If I’m as smart as you say I am, how come I don’t see your example? I think the essay demonstrates that going long in natural gas while JP Morgan is going short will put a company out of business. I agree that the asset bubble is behavioral, but it is a result of the low spreads, not the cause. The spreads were lowered as people chased yield to the point of insanity, buying traunches of junk with a fake “AAA” rating insured with fake insurance. That kind of excess can only occur from the credit excesses, and it drives the asset bubble. Your notion of future expectations depends on the reality (or nonreality) of the asset pricing. That is good and will help dampen the bubble in the extreme situations. But my expectations are based on the Fed lowering short term rates, and eventually the Fed jiggering longer yields lower. That’s what ultimately drives the tight yields.
In other words...making cheap money available only turns into an asset bubble if everyone does the same thing with it. And the reason everyone has done the same thing (favored the short volatility trade which then tightened spreads) was because it was impossible given public information, to form an opinion about the long volatility trade. But the suggestion I point to would change that. It would make it possible for sophisticated professionals to form an opinion (build a probability distribution) about the likelihood of a spike in volatility. And so long as there is enough people out there saying “today is the day it all falls down”, the crisis will never occur because they will be there to provide a bid when it does. Instead the money goes from one participant to the other rather than just driving bids to zero.
The Amaranth collapse was larger than LTCM but there was no need for a bailout. They didn't just go long NatGas like you say, it was a complex spread position identical in risk terms to the circumstance we're discussing. It was the same thing... the only difference was that there was no collapse of asset values because other market participants were there with long volatility exposure and were willing to provide a bid. That could be our model going forward if we made this one simple change. I don't think this can be explained any more plainly than that. At this point, it's really on you... if you still don't understand what I'm talking about I'll be happy to reccomend other reading material, but this is how markets actually work whether it matches your understanding or not.