The Collapse of Barings Bank
In February of 1995, one man single-handedly bankrupted the bank that financed the Napoleonic Wars, Louisiana Purchase and the Erie Canal. Founded in 1762, Barings Bank was Britain’s oldest merchant bank and Queen Elizabeth’s personal bank. Once a behemoth in the banking industry, Barings was brought to its knees by a rogue trader in a Singapore office. The trader, Nick Leeson, was employed by Barings to profit from low risk arbitrage opportunities between derivatives contracts on the Singapore Mercantile Exchange and Japan’s Osaka Exchange. A scandal ensued when Leeson left a $1.4 billion hole in Barings’ balance sheet due to his unauthorized derivatives speculation, causing the 233-year-old bank’s demise.
Nick Leeson grew up in London’s Watford suburb, and worked for Morgan Stanley after graduating university. Shortly after, Leeson joined Barings and was transferred to Jakarta, Indonesia to sort through back-office mess involving £100 million of share certificates. Nick Leeson enhanced his reputation within Barings when he successfully rectified the situation in 10 months (Risk Glossary).
In 1992, after his initial success, Nick Leeson was transferred to Barings Securities in Singapore and was promoted to general manager, with the authority to hire traders and back office staff. Leeson’s experience with trading was limited, but he took an exam that qualified him to trade on the Singapore Mercantile Exchange (SIMEX) alongside his traders. According to Risk Glossary:
"Leeson and his traders had authority to perform two types of trading:
1. Transacting futures and options orders for clients or for other firms within the Barings organization, and
2. Arbitraging price differences between Nikkei futures traded on the SIMEX and Japan's Osaka exchange.
Arbitrage is an inherently low risk strategy and was intended for Leeson and his team to garner a series of small profits, rather than spectacular gains।"
As a general manager, Nick Leeson oversaw both trading and back office functions, eliminating the necessary checks and balances usually found within trading organizations. In addition, Barings’ senior management came from a merchant banking background, causing them to underestimate the risks involved with trading, while not providing any individual who was directly responsible for monitoring Leeson’s trading activities (eRisk). Aided by his lack of supervision, the 28-year-old Nick Leeson promptly started unauthorized speculation in futures on Nikkei 225 stock index and Japanese government bonds (Risk Glossary). These trades were outright trades, or directional bets on a market. This highly leveraged strategy can provide fantastic gains or utterly devastating losses; a stark contrast to the relatively conservative arbitrage that Barings had intended for Leeson.
Nick Leeson opened a secret trading account numbered 88888 to facilitate his furtive trading. Risk Glossary says of Leeson:
He lost money from the beginning. Increasing his bets only made him lose more money. By the end of 1992, the 88888 account was under water by about GBP 2MM. A year later, this had mushroomed to GBP 23MM. By the end of 1994, Leeson's 88888 account had lost a total of GBP 208MM. Barings management remained blithely unaware.
As a trader, Leeson had extremely bad luck. By mid February 1995, he had accumulated an enormous position—half the open interest in the Nikkei future and 85% of the open interest in the JGB [Japanese Government Bond] future. The market was aware of this and probably traded against him. Prior to 1995, however, he just made consistently bad bets. The fact that he was so unlucky shouldn't be too much of a surprise. If he hadn't been so misfortunate, we probably wouldn't have ever heard of him.
Betting on the recovery of the Japanese stock market, Nick Leeson suffered monumental losses as the market continued its descent. In January 1995, a powerful earthquake shook Japan, dropping the Nikkei 1000 points while pulling Barings even further into the red. As an inexperienced trader, Leeson frantically purchased even more Nikkei futures contracts in hopes to gain back the money already lost. The most successful traders, however, are quick to admit their mistakes and cut losses.
Surprisingly, Nick Leeson effectively managed to avert suspicion from senior management through his sly use of account number 88888 for hiding losses, while he posted profits in other trading accounts. In 1994, Leeson fabricated £28.55 million in false profits, securing his reputation as a star trader and gaining bonuses for Barings’ employees (Risk Glossary). Despite the staggering secret losses, Leeson lived the life of a high roller, complete with his $9,000 per month apartment and earning a bonus of £130,000 on his salary of £50,000, according to “How Leeson Broke the Bank.”
