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“The Ten Big Financial Bubbles of Our Time”

According to Charles Kindleberger in his book about speculative stock market bubbles “Manias, Panics, and Crashes”, the biggest financial bubbles are ten. Kindleberger, who has been refered to as "the master of the genre" on financial crisis by The Economist[1] includes a list of these ten bubbles and discusses them shortly. This article is aimed at providing a detailed summary of these bubbles, which might be of interest given their common features and their importance in better understanding the “bubble phenomenon” which precedes most financial crises. In his discussion of the Minsky's model Kindleberger claims that “booms are fueled by an expansion of credit." (p. 28, Kindleberger & Aliber, 2011; p. 26, Kindleberger & Aliber, 2005). As can be seen in the analysis that follows this expansion of credit and subsequent boom is a characteristic of all the major financial bubbles.

Contents:

1.The Dutch Tulip Bulb Bubble 1636 2.The South Sea Bubble 1720 3.The Mississippi Bubble 1720 4.The Late 1920s Stock Price Bubble 1927-29 5.The Surge in Bank Loans to Mexico and Other Developing Countries in the 1970s 6.The Bubble in Real Estate and Stocks in Japan 1985-89 7.The 1985-89 Bubble in Real Estate and Stocks in Finland, Norway, and Sweden 8.The Bubble in Real Estate and Stocks in Thailand, Malaysia, Indonesia and other Asian Countries 1992-97 9.The Bubble in Over the Counter Stocks in the US 1995-2000 10.The Real Estate Bubble in the US, Britain, Spain, Ireland and Iceland 2002-2007 and the Greek Sovereign Debt Crisis. 11. Common Features and Characteristics

1. The Dutch Tulip Bulb Bubble of 1636

According to Palgrave's Dictionary (1926, p.181) a bubble can be defined as "any unsound commercial undertaking accompanied by a high degree of speculation." "Tulipmania" on the other hand, is defined as a situation in which asset prices do not behave in ways that can be explained by economic fundamentals.

The Dutch Tulipmania has its roots in the 1600s, when the Netherlands became the center for the cultivation and development of new tulip bulb varieties (Garber, 1990). A market for rare varieties, were bulbs sold at very high prices, was created by a group of flower lovers and professional growers. For example, one of the most acclaimed tulip bulb varieties, the Semper Augustus was priced at 2000 guilders in 1625, an amount of gold worth about $16,000 at $400 per ounce. Common bulb varieties, on the other hand traded at very low prices. By 1636, the rapid price increases attracted speculators which led to further price increases from November 1636 to January 1637. After the first week of February 1637 there was a sudden price collapse and bulbs could not be sold at 10 percent of their peak values. By 1739, the prices of all the most prized bulbs of the mania had fallen to no more than 0.1 gulder (amounting to 1/200 of 1% of Semper Augustus's peak price). This huge collapse in tulip bulb prices had further repercussions for the Dutch economy (after a period of prosperity, “The Dutch Golden Age”), leading to economic distress for many years following the collapse. Usually (even in modern markets), new varieties of tulips are associated with a standard pricing pattern. When a special new variety is created, the original bulb of this variety sells at a very high price. Thereafter, as more bulbs of the same variety are accumulated, its price declines quickly. After a period shorter than 30 years, the variety’s bulbs will sell at merely their reproduction cost. Given this pattern of tulip pricing, two points of discussion arise: why was the price increase of bulbs so extremely fast and did prices decline faster than should have been expected? When talking about the tulipmania, it is more interesting and accurate to focus on the rapid increase followed by the quick collapse in common bulbs during the last week of January and first week of February 1637, rather than focusing on the pricing patterns of rare tulip bulbs, which can be explained logically to a certain extent. According to Garber the fast increase in tulip prices was logical, becauce some tulip varieties were rare and more desirable than others, so as the demand for these tulips rose, so did the prices for those varieties, because the buyers would pay any price to have them. After some time the prices fell because these varieties weren’t as rare as they were before because they started to spread, and there was also a depreciation of tulips in general. However, common bulbs, were subject to a purely speculative phenomenon which developed among the lower classes in a future market emerging in November 1636. These future markets were developed in local taverns, and each sale of a tulip bulb was associated with a payment of "wine money." At the beginning of January, some of these bulbs were priced at .035 guilders/aas. During the last week of January and the first week of February their prices increased by up to 25 times. Thereafter, they declined sharply in February to a mere 0.11 guilders/aas. This represents a substantial decline from prices in the first five days of February, but it still exceeds the price of attained on January 23. Even though many modern economists have given several possible explanations for the rapid rise and fall in tulip prices (and why it might not have been a real “bubble”), there are still many who believe the Tulipmania to have been the first big example of a financial bubble as first suggested by Mackay.

