Things go up in a market because the fundamentals are good. That's not yet a bubble - it's based on the reality of the fundamentals. But a bunch of people see the market go up and decide to invest in it, not because the fundamentals look good, but because they want to make money and that market is going up. That makes the market go up more. So more people invest in it, because it's going up, and there's fear of missing out. Now it's starting to become a bubble, but it's not yet a dangerous one. If it breaks, people will lose money, but it won't destroy the economy.

The next step comes when people borrow money to invest in the market, because it's going up, and they can make more money that way. So now the market really starts to go up, because there's so much money pouring in. The fundamentals are completely out of view here - they're not even a distant reflection in the rear-view mirror. Everyone's making money, and nobody wants to get out, but everyone kind of has this nagging sense that the party's going to end sometime.

Eventually, the banks kind of wise up (way too late) and start limiting the amount of money they're going to lend for purposes of buying assets in this market. Then the price stops going up. Then everyone rushes for the exits, because they don't want to lose money, especially since most of the money is borrowed. But everybody can't be one of the first ones out the exit, and so a bunch of people lose money.

Borrowed money. Money they can't pay back.

Now the banks are in trouble, because they've made a bunch of loans that people can't pay back. That's how a bubble can hurt the larger economy.

The bubble doesn't cause fear, the popping of the bubble does. People overreact, sell all their investments, drive down the cost and everything overcorrects on the bottom as well.

It's not so much people overreacting as banks. Banks call in loans which forces the borrower to stop whatever economic activity they were engaging in.

Basically, people expect momentum. During a boom, people expect values to keep going up which serves to drive values up but eventually they'll get past what is reasonable. Once they start correcting downward, people expect them to keep going down which drives them further down until the opposite phenomena occurs and the cycle restarts.

As I recall this has been experimentally verified but I can't remember enough to find a citation.

I would love to read some "experimentally verified" economics, as it is something that economics seems to be lacking.

Experimental econ is a fairly large sub-field that is very useful for micro phenomena.

Unfortunately because even the micro phenomena are complex and difficult to quantify, you can't reliably use micro knowledge to mathematically predict macro phenomena the way you could in something like physics.

Since the economics that most non-economists really care about are all macro stuff, this tends to mean that people are not really aware of experimental econ. It's still useful in cases like this, though: You can't experimentally confirm the actual causes of boom and bust cycles, for instance, but you can show that certain conditions are sufficient for the emergence of boom and bust cycles.

>suggesting the bubble causes fear, but what causes the bubble to pop?

too much fear / too much greed

The last obvious one for me was in the UK, when the first bank needed bailed out.