The horrific losses accrued by Nick Leeson were due to his financial gambling, as he placed his trades based upon his emotions rather than by taking calculated risks. After the collapse of Barings, a worldwide outrage ensued, decrying the use of derivatives. The truth, however, is that derivatives are only as dangerous as the hands they are placed in. In this case, Nick Leeson was reckless and dishonest. Derivatives can be tremendously useful if used for hedging and controlling risk or even careful trading.
After a series of lies, cover ups and falsified documents, Leeson and his wife fled Singapore for Kuala Lumpur, Malaysia. By then, Barings’ senior management had discovered Nick Leeson’s elaborate scheme. The total damage suffered by Barings was £827 million, or $1.4 billion. In February 1995, England’s oldest, most established bank was unable to meet SIMEX’s margin call, and was declared bankrupt. Leeson and his wife were arrested in Frankfurt, Germany on March 3 rd , 1995. That same day, the Dutch bank, ING, purchased Barings for a mere £1 and assumed all of its liabilities (eRisk).
Nick Leeson was placed on trial in Singapore and was convicted of fraud. He was sentenced to six and a half years in a Singaporean prison, where he contracted cancer (Risk Glossary). He survived his cancer, and while imprisoned, wrote an autobiography called “Rogue Trader”, detailing his role in the Barings scandal. “Rogue Trader” was eventually made into a movie of the same name. Nick Leeson was released from prison in July 1999 for good behavior.
Wednesday, May 16, 2007
The Nikkei Bubble
The Nikkei Bubble
Can a bear market last for 14 straight years? Well, this is exactly what occurred in Japan, starting in 1991।
After World War II, Japan was devastated-several of its major cities were obliterated and its economy was virtually nonexistent. Due to much effort and hard work, the Japanese economy slowly began to stabilize and recover. Additionally, the United States helped Japan rebuild, and provided capital and military protection, as well. The value of military protection should not be overlooked, as this is usually the highest expense of any government. This benefit allowed the Japanese economy and government run more freely and efficiently.
Factories were quickly built and peasants became factory workers. Middle and upper class men became white collar workers, called salarymen. Salarymen and factory workers were offered lifetime employment. This caused salarymen to have fierce loyalty towards their employers. Most Japanese workers at the time were highly frugal, saving much of what they earned. Many companies merged together to become large industrial and banking conglomerates, called zaibatsu.
The zaibatsu gained their competitive edge by copying and improving Western products and selling them for much cheaper. The cheaper products won Western customers and started to hurt US companies. Tremendous economic growth occurred allowing the zaibatsu to evolve into even larger business alliances, called keiretsu। The keiretsu philosophy was one of cooperation, where all facets of business and government worked hand in hand. As the Japanese stock market soared, the keiretsu purchased each other’s shares.
Factories were quickly built and peasants became factory workers. Middle and upper class men became white collar workers, called salarymen. Salarymen and factory workers were offered lifetime employment. This caused salarymen to have fierce loyalty towards their employers. Most Japanese workers at the time were highly frugal, saving much of what they earned. Many companies merged together to become large industrial and banking conglomerates, called zaibatsu.
The zaibatsu gained their competitive edge by copying and improving Western products and selling them for much cheaper. The cheaper products won Western customers and started to hurt US companies. Tremendous economic growth occurred allowing the zaibatsu to evolve into even larger business alliances, called keiretsu। The keiretsu philosophy was one of cooperation, where all facets of business and government worked hand in hand. As the Japanese stock market soared, the keiretsu purchased each other’s shares.
In the 1970’s, the oil crisis and inflation crippled the global economy. Most American cars had large gas guzzling V8 engines, which cost a fortune to run. Japanese car makers, such as Honda, quickly mobilized to produce small fuel efficient cars. Additionally, these cars cost a fraction of the price of American cars. These cars were quickly increasing in quality, as well. Even as early as the 1960’s, Japanese cars were being assembled with robots, making human error almost nonexistent. This started the decline of the low tech American automobile industry. Throughout this entire boom, the Nikkei stock average was soaring to new heights.
By the 1980’s, Japan added electronics to its list of specialties. Japanese keiretsu corporations, such as Hitachi and Sony, copied and produced quality electronics hardware needed by the growing computer industry. Japan trounced American companies, due to its ability to compete on price, aided by robots and cheap labor. With the exception of microprocessors, Japan dominated the market for all chips, circuit boards and other components. It was widely believed that Sony and Hitachi, would eventually acquire Intel and IBM.