2. The South Sea Bubble of 1720

During the 1700s, the United Kingdom was the world’s most powerful economic force. People in the British Empire were wealthy and eager for new investment opportunities (Investopedia). During that time, the South Sea Company was a British joint stock company that traded in South America. The SSC attracted many investors when it purchased the "rights" to all trade in the South Seas with an IOU to the British government worth 10 million pounds. At the beginning of September 1720, SSC’s shares had a market value of 164 million pounds. The visible asset supporting this price was a flow of revenue from the Company's claim against the government of 1.9 million pounds per year until 1727 and 1.5 million pounds from then onwards (amounting to an overall 40 million pounds at a 4% discount rate). On the other hand the SSC had agreed to pay 7.1 million pounds for the conversion privilege and owed 6 million pounds in bonds and bills for a net asset value of 26.1 million pounds (Garber, 1990). In addition, the Company's cash receivables were 11 million due on loans and 70 million due from cash subscribers. As can be seen, share values exceeded asset values by more than 60 million (or even worse, more than five times if the dubious value of the company's cash claims is taken into account). What intangible assets could have justified this market value? “The answer lies in Law's prediction of a commercial expansion associated with the accumulation of a fund of credit.” Not only did the SSC succeed in gathering this fund, but it was also supported by the Parliament throughout its endeavors. The SSC’s repeated stock re-issues were not questioned by anyone, investors just continued buying the appreciating stocks as soon as they were offered. What mattered to investors was not the level of expertise of the company’s management; they cared only about the huge amounts of money that the SSC was supposedly generating. Towards the end of summer 1720, SSC’s managing team realized that SSC’s share price did not reflect the company’s actual value or its dismal earnings. As a result they sold their shares, hoping that this would go unnoticed by the other shareholders. However, this was not the case. The news spread quickly and a massive panic selling of the worthless certificates followed (Investopedia). The experiment was terminated with the liquidity crisis and the withdrawal of parliamentary support while it was still in its finance stage. A complete crash was avoided due to the British Empire’s powerful economic position and government's intervention which helped stabilize the banking industry. In retrospect, while it is true that investors may have been unduly optimistic in paying 300 or 400 for a share of the company’s stock, there was at least a possibility that their confidence would have been rewarded at some point. “The episode is readily understandable as a case of speculators working on the basis of the best economic analysis available and pushing prices along by their changing view of market fundamentals.”

3. The Mississippi Bubble 1720

Soon after the appearance of the South Sea Company, another British company, the Mississippi Company, was established in France. The Mississippi Company was a creation of John Law, an exiled Scottish economist. John Law had a scheme to refinance the French debt by having the success of The Mississippi company combine investor fervor and the wealth of its Louisiana prospects into a joint-trading company (Garber, 1990). The Mississippi Company caught the eye of most continental traders and provided a good opportunity for them to invest their money. Soon enough, the Company's stock was worth 80 times more than all of France’s gold and silver. Law also began collecting defunct companies to add to his massive conglomerate (Investopedia). He created the Banque Generale, a note-issuing bank and then organized the Compagnie d'Occident to take over the monopoly on trades with Louisiana, Canadian beaver skins and the tobacco industry (Garber, 1990). In order to provide financing for the company, Law took subscriptions on shares to be paid in government debt and converted the debt into rentes, offering an interest rate reduction. By acquiring the East India and China companies, he monopolized French trade outside Europe. Law also purchased the right to mint new coinage and collect all indirect French taxes. At that point, he was made controller of all government finance and expenditure under King Louis XV. Finally Law determined to refund most of the French national debt through the Compagnie and undertook three stock sales. The company’s shares became popular so more paper bank notes were needed, therefore the bank and the company united and were successful until the government admitted that the paper notes being issued by the Banque were more than its metal coinage. The "bubble" burst when opponents of Law attempted to massively convert notes to gold, forcing the bank to stop payment on its paper notes (Garber, 1990).

