In Mindful Money, we examine the human drive to ‘keep up with The Joneses’. Nothing exemplifies this drive more than FOMO (otherwise known as Fear Of Missing Out). With Speculative Bubbles, everyone around you is making money hand over fist. And their participation in some no lose scheme that can look irresistible.
Purveyors of Ponzi Schemes and other scams rely on FOMO to reel in the constant flow of new investors. These new investors don’t want to miss out. We see FOMO manifest in markets of all kinds. From stocks to commodities to real estate, misled investors chase illusory gains.
One could argue that we are currently in the midst of several speculative bubbles at this very moment. Cryptocurrencies, NFTs, or real estate may turn out to be bubbles through history’s lense.
FOMO driven bubbles are nothing new. In fact, the oldest speculative bubble we’ll look at today occurred nearly 500 years ago. It involved a commodity that would never even make it onto our bubble radar today: the humble tulip bulb.
With that, let’s dive into seven speculative bubbles that ended in disaster.
The Dutch Tulip Bubble (1634 – 1638)
Also regarded as Tulipmania, the Dutch Tulip Bubble is an excellent example of the financial pitfalls of speculative bubbles. Having arrived in Holland via trade routes in the late 16th century, tulips became prized additions to the gardens of the wealthy and influential. Soon the merchant class, seeking to emulate the elite, began acquiring these status symbols in earnest.
As tulip bulbs and the status they granted their owners grew, prices soared. This kicked off a virtuous cycle where the more expensive the bulbs became, the more status they conferred.
It is said that at its height, a single tulip bulb could cost as much as $750,000 in today’s money. Many bulbs sold for between $50,000 and $150,000. That makes Bitcoin look like a relative bargain!
Everyone and their brother (sister, aunt, uncle, cousin, etc) got in on the action. Many used leverage (borrowed money) to purchase bulbs in hope of paying off their debt once they flipped those bulbs to the next sucker. The whole scheme came crashing down in 1638 merely a year after the peak. This left mountains of speculative debt and broken dreams in its wake.
The South Sea Bubble (1711 – 1720)
This speculative bubble revolved around the perceived fortunes of the South Sea Company which was established in 1711 to trade with Spanish colonies in America. Speculators were betting on a favorable close to the War of Spanish Succession that might include a treaty permitting trade. Unfortunately, the Treaty of Utrecht was not as favorable as many hoped.
In 1717, King George 1st became governor of the company. Catapulting confidence increased interest payments from 6% to a whopping 100%. But the real speculative bubble was to manifest itself in 1720 following Parliament’s approval of South Sea Company to assume Britain’s national debt. Over exuberance catalyzed interest in the company and from January through August 1720, shares rose almost 8x to 1,000 each.
In September of that year, the market crashed. South Sea Company shares plunged nearly 90% ruining investors along the way.
Railway Mania (1840s)
Another speculative bubble occurred in Great Britain and Ireland in the 1840s. It resulted from the repeal in 1825 of the eponymous Bubble Act. Put in place following the South Sea Bubble in 1720 to protect against such things (go figure).
Repealing the Bubble Act opened up investment in new ventures and railroads were the hot tech stocks of their day. These were promoted in newspapers and on the stock markets as foolproof investments (Kind of like NFTs).
What made this bubble particularly pernicious was that all an investor needed to buy stock in a railroad was a 10% deposit. The balance called due by the railroad at some future time. Many families, who could only afford the 10% deposit, invested their entire fortunes in this scheme. Railways proved to be much more difficult to build than promised. Combined with Bank of England interest rate hikes in 1845 that resulted in less cash flowing to railroads, the 90% balances were called. Those heavily invested in these schemes lost everything.
1920’s Stock Market Bubble (1924 – 1929)
With days aptly named Black Monday and Black Tuesday kicking off what would ultimately result in The Dow losing half its value in under three weeks and 90% within four years, this bubble didn’t just pop, it burst. Today, we credit this bubble with starting the Great Depression.
At work here was an expansion of credit that infiltrated the economy in the 1920s. This newly minted credit drove sales of houses, cars, appliances, and the like. It also allowed an ever-expanding group of investors, inspired by a sixfold rise in stock values, to buy stock on margin.
But in September 1929, the stock market experienced gyrations (sudden drops and recoveries) that spooked investors. They began selling their shares in earnest. Even a Hail-Mary pass by the Federal Reserve Bank of New York in October 1929 of publicly purchasing large blocks of stock at high prices wasn’t enough to instill confidence, and the stock market plummeted. The rest, as they say, is history.
