Reading Rigid Bubble: Why Do Bubbles Become "Rigid"?

Rigid bubble · Implicit guarantee · Government backstop · Financial risk · Market clearing · Destruction before renewal

To me, the path of a person — or of anything — looks a bit like the sine wave y = sin x: a start, a rise, a peak, a fall, a zero, a reverse descent, a trough, then a climb again… Over time the trajectory repeats. Nothing stays in the upswing forever. Often, to rise again, you first have to pass through a valley. That is what we mean by destruction before renewal — you cannot build anew without breaking what no longer works.

When I first picked up Rigid Bubble, the title itself pulled me in. My first reading was simple: markets are supposed to be free; as The Wealth of Nations puts it, an “invisible hand” coordinates them. But once government enters the market — intervening in prices, in risk, in investor expectations — the invisible hand becomes a visible one. The market no longer runs purely on risk and return; it is steered toward goals the state wants to hit.

So my first definition of a “rigid bubble” was: a bubble propped up after the government steps in.

Reading on, I realized the book is not a simple claim that “government intervention causes bubbles.” It is more complicated.

The real question it asks is: Why has China’s financial system both powered decades of high growth and accumulated such severe financial risk?

That is a big question. On the surface, trusts, real estate, A-shares, P2P, state-owned enterprises, and local government debt look like separate problems. The book’s point is that they share a common mechanism: implicit guarantees.

How do implicit guarantees prop up a bubble, step by step?

What matters most is not memorizing every chapter, but seeing the logic that links them. Roughly:

To stabilize markets and protect investors, the state creates an expectation of a backstop; investors, believing someone will catch them, underprice risk; financial institutions and firms, seeing that investors will pay, expand financing and investment; risk is not released in time, piles up, and becomes a bubble.

Trusts are a clear example. In principle, a trust product is an investment — and investments carry risk. Yet in China’s trust industry, many people feel trusts “cannot default,” or at least that investors should not truly bear losses. That belief is not written into the contract; it is assumed.

Investors believe that if something goes wrong, the trust company, a bank, a local government, or a regulator will step in to coordinate. So investors dare to buy high-yield trusts, banks dare to package them, and borrowers dare to take expensive money.

Shadow banking grew the same way. On the surface, banks faced constraints — loan-to-deposit ratios, capital adequacy, credit quotas — and moved business off balance sheet. Dig deeper, and shadow banking scaled not only because it could technically dodge regulation, but because investors believed the products were safe behind the scenes. Without implicit guarantees, they would not have bought high-risk products so calmly.

So “non-defaultable loans” are not loans that never default. They are loans everyone pretends will not default. That pretense is where the bubble begins.

Real estate follows the same pattern. The rigid bubble in housing is not only high prices. It is the belief that prices must not fall, buyers must not lose, unfinished buildings cannot be left unmanaged, and if a developer fails the government cannot fully walk away. That hardens into a strong expectation: Buying a home is safe — safer than other assets. Even if trouble hits in the short run, the government will find a way to stabilize things.

Add relatively loose money in the past and few other places for household savings to go, and a great deal of capital flowed into property. Plenty of money, nowhere else to put it, and a belief that prices will not fall: stacked together, prices rise easily. People buy not only to live, but because they believe homes will appreciate and will not lose value. That is the rigid bubble in real estate.

A-shares rhyme with the same logic. Many rules were meant to protect investors — strict IPO approval, limits on short selling, constraints on derivatives, regulators defending market stability. Those protections can also teach investors another lesson: if a company listed, it must have been screened as “good”; if policy arrives whenever markets plunge, someone is backstopping the market. Prices then reflect optimism more than they fully price risk.

One judgment matters here: A good market is not a market that never falls. It is a market that allows rises and falls, disagreement, and correction. If a market may only rise, never fall — only optimism, never pessimism — it looks stable while risk is being compressed. Compressed risk is not eliminated risk; it is postponed risk.

P2P looks like rigid payout expectations taken to the extreme. In theory, P2P could be financial innovation: borrowers and lenders match directly; the platform is only an information intermediary. In practice, investors had already been trained by trusts, housing, and wealth products to believe invested money must not lose. So platforms, to attract users, had to promise principal and return protection — if you do not, someone else will, and users leave. The industry falls into a prisoner’s dilemma: honesty dies first.

Yet platforms lacked strong risk control, and credit infrastructure was weak. As bad loans rose and rigid payouts remained mandatory, platforms borrowed from one pocket to pay another — funding pools, rolling old debt with new — and many became Ponzi schemes. P2P taught me this: Financial innovation is not automatically good. If risk control lags and rigid-payout expectations stay unbroken, “innovation” is just the old problem in a new bottle.

