I read a book during my NITIE days titled Psychology & Investing or something like Traders’ psychology which I don’t remember precisely. It gave a very crisp & simple description of the famous asset bubbles recorded in history. Unfortunately whatever information & knowledge we gather – majority of it is justified only in retrospect. I have tried to list these “(In) famous Asset Bubbles” in chronological order keeping in mind that I don’t get into too much detail
Tulip bulb Mania
- Generally considered the first recorded speculative bubble
- Place – Netherlands; the bubble reached its peak in February 1637.
- A species of tulip bulbs infected with a kind of virus & capable of growing beautiful tulips became so famous that they became a status symbol.
- Speculative traders start trading in tulip bulbs because of their growing popularity; futures contracts started for buying bulbs increasing their prices exponentially.
- An upward spiral on futures price kept on building without actually a single tulip being traded. Some tulips were traded for 12 acres of land & some for 2500 florins (equivalent to 16 years’ wage of a skilled laborer, phew!!)
- Many people got suddenly rich; but the process of buying contracts at higher & higher prices couldn’t last because no one was willing to purchase & take possession of real tulips at such high price.
- Finally when this realization set in; prices came crashing down by more than 90% from peak; many people & traders were stuck with tulips which were worth fraction of the money they paid for them. poor fellows :-(
South sea bubble
- Place- England; occurred in mid 1720
- The South Sea company was given exclusive rights to trade in the “South seas” which was the area surrounding South America & Mexico. The rights included sending one ship every year to trade goods & one to sell slaves.
- Short term government debt of 10m pounds was converted into stock of the company; more debt was later raised in exchange for equity. It is said that at one time the South Sea Company took more than half the national debt of Britain against exchange of shares.
- The business prospects of the company were presented in a very rosy manner. People thought it was an opportunity of a lifetime to invest in a company having exclusive rights to trade in South America.
- The share price of the company zoomed from 100 pounds to 1000 pounds in a few months!!! Many companies promising “bright future” came with stock offerings. Thousands of people subscribed for South Sea & other companies’ stocks even without having an idea what the “bright prospects” were.
- Realizing that the share price of the company was much more than the true value; some directors tried to secretly sell their shares. But once this news was out there was widespread panic to sell the company’s shares.
- Many people lost their lifetime savings in the company; many financiers & goldsmiths who financed them also went bankrupt. The share price tumbled from 1000 pounds (at peak) back to 100 pounds wiping out many people in the process.
The Great Depression
- This has been the longest & most severe financial crisis ever in developed world.
- Started in 1929 in USA & ended with the beginning of Second World War in 1939.
- Irrational exuberance in the stock markets led to many uneducated investors putting their money in stock markets. Some stock brokers & traders took advantage of this situation & started manipulating prices by trading shares at a high price between them. They made a lot of money & some of them got out at the right time.
- Markets crashed by 40% between Sept 1929 & October 1929 when prices reached unsustainable levels.
- During that time, the American economy had an excessive liquidity provided by cheap credit. This was available to both consumers as well as investors which kept the economy going till that time.
- Heavy market losses led to default on bank debts & created panic. Banks had to pay their depositors & couldn’t recover money from debtors. As many as 9,000 banks defaulted during the depression. Liquidity was wiped out & people lost faith in the banking system.
- Demand worsened & there was a complete lack of confidence; markets plummeted by 90% from 1929 to 1933. Industries got wiped out due to lack of demand & price deflation. Money supply was restricted because of the “Gold Standard” according to which more money could be issued only when there were substantial reserves of gold backing it.
- This situation spread to other trade partners of US; unemployment reached to 25-30% of total available work force. All asset prices remain subdued for years to come.
- The depression ended with the outbreak of Second World War when production & war spending doubled the GNP. Many new factories were set up to assist in war & economy was revived
The Asian currency crisis
- This crisis gripped the Asian “Tiger economies” of Thailand, Indonesia, South Korea, Philippines, Hong Kong & other south east Asian countries in July 1997.
- Like other asset bubbles this too started with blind confidence in the tiger economies after they grew at high rates of 8-12% in late 1980s & early 1990s.
