Market bubbles, crashes, panics and crises – what do we learn from them?
The strong urge to make a quick buck always counters sage warnings. It is different this time – but is it?
Market bubbles are built upon financial desire and excessive greed. Crashes are then built upon excessive fear. So too are panics, that you can not get out before your profits implode. Crises are the result of a mixture of all of these and the aftermath.
I have taken a look at what history has thrown up surrounding a host of market bubbles, crashes, panics and crises – can we learn anything from what happened in the past?
In the 1590’s tulips were introduced to the Dutch. Coming from Turkey the new exotic and beautifully coloured flowers became much sought after, with prices shooting up as they became ‘must have’ adornments for houses.
After a few years the tulip bulbs contracted ‘mosaic’ which was a harmless virus, however it created flames of colour in the tulips, the patterns of which made the flowers even more unique.
What the Dutch did not know at the time was that after a growth period of nine years or so a tulip will become striped or speckled because of that disease. The people were amazed at the changing flowers and that made them even more in demand.
Accordingly, the price of tulips rose even higher, with everyone now more than keen to deal in tulip bulbs, the speculation was rife as values appeared to have no limits.
Personal savings were put at risk as one and all joined in the frenzy. Over the years of 1634 to 1637 prices started to reach ridiculous heights, with suggestions that even 5,000 gilders bought just one tulip bulb. That was a fortune, the price of a house and many times a year’s salary.
As prices rose some speculators started to ‘flip’ their contracts to buy bulbs and made big profits in the process. But that encouraged so many more to play that market, which was obviously only going one way – up.
However, at the massively inflated prices the ‘dealers’ started to sell hard and the big fall was in process. By the end the value of a tulip bulb crashed down to equal the cost of an onion. A Dutch Depression followed the dawning of reality.
The South Sea Bubble and The Mississippi Company
In the early 1700’s the British Empire was growing fast and it brought prosperity to many of its citizens. Money was flowing easily and always looking for a new home.
The East India Company, which had just 499 investors, was a veritable money machine and its dividends were legend. So, in 1716 when The South Sea Company was ‘floated’ it gained enormous following.
South Sea had given the UK Government a promise to pay £10m for the ‘rights’ to all the trade in the South Seas. The investing public deemed this opportunity to be where their money should be invested – and they piled into the many issues and re-issues of South Sea Company stock.
About the same time over in France John Law came up with the idea of switching the monetary system from silver and gold over to a paper currency system.
When he floated his Mississippi Company, to exploit the French colonies, it too gained massive investor attention. At one time, it is said, the company’s stock was worth more than 80 times the value of all the gold and silver in France.
The investing public believed that the Brits could do no wrong – whether in the Americas, France or wherever. And a plethora of public issues hit the markets to soak up the ensuing investment frenzy.
By the summer of 1720, deciding that the value of their own holdings in the South Sea Company were out of reality, made its management start to sell off their stakes.
Thereafter a wave of selling turned into a panic and the values of the majority of the recent issues started to crash. Similarly, The Mississippi Company stock fell and eventually went out of business.
Sarcasm or mockery about John Law and his various schemes created the island of Mad-head, discovered by one Mr Law-rens, it was inhabited by a nation of ‘shareholders’ and was amidst a sea of certificates.
The Bengal Bubble of 1769
Following the conquest in 1757 of Bengal by Robert Clive, the valuation of The East India Company rose significantly between the years of 1757 and 1769. Just before the Bengal Famine in 1770 the shares were peaking at £284 each.
Together with recognition of various corporate management actions and its growing predatory nature, brought about several attacks on the East India Company holdings and led to the collapse of the Bengal textile industry.
Within a short period of time the company’s shares had fallen back to £122, before a number of ‘bailouts’ of the company eventually led to the Crown taking control.
The Credit Crisis of 1772
As the price of the East India Company shares continued to rise, Alexander Fordyce, a banker, was shorting the stock heavily. He eventually covered his position whilst it was still rising, which lost him some £300,000.
Unable to meet his debts he decamped to France, but the resultant collapse of his bank in turn led to other banks falling. Dependence upon credit by banks then led to public doubt of the banking system – with an ensuing credit crisis as confidence waned.
Around twenty banking houses either went bankrupt or refused to meet debt repayments, causing a financial meltdown.
The Poyais Panic of 1823
Following the Napoleonic Wars Britain’s financial system was extremely profitable as money was pumped into all parts of its economy. Not only did that bring about strong elements of prosperity but it also engendered several speculative ventures.
A stock market boom led to propositions of all sorts for the investing public, especially for interests across the oceans. Latin America was a particularly fashionable area for investors, as confidence in the region grew following several states gained independence from Spain.
Government bond issues for Colombia, Peru and Chile whetted investor appetites, as such interest was then created for Latin American mining companies.
This investment bubble suited Gregor MacGregor, who was seeking investment in his scheme to colonise an area of the Mosquito coast called Poyais. Described as ‘one of the most healthy and beautiful spots in the world’ in a 350-page guidebook.
The territory was ‘fertile with considerable gold and silver reserves, possessing the elegant capital of St Joseph, with its wide boulevards, bank, cathedral and opera house.’