From financial bubbles to structural problems in the economy

If the book stopped at trusts, housing, A-shares, and P2P, it would be a book about financial risk alone. It goes on to overcapacity, SOEs, and local government debt — because the author wants a larger claim: rigid bubbles are not one sector’s disease; they sit inside the economy’s long-running structure.

For decades of high growth, many problems were covered by growth itself. As long as the economy rose, asset prices rose, and investment expanded, debt and risk could be postponed. Once growth entered the “new normal,” problems began to surface.

Take overcapacity. In a normal market, when an industry is already excess, inefficient firms exit; prices, profits, and bankruptcy reallocate resources. With implicit guarantees behind the industry, the story changes: firms believe they will not fail; banks believe loans will not truly go bad; local governments do not want local firms to bankrupt, because jobs, tax, and social stability are at stake. So even with overcapacity, investment continues, lending continues, and inefficient firms keep living.

SOEs follow the same logic. Backed by government credit, they access cheaper finance more easily. Banks lend to SOEs not necessarily because SOEs are more efficient, but because they feel safer. Resources then flow to departments with state backing, not to the most efficient ones. Private firms and small businesses may need capital more, may be more efficient, and may employ more people — yet without the same backing, financing is harder and costlier.

In other words, implicit guarantees do not only inflate financial bubbles; they distort resource allocation. Money does not go where it is most needed or most productive; it goes where it is safest, best connected, and least likely to fail.

Local government debt is the same story. Building infrastructure and driving investment requires heavy financing. Local financing vehicles, local SOEs, and infrastructure projects often sit on local government credit. A guarantee chain forms: higher levels will not let lower levels fail, so banks keep lending. The chain looks like stability; in practice it accumulates debt. As long as everyone believes someone will ultimately backstop, borrowers keep borrowing and lenders keep lending. Risk does not vanish; it is wrapped inside a larger credit envelope.

At that point, the rigid bubble is no longer about one asset’s price. It is about how the whole economy runs.

What the book left me with

After finishing, I would compress Rigid Bubble into one line:

Implicit guarantees propped up two decades of growth — but the tide will go out, and reforming early is better than waiting for a forced crisis.

A truly healthy market is not a market where nothing goes wrong. It is a market that allows problems to surface, prices to correct, and failure to happen. Default is not always bad; losses are not always bad; bankruptcy is not always bad. They are how markets clear risk. The real danger is a world where no one allows risk to occur. When small risks are forbidden, what arrives later may be a large one.

Questions I still have not settled

First: how should a backstop actually work?

If there is no backstop at all, risk may fall straight onto ordinary people. If there is always a backstop, investors will believe the next one is coming too — and take even bigger risks next time. So the question may not be “backstop or not,” but: Do we rescue investment returns, or basic livelihoods? Asset prices, or a social floor? Firms, or people? If every rescue saves assets, prices, and investor returns, rigid payout expectations will never break. If we only protect basic living standards and a social floor — without guaranteeing that investments never lose — markets may slowly relearn risk.

Second: why doesn’t capital flow to those who truly need it?

The book keeps showing capital flooding into implicitly guaranteed domains. Who actually needs the money? Often private firms, small businesses, and ordinary households. That makes me think a rigid bubble is not only an economics problem; it is also structural and institutional. Where capital goes is not decided by efficiency alone.

Third: what is stability, really?

Short-term backstops can stabilize markets and expectations. But if markets permanently believe “someone will always handle it,” then the day someone cannot — or will not — expectations may collapse even faster. What the book finally made me ask is this: stability is not the absence of problems; it is whether a system can bear them, digest them, and correct them. A system that stays “stable” only by compressing problems may not be truly stable.

Closing

In my own words: Rigid Bubble is not about one industry’s bubble, and not a simple critique of government intervening in markets. It is about a long-formed market belief: that someone will backstop; that some things must not lose, must not fall, must not default, must not fail. In years of high growth, that belief seemed to underwrite prosperity. When growth slows, debt piles up, and asset prices stall, the same belief becomes risk.

The core of a rigid bubble is not the bubble itself, but the faith that it will not burst. And the real question is not only whether it will burst, but whether we can, before it does, admit that risk exists, allow markets to correct, and allow some failures to happen. Because if every small failure is forbidden, what arrives in the end may be one large failure.

By Miaoqiu (reading notes; some arguments drawn from the book)