Japan’s Real Estate and Stock Market Bubble (1984 – 1991)
Resulting in what has come be known as “The Lost Decades”, Japan’s Asset Price Bubble collapse in late 1991 was essentially caused by a systemic loosening of lending standards and money expansion. This was itself driven by loan growth quotas dictated by The Bank of Japan.
The result? Rampant speculation and massive inflation which drove the Nikkei Stock Index to a record high of 38,957.44 on December 29, 1989. Unfortunately, The Bank of Japan had to rein in inflation. It hiked rates from 2.5% to 4.25% in 1989 and hike them again in 1990 to 6%. The fallout was swift.
By December 1990, the Nikkei dropped to 23,849, losing nearly 40%. By 1991 land prices in Tokyo fell sharply with other regions following suit. The Nikkei fell nearly another 1,000 points and by 1992, the Nikkei fell as low at 15,951. Stagnation followed and has dogged the Japanese economy for decades since. In fact, as of the publishing of the article in 2022, the Nikkei stood at 27,553 having never recovered its 1989.
Dot Com Bubble (early 2000s)
While you may to too young to have lived through the Great Depression or the Japanese Asset Bubble, you might be old enough to remember The Dot Com Crash. This was a heady time of abundant money, speculative investing, and rapid and extreme equity value appreciation. I remember it well. I was working for a Silicon Valley startup that IPO’d in 1999 only to go bankrupt in 2000 when the money dried up. And I can tell you from personal experience that the Joneses were chasing every IPO with a dot-com appended onto the end of it.
Plentiful venture capital funds financed and took public an endless array of ‘dot com’ startups selling and doing everything under the sun. Pick any noun from Webster’s Dictionary. There was probably someone that dot-com’d it and took it public between 1995 and 1999.
Internet companies lacking any kind of technical or other differentiation poured money into marketing. Some spent upwards of 90% of their annual budgets on advertising. To illustrate this, Super Bowl XXXIV (Kurt Warner was the MVP!) saw 14 different dot-com companies pay an average of $2.2 million each per spot. Ever heard of LastMinuteTravel.com, OurBeginnings.com, Pets.com, Computer.com, or Epidemic.com? Well, many investors would soon wish that hadn’t heard of them either.
On March 10, 2000, just a couple of months after Super Bowl XXXIV, the Nasdaq reached a high of 5048 following 457 IPOs in 1999 and another 91 in the first quarter of 2000. At this apex, Dell and Cisco, looking to cash out, placed huge sell orders on their stocks and panicked the market, causing an initial 10% correction. By October 2002, the Nasdaq had crashed to 1140, losing nearly 80% of its value. By then, the majority of dot-com IPOs had folded and taken billions of dollars with them to their graves.
U.S. Housing Bubble (2007 – present)
Another bubble you may remember well and is associated with terms like credit default swaps, subprime mortgages, and The Great Recession. Like so many of the others mentioned here, this bubble was inflated with easy money that was easily lent to people who could not repay it.
There was even something known as a liar loan. Essentially, a borrower could simply ‘state’ their income and nobody, including the bank or its underwriters, would ever actually check to see if the borrower was being truthful. They simply looked the other way. It was so easy to get a loan, people bought way more house than they could afford and/or bought multiple houses.
With all of these unqualified buyers flooding the market, housing prices rose rapidly. It wasn’t to last since the demand was artificial. Before long, these unworthy borrowers did what unworthy borrowers do: they defaulted, en masse! A painful market correction ensued. Housing prices plummeted. The stock market crashed. Huge corporate bankruptcies and bailouts (GM, Chrysler, all the ‘Too Big To Fail’ Banks, etc) followed. And a Great Recession resulted job losses, particularly in construction which grinded to a halt. This due to a market flooded with an endless supply of discounted and foreclosed homes. Ramifications are still being felt today. Chronic under construction since 2008 is one of the primary reasons we are seeing demand outstrip supply in 2022. The result, stubbornly high housing pricing soaring to new record highs.
Not So Easy to Spot
Speculative bubbles are easily spotted and intensively studied and critiqued in hindsight. But they are not so easy to spot when we’re in the midst of them. Are today’s crazy housing prices a bubble? What about crypto? Growth stocks? NFTs?
Only time will tell. In the meantime, if the Joneses are climbing over each other to get a piece of something, it’s best to turn and walk the other way. The only fear you should have of missing out is missing out on the inevitable crash.