He raised £200,000 by issuing Poyais 30-year bonds carrying a 3% interest rate. He also sold plots of land to settlers, with 100 acres costing £11.
One ship with 70 settlers aboard departed from London in September 1822, the next with 200 left Leith in January 1823.
However, the land of Poyais was a total lie by MacGregor. By the time that some of his bond instalments came due the Latin American political instability had taken over the marketplace. The bond bubble burst in Spring 1823.
The Railway Bubble of 1846
The Industrial Revolution in the early 1800’s enticed many companies to seek investors to support their growing companies. It crossed all aspects of UK business.
By the mid-1840’s new businesses were collecting fresh funding, especially the railway companies. And the investors were enthusiastically joining in the frenzy that was circling, what many now call, the first and possibly the biggest technology bubble.
Anyone, it seemed, could form a new railway company and get it funded. It led to several thousands of miles of track being laid across the country, a lot of which was of little real use.
Railway companies sprang up like weeds, their shares were traded to dizzying heights.
Some new companies eager to get investors into their equity actually offered their stock at 10% down, with the 90% to be paid when the companies called up the balance.
The speculation reached a fever point just as a number of the new companies were discovered to be fraudulent.
By 1846 the Railroad Stock Index peaked as interest rates started to be raised and investors began to realise that some of the schemes in which they had invested were not only unviable, but many were frauds.
Prices later fell and many companies went out of business as a result.
The L’Union Generale - 1882
What seemed like an unending stock market boom in France saw share prices rise strongly in the late 1870’s.
However, the worst crisis in the French economy followed the collapse of L’Union Generale in January 1882. The banks shares had risen from 500 francs in 1879 to as high as 3,000 francs before its demise. A failure to repay its debts combined with falsified public reports did not help.
The market crash in 1882 saw some 25% of brokers close to failure, including seven that went bankrupt.
The Encilhamento Bubble of the Mid-1890’s
The industrial innovations surrounding rail transport, gas lighting and steamships in Brazil during the 19th century, created major investment opportunities.
The Brazilian Government helped to back an abundance of capital as an encouragement. Economic incentives fuelled increased inflation, as well as unbridled speculation. All of which engendered several scam public offerings and ill-advised takeovers.
‘Saddling up’ or ‘encilhamento’ was a horse-racing term which also described the very speculative ‘get rich quick’ schemes.
The bubble created by the Government’s easy credit quickly got out of hand and was succeeded by the inevitable market crash.
The Florida Real Estate Bubble
The boom of the Roaring Twenties helped to make many US citizens extremely wealthy. Their money was quickly invested in a fast-developing area that had previously been deserted – the Florida Coast.
Offering sunshine and lovely beaches it quickly caught on as being the ‘new destination’.
Real estate prices rapidly escalated and a fully-fledged boom was under way. Land started to change hands at multiples of the original purchase value.
Everyone knew that prices only went up and that land was the best investment you could have.
Speculators having chased values higher then realised that a profit is not a profit until its in your pocket. They started to sell off, the panic followed as sellers quickly outnumbered the buyers of Florida property.
A hurricane in 1926 did not help values to recover at all and the slump continued for another couple of years or so.
The Wall Street Crash
The boom that followed the First World War had made everyone realise that dealing on the stock market was a guaranteed way of getting rich.
Life savings were pumped into a multitude of stocks, in what was the no-risk world of finance.
Manipulated prices by brokers, bankers and even company owners threw petrol on the flames of an alight market.
The herd mentality drove prices higher as one and all jumped aboard the money-making machine. And better still, the banks and brokerage houses were lending money to buy stocks on margin.
However, inevitably, three very Black days occurred in late October 1929, panic selling hit the US market. Prices fell steeply despite several well-heeled financiers wading into the market buying as much stock as they could in an effort to hold it all up. But to no positive end.
Margins were called and investors failed to meet their commitments. Banks and brokerage houses also buckled under the financial strains that occurred, many of them failing in the process.
The crash led to The Great Depression, which lasted well into the next decade.
The UK Market Crash of 1973-74
From January 1973 until December 1974 what became known as ‘the worst bear market in history’ hit global markets.
Bretton Woods, the ‘Nixon Shock’, the US dollar devaluation and then the October 1973 Oil Crisis all combined to drive markets lower. World economies had slowed and fallen back into deficit.
In the UK a period of recession saw prices fall dramatically, whilst the secondary banking sector imploding did not help, as the Bank of England started to bail out lenders.
It took another 13 years for the UK market to recover to its previous best levels.
The Al-Manakh market was Kuwait’s unofficial stock market. Housed in an air-conditioned parking garage, that had previously been a camel trading venue, the market specialised in highly speculative and unregulated non-Kuwaiti companies.
The massive oil revenues in the 1970’s saw many local families amass fortunes. Those fortunes were used to play in the Kuwait official market. But a small crash there in 1977 led to Government controls tempering that market.
Substantial funds then flowed into the alternate market – the Souk Al-Manakh. Shares were purchased using post-dated cheques, thereby creating a major expansion of credit.
