Chief Executive Briefing #26. A Brief History of Financial Crises

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Chief Executive Briefing #26 A Brief History of Financial Crises Those who cannot remember the past are condemned to repeat it George Santayana There is nothing new only the history you haven t read

1 Chief Executive Briefing #26 A Brief History of Financial Crises Those who cannot remember the past are condemned to repeat it George Santayana There is nothing new only the history you haven t read Larry Swedroe There is nothing so disturbing to one s well being and judgment as to see a friend get rich James Stewart Consider with attention what has been the conduct of almost all the great unfortunate, either in private or public life and you will find that the misfortunes by far the greater part of them have arisen from their not knowing when they were well, when it was proper for them to sit still and be contented Adam Smith All life is suffering the source of all suffering is desire Buddhist teaching il dolce far niente The sweet art of idleness (doing nothing) PO Box Greenville, SC F

2 I. General Considerations A. A knowledge of history is not essential in many fields, but it is imperative in finance B. Is history repetitive and cyclical or non-repetitive and progressive? C. The great engine of stock returns is the rate of technological progress D. The technological explosion that occurred from 1820 to 1850 was one of the deepest and most far-reaching in human history 1. In 1802, nothing moved faster than the horse 2. With the invention of the steam engine, transportation increased almost 10-fold 3. With the invention of the telegraph, communication became almost instantaneous 4. The economic and financial effects of technological revolutions do not occur immediately 5. Inventors seldom make as much money as those who can apply the new technology (Al Gore did not get rich by inventing the Internet) E. The effect of going from defined benefit plans to defined contribution plans forced financially uneducated people to become investors. II. Necessary conditions for a bubble: A. A major technological revolution or shift in financial practices B. Liquidity i.e. expansion of easy credit C. Amnesia for the last bubble. Usually takes 30 years D. Abandonment of time honored methods of security valuation, usually caused by the takeover of the market by inexperienced investors

3 III. Government debt financing of wars A. The U.S. Revolutionary War was the first to be funded by worthless paper money 1. The Continental Congress was authorized to print money, take on debt, raise an army, and make purchases, but it did not have the power to levy a tax to pay for any of that 2. Robert Morris personally helped to pay the debt B. The South Seas bubbles developed simultaneously in England and France. 1. The English and French became addicted to using debt to fund wars 2. Both countries made deals with private companies whereby citizens could exchange their government bonds for shares in the private companies thus relieving the government of its crushing war debt IV. It takes two to tango A. Insiders destabilize the market by driving the price up and selling at the top. B. Outsiders buy at the top and sell at the bottom as insiders are driving the price down. C. Wealth is not destroyed. The insiders' gains equal the outsiders' losses V. The Ponzi scheme A. Charles Ponzi agreed to pay 50% interest for the use of deposits for fortyfive days or 100% for ninety days B. He would repay old debt with the issuance of new debt C. In a few months in 1920, Ponzi raised 7.9 million D. The U.S. Government is one of the most successful users of the Ponzi scheme

4 VI. Tulipmania A. The tulip is not native to the Netherlands B. The most coveted tulip was the Semper Augustus a broken tulip C. Originally trading tulip bulbs was limited to 1. Growers 2. Apothecaries 3. Connoisseurs D. The creation of florists 1. They had no interest or skill in growing or enjoying tulips 2. Florists were in the market strictly for the profit 3. Used in-kind payments to increase the money supply E. Development of a futures market 1. Promissory notes 2. It became normal for florists to sell tulips they did not have to other florists who did not have the money to buy them 3. Promissory notes changed hands as much as ten times a day F. Anonymous pamphlets hawked the value of tulips and their profitability G. In 1636, 360 different commodities were traded on the Amsterdam exchange Tulips were not among them H. The trading in tulips took place in churches and taverns by country people and poor city dwellers who had absolutely no knowledge of or experience in investing I. The colleges of growers and dealers met in inns with such names as The Golden Grape, Beelzebub and Devil on a Chain 1. The inns frequently doubled as brothels 2. Traders would arrive in Haarlem (west of Amsterdam) by canal boat

5 3. The inns would be filled with smoke from the open fireplaces and the long-stemmed clay pipes. 4. Apothecaries promoted tulip bulbs as prodigious 5. The colleges met two or three times a week for one to two hours. As the mania progressed some colleges met for more than 24 hours 6. Each deal was celebrated with a call for wine 7. Bulbs were put up for auction and each transaction recorded by a secretary of the college J. The mania reached its peak in December 1636 and January 1637 and crashed on February 3, The bulbs were in the ground and would not be lifted until late spring 2. It was now possible for a florist or grower who owned no bulbs to trade or sell to a buyer who had no money to buy K. The bust came on Tuesday, February 3, A college met in one of Haarlem s taverns. 1. As usual, it was customary for the auctioneers to test the state of the market by offering for sale a pound of tulips that had a known and consistent price a. The pound of tulips was offered at 1250 guilders there were no offers b. The price was cut to 1100 guilders there were no offers c. The price was cut to 1000 guilders there were still no offers 2. There was an awkward silence 3. The traders had no idea what to do. Bedlam broke out 4. When the news spread, every trader in town wanted to sell VII. It ain t over till it s over A. In the 1700 s in the Netherlands, another bubble was created involving hyacinths

6 VIII. Like the man said it ain t over till it s over A. In the early 1980 s in China, Spider Lily bulbs were seen selling for $20.00 B. By 1985, they were selling for $50,000 IX. Like the man said, It ain t over till 1. In terms of speed, severity, and losses the spider lily mania surpassed the tulip mania. A. Booms have occurred in canals and elaborate public clocks B. The Florida land boom of New roads, railroads, and draining of swamp lands made Florida popular after Rich Americans bought vacation homes in Miami 3. Poor people became attracted 4. Land that sold for $30.00 an acre before 1920, sold for $75,000 an acre in Land in Miami became more valuable than land on Fifth Avenue in New York 6. In 1925, the Miami Daily News ran 504 pages, almost all related to real estate 7. There were 25,000 real estate agents in Miami 8. The crash came in late autumn of 1925 a. The number of winter visitors to the state was 10% of what was expected b. Sellers received only their deposits if they were lucky c. Banks failed d. Rents plunged from $ a month to $35.00 a month in Miami

7 X. The last step of a bubble is when poor, amateur speculators get in the market XI. It still ain t over yet. A. A shoeshine boy named Billy caused Joe Kennedy to get out of the market one week before the 1929 crash B. Going from defined benefit plans to defined contribution plans forced amateurs to make their own investment decisions A. On the Florida Alabama Gulf Coast 20,000 condominiums are scheduled to be built in the next two years, ranging in price from $125,000 to over $1 million B. People are making fortunes in real estate C. You can buy contracts on condominiums before they are out of the ground D. How to finance the down payment 1. Adjustable rate mortgage 2. Cash out re-financing 3. Interest only mortgages 4. Negative amortization loans year mortgages E. Use a Letter of Credit for 20% down payment 1. The cost of the 20% down payment is 3% F. A quote by investor Kathy Martinez - With a letter of credit you are not using any of your cash and protecting your cash is one of the most important things to an investor

International financial crises

International Macroeconomics Master in International Economic Policy International financial crises Lectures 11-12 Nicolas Coeurdacier nicolas.coeurdacier@sciencespo.fr Lectures 11 and 12 International