Throughout the 1980’s, Japan became viewed as a utopia, due to its people having the highest quality of life and longest life expectancy. In addition, Japan was the world’s largest creditor and had the highest GDP per capita. Many Americans feared that their workforce would become obsolete due to the use of robots in Japan. With the economy booming and the stock market climbing, Japanese corporations crammed many skyscrapers in Tokyo and Osaka. This caused real estate prices to skyrocket as well. Between 1986 and 1988, the price of commercial land in greater Tokyo doubled. Real estate prices soared so much that Tokyo alone was worth more than the United States! Between 1955 and 1990, land prices in Japan appreciated by 70 times and stocks increased 100 times over. An average home near Tokyo cost well over $2 million in 1989. Large scale stock speculation occurred causing a worldwide mania. Investors all over over the world were vying for Japanese shares. These euphoric investors believed in the fallacy of a perpetual bull market. Luxury goods were purchased in large numbers by the newly wealthy.
Unfortunately, all excessively good things must end. To cool the inflated economy, the Japanese government raised rates. Within months, the Nikkei stock index crashed by over 30,000 points. At its height, the Nikkei stood at 40,000. The Nikkei could crash this far because its value was inflated on false hopes and hype, not solid financials. Eventually, many scandals came to light showing the corruption that always occurs in a bubble’s heyday. Japanese housing prices plummeted for 14 straight years, and may continue in the future. The Nikkei sank until its low of 8,000 in 2003. The Japanese government and corporations are still suffering under unwieldy debt loads gained since the late 1980’s. This debt was used for stock speculation and buying overpriced land. Even today, in 2004, the Japanese economy is still in the doldrums.
Once again, we have seen the development of a bubble and the inevitable stock market crash that always follows it.
By the 1980’s, Japan added electronics to its list of specialties. Japanese keiretsu corporations, such as Hitachi and Sony, copied and produced quality electronics hardware needed by the growing computer industry. Japan trounced American companies, due to its ability to compete on price, aided by robots and cheap labor. With the exception of microprocessors, Japan dominated the market for all chips, circuit boards and other components. It was widely believed that Sony and Hitachi, would eventually acquire Intel and IBM.
Throughout the 1980’s, Japan became viewed as a utopia, due to its people having the highest quality of life and longest life expectancy. In addition, Japan was the world’s largest creditor and had the highest GDP per capita. Many Americans feared that their workforce would become obsolete due to the use of robots in Japan. With the economy booming and the stock market climbing, Japanese corporations crammed many skyscrapers in Tokyo and Osaka. This caused real estate prices to skyrocket as well. Between 1986 and 1988, the price of commercial land in greater Tokyo doubled. Real estate prices soared so much that Tokyo alone was worth more than the United States! Between 1955 and 1990, land prices in Japan appreciated by 70 times and stocks increased 100 times over. An average home near Tokyo cost well over $2 million in 1989. Large scale stock speculation occurred causing a worldwide mania. Investors all over over the world were vying for Japanese shares. These euphoric investors believed in the fallacy of a perpetual bull market. Luxury goods were purchased in large numbers by the newly wealthy.
Unfortunately, all excessively good things must end. To cool the inflated economy, the Japanese government raised rates. Within months, the Nikkei stock index crashed by over 30,000 points. At its height, the Nikkei stood at 40,000. The Nikkei could crash this far because its value was inflated on false hopes and hype, not solid financials. Eventually, many scandals came to light showing the corruption that always occurs in a bubble’s heyday. Japanese housing prices plummeted for 14 straight years, and may continue in the future. The Nikkei sank until its low of 8,000 in 2003. The Japanese government and corporations are still suffering under unwieldy debt loads gained since the late 1980’s. This debt was used for stock speculation and buying overpriced land. Even today, in 2004, the Japanese economy is still in the doldrums.
Once again, we have seen the development of a bubble and the inevitable stock market crash that always follows it.
Worlds Financial Crisis(Stock Market Crash of 1929 )
Stock Market Crash of 1929
The 1920’s were a time of peace and great prosperity। After World War I, the “Roaring Twenties” was fueled by increased industrialization and new technologies, such as the radio and the automobile। Air flight was also becoming widespread, as well. The economy benefited greatly from the new life changing technologies.
The 1920’s were a time of peace and great prosperity। After World War I, the “Roaring Twenties” was fueled by increased industrialization and new technologies, such as the radio and the automobile। Air flight was also becoming widespread, as well. The economy benefited greatly from the new life changing technologies.
