Manias, Panics and Crashes

Dr Larry Haverkamp
lhaverkamp@smu.edu.sg
Jun 2015

I DON'T read many books but the title of this one looked too good to pass by. It is "Manias, Panics and Crashes" by Charles Kindleberger and is about how money makes people crazy.

A similar book with fewer but more colourful stories is "Extraordinary Popular Delusions and the Madness of Crowds", by Charles Mackay. It was first published in 1841 and, incredibly, is still a bestseller.

Sir Issas Newton (1720)
An early episode is about one of the world's greatest minds: Sir Isaac Newton. He discovered the laws of gravity but couldn't resist a quick fling with a hot stock. Unfortunately, he found stock prices confusing as he explained in 1720 when he said:I can calculate the motions of the heavenly bodies, but not the madness of people."

He was talking about a market bubble in a stock called South Sea Company. He wasn't going to get caught when the bubble burst so he sold his shares at a 100 per cent return on his investment, earning a profit of 7,000 British pounds. It was a lot of money in those days and Sir Isaac was feeling pretty good about his investing skills when tragedy struck: The stock continued to rise.

At that point, greed got the better of this great man who expressed frustration that the stock market continued to go higher even though he had declared it over-bought and sold his shares. The audacity! His solution was to buy it again and - bad luck - that was just before the bubble burst. The shares fell to zero and Sir Issac Newton ended up losing 20,000 pounds, which was most of his fortune.

He couldn't forget this tragedy and found that it even interfered with his scientific concentration, which Isaac Newton considered most important. He resolved to use his mind to completely block out the experience and for the rest of his life, could not bear anyone to mention the name South Sea Company in his presence.

Tulip mania (1638)
An even earlier speculative bubble in Holland in the 1630s was called -tulip mania". The Dutch people's love affair with tulips began around this time, and it is easy to understand since the flowers had beautiful deep colours, never before seen in Holland. They were not only beautiful, but also rare since it took seven to 12 years to grow a tulip from a tulip bulb,

Accounting records from 1637 at the height of the mania show that a single tulip bulb sold for the sum of the following:
3,600 kilograms of wheat
7,200 kilograms of rye
Four fat oxen
Eight fat swine
Twelve fat sheep
Two hogsheads of wine
3,800 litres of beer
Two tons of butter
450 kilos of cheese
A complete bed A suit of clothes
A silver drinking cup

It totalled 2,500 florins which is $400,000 today - and keep in mind this was for only one tulip bulb.
An amusing anecdote of the time is about a new servant who was immediately sacked upon discovery of his having eaten a tulip bulb that he mistook for an onion.

Like most manias, this one had a sudden ending. The bubble burst in 1638 when tulip bulb prices collapsed to just 1 per cent of their previous highs. Fortunes were lost and Holland fell into a recession the following year.

Modern-day manias
Do you think we are smarter now? think again. Today's manias are more frequent and devastating.

Japan's bubble: An easy one to measure was Japan in the 1980s. I lived in Hawaii at the time and remember the story of a new Japanese property billionaire who vacationed in Hawaii in 1987. He purchased a few homes during his holiday by driving around the capital of Honolulu and telling his staff which properties to buy after viewing them from his car.

The Nikkei 225 stock index hit its high of 38,000 in December Then it crashed and has never recovered, Today, it trades at 20,000, which is about half its former high. US housing bubble: The most recent mania has been the US housing bubble. It caused the great recession of 2008/09" from which we are still recovering.

The excesses of that time make for entertaining stories, like banks which made "no money down loans" that had 100 per financing. There were also "no doc" loans which required no personal documentation such as a buyer's income, It was considered unimportant.

None of this was a problem since rising home prices seemed to be a sure thing, as US Central Bank Chairman Ben Bernanke said in July 2005 "We've never had a decline in house prices on a nationwide basis."

He was correct. In the previous 200 years, US home prices had only gone up, never down. But that came to an end only three years alter Chaitrwin bernanke said it wouldn't happen. US home prices fell by one third and sent the US into its deepest recession the Great Depression in 1929.

The next mania? No one knows when it will be, but it will happen. The world has never gone longer than 12 years without one, and it invariably leads to a recession

It's been six years since they last one.

An adjunct professor at SMU, Dr Haverkamp contributes this column weekly to help our readers understand money matters better.