4. The Late 1920s Stock Price Bubble 1927-29 In the 1920s the stock market did not appear as a risky investment in the investors’ eyes. The US was enjoying a period of prosperity and boom, and people were looking for lucrative investments and “easy ways” to make money. More and more people started investing in the stock market, which led to increasing stock prices from 1925 through 1927. In 1928, the strong bull market (when prices are increasingly rising) led more and more people to invest and by 1928, a stock market boom had begun. This boom changed investors’ viewpoint of the stock market, which had now become a place where everyone could become rich. Interest rates surged upwards. However, not everyone who wanted to become rich had the money to purchase these ever appreciating stocks. As a result many people bought stocks on margin. Buyers would put down some of their own money to buy the stock (barely 10-20% in the 1920s), and they would borrow the remaining money from a broker. However, many people failed to realize how truly risky buying on margin was. If the price of stock decreased to a level lower than that of the loan amount, the broker had the right to issue a "margin call," and thus the buyer would have to come up with the money borrowed immediately. On March 25, 1929, the market was subject to a small crash. Prices started falling, resulting in panic all over the US as margin calls were issued. However, as banker Charles Mitchell announced that his bank would continue lending, the panic subsided. During the summer of 1929 share prices increased again, peaking on the 3rd of September 3 when the Dow Jones closed at 381.17. In the two following days the drop began. Share prices fluttered from September to October until they dropped heavily on Black Thursday. In the morning of October 24 (Black Thursday) people were selling massively. Margin calls were sent out and there was massive panic. However, in the afternoon the panic subsided, as a group of bankers pooled their money and invested them into stock market. The bankers’ willingness to invest their own money convinced people to stop selling. By the end of black Thursday, many were buying again reaching total of 12.9 million shares bought which was double the previous record. Nonetheless, the market fell again four days later, and there was no-one who could save it. Four days later the stock market fell again because people were still scared and they wanted to get out before they lost all their money. October 29 or "Black Tuesday," is known as the worst day in stock market history. The orders to sell were so many that the ticker fell behind. Everyone was in panic and they could not get rid of their shares fast enough. Since everyone was selling (over 16.4 million shares) and almost no one was buying prices collapsed. Afterwards, the stock market was closed for a few days, but continued dropping thereafter until the end of November. Over the next two years, it continued dropping, reaching its lowest in July 1932 when the Dow Jones closed at 41.22. In conclusion, the stock market crash of 1929 devastated the economy, as most people lost their savings, many companies went bankrupt and faith in the banking industry was ruined.

5. The Surge in Bank Loans to Mexico and Other Developing Countries in the 1970s

With the rise in petroleum prices in the mid 1970's dollars flowed to the petroleum-exporting countries, which found it increasingly easier to gain access to loans. Furthermore, in the spring of 1970 the Fed adopted an expansive monetary policy. US Banks were very liquid and looked for attractive borrowers which they found in Third World governments and government-owned firms, mostly in South America. Because of the sharp increase in commodity prices, nominal incomes and real incomes in Mexico, Brazil, and most other developing countries were increasing (Kindleberger). For example, Mexico’s government had more revenue from its petroleum exports and at the same time it could borrow vast amounts from international banks. At the time there was a great need for capital investments. As funds started flowing abundantly many investment projects were approved, even though some of them were not necessarily valid. Many of these investments (corruption aside) were unable to generate enough revenues to cover the costs. In 1979 oil prices increased even further due to Iran’s temporary exit from the market, thus leading to Mexico borrowing even more. Its debt level mounted and the interest to be paid increased. However, this did not seem problematic at the time. The increase in oil prices had caused an increasing inflation rate, and moderate anti-inflationary measures were not working in the US. As a result, in order to fight this increasing inflation in the autumn of 1979 the Fed implemented a new, tight monetary policy. Restrictions on the growth rate of the money supply brought the prime interest rate, the interest rate banks charge their best commercial customers, from 12% to 24%. Borrowers whose loans had floating interest rates were suddenly faced with doubled interest payments. In Mexico, as interest payments were increasingly higher, income from oil sales started decreasing because Iran was back in the market, and non-OPEC countries were expanding their production. Oil prices started decreasing. Furthermore, the high interest rates in the U.S. discouraged investment and produced a recession in the U.S which led to worldwide recession. In 1982 the dollar’s value increased with respect to foreign currencies such as the Mexican peso, the Brazilian cruzeiro, the Argentinean peso, and the currencies of the other developing countries which depreciated sharply. These developing countries were subject to what is called “the original sin” – their loans were denominated in dollars, whose value was rising with respect to the declining value of their currency. As a result it cost them more of their national currencies to repay their loans. In the 1980s commodity prices declined sharply, as did nominal and real incomes declined in the developing countries. Most of the banks in these countries failed as a result of the large loan losses.