It took just one punter ‘bouncing’ his payment, in 1982, to bring that market to its knees. The Kuwait Ministry of Finance ordered all dubious cheques to be turned in for clearance, as it shut down the market.
The total extent of this crash was shown when the value of the worthless cheques, from 6,000 investors, totalled some $94bn.
It shook the Kuwait economy and its entire financial sector.
Program trading and illiquidity helped to cause a mega meltdown of the US stock market in October 1987. That followed years of increasing prices and valuations, many from companies that over-embellished their balance sheets and activities.
That was when investors started to notice the number of increasing market investigations that were underway.
The fall in the Dow Jones was over 500 points at one stage in just one day, swiping $500bn in losses. It was the largest one-day percentage drop in history, by some 22.6%.
And here in the UK our market fell in tandem. Prices were slashed across the boards, causing even further drops as panic set in and the market suffered a vicious decline.
The Dot.Com Crash
The 1990’s saw the dawning across the world of the Internet generation. This new technology wave was something very special – and it presaged a period of incredible growth from 1994 until early 2000.
Investors were increasingly anxious to get into the equity of any company involved in some way in the Internet, even if it just had .com after its corporate name.
Venture capital was incredibly easy to raise. The Nasdaq Index rose 400% in the same time, with price-earnings ratios reaching an incredible 200 times. Major floats like Yahoo, Lycos, Netscape and Excite came to market, raising billions of dollars in the process and going to significant premiums.
The ‘New Economy’ and its constituents enjoyed a substantial ride – negative earnings and sky-high valuations were the norm for these new players. Sense did not come into the equation because everyone was going to become a dot.com millionaire.
The global dot.com bubble popped in early 2000, and the slide lasted for the next couple of years. Too many new issues, overpriced companies, any form of realism having gone out of the window, combined with the wise few taking profits – the crash was inevitable.
The Nasdaq fell from 5000 to almost 1000 by 2002, with the US economy being thrown into recession in the process.
The Housing Sub-Prime Bubble
As a result of an overall easing of credit and lower interest rates the value of property, especially housing, rose impressively. The higher prices fuelled real estate speculation backed by the easy money.
House values soared and mortgages were almost given away to one and all, with little consideration of ability to meet repayments.
The banks and building societies were aware of this massive growth and they started to securitise their positions by bundling together parcels of sub-prime property mortgages.
The major investment banks then commenced trading in those packages. Buying and selling between themselves and then passing them off to their luckless clients. The sub-prime areas were almost shanty towns full of new ‘owners’ who had no incomes, certainly insufficient to pay their mortgages.
Collapse was due, both in property prices and the other asset markets.
The late summer of 2008 climaxed with the bankruptcy of Lehman Brothers in September. Credit markets had been tightening over that summer, but after the banks failure the resultant freeze brought about the global financial crash.
If it was not for central governments adopting policies of quantatative easing a multitude of banking names would have disappeared entirely.
Equity markets during this whole period fell significantly, more than halving in just months.
From less than a dollar to almost $20,000 the price of Bitcoin exploded in the couple of years to the end of 2017. Everyone, it seemed, was talking bitcoin, playing the bitcoin market, and making a fortune in the process.
The blockchain currency has global attraction and is a subject upon which I will not opine without total knowledge, there are others far better than I to do that.
However, I do see a lot of media comment about hackers breaking into and ripping off bitcoin ‘wallets’, about banks of bitcoin being raided and pilfered. Also, such an international and faceless currency attracts illegal use, particularly in the dealing of drugs.
Prices fell to around $2,000 before rising again to circa the $8,000 level currently.
Is this a bubble? I will not comment but instead stand back and watch blockchain aficionados getting excited. Even reticent investment bankers and institutional fund managers across the world are participating – but I am refraining.
So What Are The Lessons To be Learned
The stages of markets are needed to be studied. So often mania and greed outweigh common sense.
Investors were said by Charles Mackay, as he lost a fortune in the railway debacle, to ‘go mad in herds and only recover their senses one by one’.
John Templeton, the legendary US investor observed that ‘bull markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria’. That is borne out by practically all of my previous examples.
Investors may think that they have the golden touch, that they are guaranteed to make profits, but nothing is that definite in life.
Sir Isaac Newton, when he made and then lost his profits in the South Sea Bubble, reflected that he could ‘calculate the motions of the heavenly bodies, but not the madness of people’.
Looking at the cycle of market emotions gives us a very good clue how it all works.
It includes the following, in order: optimism, excitement, thrill, euphoria, anxiety, denial, fear, desperation, panic, capitulation, despondency, depression, hope, then relief, leading to optimism – the cycle persists.
Somewhere in the world. At any time, there is a new bubble underway, whether it is stocks, property, fine wines, motors or even market indices – the game is spotting, playing quickly and getting out too early.
It has been so often proved that ‘a profit is not a profit until it is in your pocket’ – that ‘you never go broke taking a profit’ even if you miss the big rise after you have sold.
Awareness of previous market events helps investors avoid the worst excesses.
But remember to always leave something in it for the next man!