- High interest rates attracted capital inflows into these countries leading to overheating of their economies; particularly the real estate sector where asset prices reached unsustainable levels.
- Foreign debt to GDP ratios went to as high as 180% leading to very high foreign currency risk exposure for these countries. When asset prices started cooling; foreign investors started taking money out of these markets leading to downward pressure on their currencies.
- The crisis triggered when Thailand announced to float the Baht (earlier, it was pegged against the dollar to make its exports feasible). This decision triggered panic among other surrounding economies whose currencies too were highly overvalued at that time. Floating the overvalued currency was equivalent to depreciating the currency which made foreign currency-denominated liabilities grow in domestic currency terms.
- IMF had to step in with a USD 40 billion bail out package to rescue these countries & preventing them from defaulting on their debt.
The Dotcom crash
- With the commercial use of internet in 1995; many new age entrepreneurs came with new companies to tap this high potential market
- Many entrepreneurs came up with fancy B-plans to exploit the new world of internet. But the fallacy was that all these ventures required a high market share to make profits & almost all of them had to bear operating losses in the start-up phase in the process of gaining market share.
- Low interest rates in 1998-99 led to huge investment in this sector, both by venture capitalists as well as through IPOs. In 1999, there were 457 IPOs; most of them internet & IT related & 117 doubled in price on the first day of trading. Similarly VCs were excited at the opportunity of investing in these companies without even assessing the feasibility of their business!!
- NASDAQ composite index doubled between March 1999 & March 2000 to reach 5,000 levels. But many interest rate hikes during that period & continuous losses & folding-up of operations by many of these companies led to panic among investors which led to massive sell-off in the technology companies.
- Total market cap of $5 trillions was erased in tech companies. Many investors went bankrupt because of this “grow big fast” syndrome & many of these companies seized operations. This crash also brought forward accounting scandals like those by World Com which overstated its profits by billions of dollars & filed the largest corporate bankruptcy in US history.
India too had its fair share of crashes
India was largely unaffected by the above bubbles; except the dotcom bubble which wiped out many internet & IT companies and led to a small recession in the economy particularly in the tech sector. There were two bubbles which are specific to the Indian markets and infamously known by the two individuals’ names who masterminded them- “Harshad Mehta” & “Ketan Parekh” scams- the latter is also known as K-10 scam referring to 10 shares in which Ketan Parekh used to operate. Both of them rigged up share prices with the help of huge money taken on debt (mostly illegally) from banks & other financial institutions. When their misdoings were revealed the share prices crashed. Both of them were convicted along with many public officials who colluded with them in these scams. The timing of Ketan Parekh scam was very close to the tech bubble.
But where is the Sub Prime Mess??
Does this one need anything to be written?? I am not writing anything about the Sub Prime because I think readers are fed up reading & listening about it. On top of it, many of them would have lost a substantial amount in the markets so they wouldn’t like it anyways. Moreover, the crisis isn’t over yet & only time can tell how nasty is it going to get with the signs of economic slowdown already visible
Conclusion
After knowing about the various asset bubbles we get to know that the cause of all of them has been exuberance & blind confidence that the price of these assets is never going to come down. A “herd behavior” leads to irrational rise in the market value of these assets & people forget the basic principle that price is what they pay & value is what they get. The bubble develops fast & encompasses many people who want to jump the money-making bandwagon.
Then suddenly some tragic event or bad news brings out the realization that the asset they’ve bought is highly overvalued. This sets in panic & prices fall faster than the pace at which they went up because no one wants to buy these expensive assets anymore. This doesn’t give room to anyone possessing these assets & the fall stops only when it reaches back to the level where it was before the bubble or sometimes even below it.
Thus we see that markets are classic example of place where human emotions of Greed, Fear & Hope interact with each other along with millions of people who try to out-smart each other. We can only hope for an efficient market where all assets trade at their intrinsic values; but that would be possible only when robots who can’t generate emotions are the only ones allowed to trade. Till then, asset bubbles would keep on appearing & crashing and prompting many like me to write an article on them.
Tanuj
(All the information used in writing this article has been taken from Wikipedia, Investopedia & few other websites)