6. The Bubble in Real Estate and Stocks in Japan 1985-89

Japan experienced an economic boom during the second half of the 80s, as real estate prices had increased 10 fold, and share prices by 6-7 fold. The major Japanese banks increased their deposits, loans and capital much more quickly than banks anywhere else in the world; at the time seven or eight of the ten biggest banks throughout the globe were Japanese. A mania began, which was coupled with economic euphoria. During the 1985-89 period credit was abundant and Japanese firms invested an increasingly high amount of money in new or existing business ventures, since they could borrow huge amounts from their bankers. Money seemed ‘free’, as it always does during manias, and people went on consumption and investment sprees (i.e: 10 thousand items of French art were bought). Real estate investors earned rates of return of almost 30% yearly, which led many firms to the conclusion that investing in real estate would be much more lucrative and beneficial to them than engaging in other types of production, manufacturing etc. Most firms invested large sums in real estate with borrowed money. However, rents were not increasing at the same pace as real estate. As a result many of the borrowers did not have enough income to repay some of their loans, and had to increase their debt outstanding in order to do so. At the start of 1990, Bank of Japan’s governor advised banks to decrease the growth of new real estate loans. As a result, these loans started increasing at 5-6% yearly instead of the previous 30%. At this point some investors that needed to refinance by paying their outstanding debt through new loans were unable to do so. This meant that they had to sell their real estate, which marked the beginning of the bubble’s implosion. In 1990 the Nikkei stock bubble finally collapsed, exposing many bad real estate loans by various institutions, and thus facing the Japanese government with the big question: what amount of the burden should be put on taxpayers? During the next few years many Japanese banks and institutions went bankrupt but stayed in business only due to the implicit understanding that the Japanese government would protect depositors from losses if the banks went bankrupt. What is particular about the Japanese story is the fact that it involved both a mania and a crash, but without the associated panic, because people believed the government would socialize their loan losses.

7. The 1985-89 Bubble in Real Estate and Stocks in Finland, Norway, and Sweden

During the same time as the Japanese bubble, the Scandinavian countries experienced an even larger increase in stock and real estate prices with a three-fold increase in Norway and an almost five-fold increase in Sweden and Finland. These countries almost replicated the Japanese bubble. In 1985, one of the major reasons of credit expansion was the financial liberalization and deregulation that prevailed in the Scandinavian countries. At the time there was an increasing competitiveness among banks with regard to who would make the most real estate loans. This competition result in very low nominal interest rates on loans. In addition, real interest rates were at an even lower level, reaching even negative values due to inflation. The credit expansion led to increasing asset prices, which in turn increased everyone’s ability to borrow. The bubble burst soon enough, causing a collapse of the financial system by leading many banks to bankruptcy and damaging the real sector of the economy at the same time due to the credit disintermediation.

