Manias and credit

The production of books on financial crises is counter-cyclical. A spate
of books on the topic appeared in the 1930s following the U.S. stock
market bubble in the late 1920s and the subsequent crash and the Great
Depression. Relatively few books on the subject appeared during the
several decades immediately after World War II, presumably because the
recessions from the 1940s to the 1960s were mild.

The first edition of this book was published in 1978, after U.S.

stock prices had declined by 50 percent in 1973 and 1974 following a

fifteen-year bull market in stocks; the stock market debacle and the U.S.

recession led to the bankruptcies of the Penn-Central railroad, several of

the large steel companies, and a large number of Wall Street brokerage

firms. New York City was on the verge of default on its outstanding

bonds and was saved from insolvency by the State of New York. Not

quite a crash, unless you were a senior official or a stockholder in one

of the firms that failed or the Mayor of New York City.

This edition appears after thirty tumultuous years in global financial

markets, a period without a good historical precedent. There was a mania

in real estate and stocks in Japan in the 1980s and a crash in the 1990s;

during the same period there was a mania in real estate and stocks in

Finland and Norway and Sweden and then a crash. There was a mania in

U.S. stocks in the second half of the 1990s—the subsequent 40 percent

decline in stock prices probably felt like a crash for those who owned

large amounts of Enron, MCIWorldCom, and dot.com stocks. Compar-

isons can be made between the stock market bubbles in the United States

in the 1920s and the 1990s, and between these U.S. bubbles and the one

in Japan in the 1980s.

The big ten financial bubbles

The Dutch Tulip Bulb Bubble 1636

The South Sea Bubble 1720

The Mississippi Bubble 1720

The late 1920s stock price bubble 1927–1929

The surge in bank loans to Mexico and other developing countries

in the 1970s

The bubble in real estate and stocks in Japan 1985–1989

The 1985–1989 bubble in real estate and stocks in Finland, Norway

and Sweden

The bubble in real estate and stocks in Thailand, Malaysia, Indonesia

and several other Asian countries 1992–1997

The surge in foreign investment in Mexico 1990–1993

The bubble in over-the-counter stocks in the United States

1995–2000

The earliest bubble noted in the box involved tulip bulbs in the Nether-

lands in the seventeenth century, and especially the rare varieties of

bulbs. Two of the bubbles—one in Great Britain and one in France—

occurred at more or less the same time, at the end of the Napoleonic

Wars. There were manias and financial crises in the nineteenth cen-

tury that were mostly associated with the failures of banks, often after

an extended investment in infrastructure such as canals and railroads.

Foreign exchange crises and banking crises were frequent between 1920

and 1940. The percentage increases in stock prices in the last thirty years

have been larger than in earlier periods. Bubbles in real estate and in

stocks have often occurred together; some countries have experienced

a bubble in real estate but not in stocks, while the United States had a

stock price bubble in the second half of the 1990s but not one in real

estate.

Manias are dramatic but they have been infrequent; only two have oc-

curred in U.S. stocks in two hundred years. Manias generally have been

associated with the expansion phase of the business cycle, in part because

the euphoria associated with the mania leads to increases in spending.

During the mania the increases in the prices of real estate or stocks or in

one or several commodities contribute to increases in consumption and

investment spending that in turn lead to accelerations in the rates of eco-

nomic growth. The seers in the economy forecast perpetual economic

growth and some venturesome ones proclaim no more recessions—

the traditional business cycles of the market economies have become

obsolete. The increase in the rate of economic growth induces investors

and lenders to become more optimistic about the future and asset prices

increase more rapidly—at least for a while.

Manias—especially macro manias—are associated with economic eu-

phoria; business firms become increasingly up-beat and investment

spending surges because credit is plentiful. In the second half of the

1980s Japanese industrial firms could borrow as much as they wanted

from their friendly bankers in Tokyo and in Osaka; money seemed ‘free’

(money always seems free in manias) and the Japanese went on a con-

sumption spree and an investment spree. The Japanese purchased ten

thousand items of French art. A racetrack entrepreneur from Osaka paid

$90 million for Van Gogh’s Portrait of Dr Guichet, at that time the high-

est price ever paid for a painting. The Mitsui Real Estate Company paid

$625 million for the Exxon Building in New York even though the initial

asking price had been $310 million; Mitsui wanted to get in the Guin-

ness Book of World Records for paying the highest price ever for an office

building. In the second half of the 1990s in the United States newly-

established firms in the information technology industry and bio-tech

had access to virtually unlimited funds from the venture capitalists who

believed they would profit greatly when the shares in these firms were

first sold to the public.