8. The Bubble in Real Estate and Stocks in Thailand, Malaysia, Indonesia and Other Asian Countries 1992-97.

During the second half of the 1990s the “dragon economies”, Thailand, Malaysia, Hong Kong and South Korea (as well as some other South East Asian countries) were experiencing a huge upward surge in real estate and share prices, which rose by almost 100% by 1993 (Kindleberger). Investors and firms from all over the world started investing in the dragon economies due to their cheap supply costs and wages. At the same time, international banks provided an increasing number of loans to these countries. However, during the autumn of 1996, domestic Thai lenders started experiencing loses because they had not been careful in evaluating the capabilities of their borrowers to repay their loans. This led to a halt in international lenders’ purchases of Thai stocks. The Thai Baht experienced a speculative attack, as the Bank of Thailand became unable to support the Baht by selling foreign reserves. As the asset bubble in Thailand burst, all the surrounding Asian countries were subject to contagion and huge declines in asset prices. The devaluation of the baht in 1997 led to big outflows of capital from these countries and the values of their currencies depreciated along with the baht (with the exceptions of the Hong Kong dollar and China’s yuen). The South East Asian countries were subject to deteriorating current accounts and an ever-increasing foreign debt (Dornbusch 1998, Sachs 1997b). Many banks went bankrupt after the second half of 1997, with the only exception of some banks in Singapore and Hong Kong). In some of these countries, the currency crises triggered banking crises, while in some others the opposite happened. Banks incurred losses of incredible amounts and economic growth slowed down significantly. An interesting aspect of the South East Asian bubble has to do with the dynamics of international investment flows that characterized it (Jones and Pfaffenzeller, 1998). According to Wolf (1998a) foreign lenders, especially commercial banks, were the main agents in producing the rapid capital outflow and the overreaction with respect to the underlying fundamental weaknesses. According to the IMF on the other hand, foreign speculators had an important influence in the production of the crises due to their attack on the Baht, but they had a much smaller impact on the crises in the other countries. “An outflow of funds from the region was likely to be destabilizing, considering the fragile local banking systems and the asset price distortions produced by the previous strong capital inflow” (Jones and Pfaffenzeller, 1998). The crises had even bigger consequences as it spread to Russia, where the ruble was depreciated and a banking crises followed in 1998 (Kindleberger).

9. The Bubble in Over the Counter Stocks in the US 1995-2000 (the Dot-com Bubbles).

During the 1990s software-producing companies were becoming very prominent and had a strong performance. This sparked an increasing enthusiasm, which resulted in the creation of various small software startups by students and other inexperienced young enthusiasts. At some point, a large portion of these startups became the object of attention in venture capitalists’ eyes, who started financing them and taking them public with the hope of gaining huge profits in the future (Colombo). These companies started paying their workers with shares on the company’s value, which would eventually become very profitable as soon as the company IPO-ed. This process was further fueled by the public availability of the internet from 1994 onwards. As the internet became very popular and commercialized, various online startups and their owners started becoming rich. Technology stocks appreciated more and more, creating incentives for many startups to IPO. A vast number of founders and employees which were shareholders in these technology companies became very wealthy overnight as soon as their companies went public. These companies rewarded their employees in stock options, which were supposed to be more and more valuable as the internet stocks continued their appreciation. There was speculation among economists that a “New Economy” had began, an era of economic boom and prosperity, in which recessions and inflation where a thing of the past. Between 1996 and 2000 there was an explosion in the NASDAQ stock index which went up from 600 to 5,000 points (Colombo). However, many of the companies which were going public and raising millions were lacking proper business plans or even worse had no earnings at all. In the beginnings of the year 2000, investors started realizing that the dot-com dream had turned into a typical speculative bubble. Within months, the NASDAQ stock index crashed from 5,000 to 2,000 (Colombo). Many stocks with multi-billion dollar market capitalizations became valueless and disappeared as quickly as they had appeared at first. A massive panic selling followed, as NASDAQ had dropped to only 800 by 2002 and the market’s value had dropped by trillions. Simultaneously, many accounting scandals were discovered, in which these companies had artificially inflated their profits. After the dot-com bubble, recession spread all over the US, forcing the Fed to cut interest rates over and over again to help the economy. Many technology employees were out of jobs and out of savings as well (since most of them were paid in stock options).

10. The Real Estate Bubble in the US, Britain, Spain, Ireland and Iceland 2002-2007 and the Greek Sovereign Debt Crisis.

The latest bubble of our times has been thoroughly analyzed and talked about recently in newspapers, books and media. Since very thorough Wikipedia articles already exist on the subject, to avoid falling into repetition, or providing too short an analysis, this section will only provide a link to these articles.

	United States Housing Bubble : http://en.wikipedia.org/wiki/United_States_housing_bubble 	Greek Government-Debt Crisis http://en.wikipedia.org/wiki/Greek_government-debt_crisis

11. Common Features and Characteristics

Throughout this detailed analysis of the ten biggest financial bubbles of our times, what strikes us the most is the fact that all of them are so similar to each-other in many different ways. As a result of these similarities, by looking at these past bubbles we could maybe draw conclusions that could help us in the future.

The most striking characteristics that these bubbles have in common are the following: -	Economic boom followed by a mania stage associated with euphoria, overinvestment and overconsumption. -	Over optimism -	Credit expansion -	Money seems “free” -	Shock -	Ensuing Bank failures

Let us analyze each of these characteristics separately. 1. Economic Boom followed by Mania Stage Starting from the Dutch Tulipmania of 1636, and through the 2002-07 bubbles, all these bubbles start with a phase of economic boom and prosperity. Things are going well in the economy, asset prices are on the rise and people are becoming wealthier and looking for ways to lucratively invest their money. The boom is always followed by a mania phase. “During these euphoric periods an increasing number of investors seek short-term capital gains from the increases in the prices of real estate and of stocks rather than from the investment income based on the productive use of these assets” (Kindleberger). People make down payments on apartments in the preconstruction phase anticipating that they will be able to sell them at big profits when the buildings are finished or else they buy extremely overinflated shares in the hopes that their prices will increase even further and they will earn a large profit margin when selling them (the same idea stands for: i.e: tulip bulbs). There was a mania phase in Japan in the 1980s, with regard to stocks and real estate, as well as in the Scandinavian countries during the same time period. Manias where also the surge in purchases of tulip bulbs in 1636, in the overpriced shares of the Mississippi and South Sea Companies and in the overinvestment in the South East Asian economies in the 1990s and Mexico in the 1970s. The same phenomenon can be observed in the US Stock market in 1920, during the last decade of the 20th century as well as in the recent mortgage mania of 2002-2007.

2. Over-optimism In all the bubbles studied above, the mania stage is associated with over-optimism. People go spending and investing sprees with the hope and faith that the upward trend of the asset prices will continue, and they will be able to send them in the future, reaping a large profit. This was the case with tulip bulbs, SSC and MC shares, as well as in all the other 7 bubbles, when investors were overconfident that assets would continue appreciating endlessly, recessions were old news etc.

3. Credit Expansion Due to these beliefs that things are looking up, the economy is booming and solid, and asset prices will continue their upward trend, underwriting standards are expanded. Lenders become less risk averse and thus loans become available to an increasing amount of people. This can be seen i.e: in the South-East Asian Bubble, where people had access to immense sums of money from both international and domestic lenders, as well as in Mexico in the 70s or in the US in 1920, the second half of the 1990s or during the 2002-07 bubble. According to Kindleberger’s interpretation of Minsky, the expansion of credit is exactly what fuels the boom even further. During this time, “money seems free”. Everyone rushes to buy assets “before it becomes too late” at what they think are bargain prices. Most of these asset purchases are financed by loans.

4. Shock During this period of boom and prosperity, there comes a point when asset prices reach their peak. Then, in all of our bubbles a shock occurs. These shocks are of a specific nature which differs from one bubble to the other. This shock can be a change in government policy, or an unexpected bankruptcy of an important bank or firm as well as many different other events which bring the asset appreciation to a halt. Soon enough, investors who had bought most of their assets on credit start panic selling, trying to get out before it’s too late. This triggers mass panic and sharp depreciations in asset prices, which sometimes depreciate to levels far below their original price, making it impossible for the investors to repay their loans. A self-fulfilling attack occurs – people’s fear that assets will become worthless leads them to sell so much that they actually end up becoming worthless. Many firms and banks go into bankruptcy, people lose most of their money and crises follow.

In conclusion, “the cycle of manias and panics results from the pro-cyclical changes in the supply of credit; the credit supply increases relatively rapidly in good times, and then when economic growth slackens, the rate of growth of credit has often declined sharply” (Kindleberger).

In conclusion, the financial bubbles discussed in this article are big both in size and in their consequences, and most importantly they are international, since they often involve many different countries simultaneously or sequentially. It is of great interest to study these bubbles and their similarities in order to draw conclusions for the future by not repeating the mistakes of the past. However, despite the many similarities, each bubble and the ensuing crisis have their own particularities. As a result it is practically impossible to have an unfaultable recipe for economic prosperity, with no bubbles, no crises and no recessions. These cycles of boom and bust have repeated throughout the centuries, and will probably continue to do so in the future.