As the Dow Jones Industrial Average soared, many investors quickly snapped up shares. Stocks were seen as extremely safe by most economists, due to the powerful economic boom. Investors soon purchased stock on margin. Margin is the borrowing of stock for the purpose of getting more leverage. For every dollar invested, a margin user would borrow 9 dollars worth of stock. Because of this leverage, if a stock went up 1%, the investor would make 10%! This also works the other way around, exaggerating even minor losses. If a stock drops too much, a margin holder could lose all of their money AND owe their broker money as well.
From 1921 to 1929, the Dow Jones rocketed from 60 to 400! Millionaires were created instantly। Soon stock market trading became America’s favorite pastime as investors jockeyed to make a quick killing. Investors mortgaged their homes, and foolishly invested their life savings in hot stocks, such as Ford and RCA. To the average investor, stocks were a sure thing. Few people actually studied the fundamentals of the companies they invested in. Thousands of fraudulent companies were formed to hoodwink unsavvy investors. Most investors never even thought a crash was possible. To them, the stock market “always went up”.
From 1921 to 1929, the Dow Jones rocketed from 60 to 400! Millionaires were created instantly। Soon stock market trading became America’s favorite pastime as investors jockeyed to make a quick killing. Investors mortgaged their homes, and foolishly invested their life savings in hot stocks, such as Ford and RCA. To the average investor, stocks were a sure thing. Few people actually studied the fundamentals of the companies they invested in. Thousands of fraudulent companies were formed to hoodwink unsavvy investors. Most investors never even thought a crash was possible. To them, the stock market “always went up”.
By 1929, the Fed raised interest rates several times to cool the overheated stock market. By October, the bear market had commenced. On Thursday, October 24 1929, panic selling occurred as investors realized the stock boom had been an over inflated bubble. Margin investors were being decimated as every stock holder tried to liquidate, to no avail. Millionaire margin investors became bankrupt instantly, as the stock market crashed on October 28 th and 29 th. By November of 1929, the Dow sank from 400 to 145. In three days, the New York Stock Exchange erased over 5 billion dollars worth of share values! By the end of the 1929 stock market crash, 16 billion dollars had been shaved off stock capitalization.
To make matters worse, banks had invested their deposits in the stock market. Now that stocks were obliterated, the banks had lost their depositors money! Bank runs started, where bank patrons tried to withdraw their savings all at once. Major banks and brokerage houses became insolvent, adding more fuel to the bear market. The financial system was in shambles. Many bankrupt speculators, who were once aristocracy, commit suicide by jumping out of buildings. Even bank patrons who had not invested in shares became broke as $140 billion of depositor money disappeared and 10,000 banks failed.
The 1929 stock market crash was beneficial for some, however. Jesse Livermore correctly forecasted the economic crisis and shorted. He made over 100 million dollars! Joseph Kennedy, John F. Kennedy’s father, sold before the 1929 stock market crash and kept millions in profit. Kennedy decided to sell because he overheard shoeshine boys and other novices speculating on stocks. Livermore and Kennedy were individuals are known as the “smart money”, who profit regardless if the market is skyrocketing or plummeting.
The stock market crash of 1929 launched the Great Depression. The Depression was the time from October 1929 to the mid 1930’s. Mass poverty occurred then, as many workers lost their jobs and were forced to live in shanty towns. Former millionaire businessmen were reduced to selling apples and pencils on street corners. One third of Americans were below the poverty line in the Great Depression. The Dow Jones finally surpassed its 1929 high, a full 26 years later in 1955.
The stock market crash of 1929 was identical to any other financial bubble. The classic pattern of extreme euphoria and irrational expectations will always lead to devastating financial crashes. Learning how to identify these timeless patterns will allow you to profit whether the market is rising or falling.
To make matters worse, banks had invested their deposits in the stock market. Now that stocks were obliterated, the banks had lost their depositors money! Bank runs started, where bank patrons tried to withdraw their savings all at once. Major banks and brokerage houses became insolvent, adding more fuel to the bear market. The financial system was in shambles. Many bankrupt speculators, who were once aristocracy, commit suicide by jumping out of buildings. Even bank patrons who had not invested in shares became broke as $140 billion of depositor money disappeared and 10,000 banks failed.
The 1929 stock market crash was beneficial for some, however. Jesse Livermore correctly forecasted the economic crisis and shorted. He made over 100 million dollars! Joseph Kennedy, John F. Kennedy’s father, sold before the 1929 stock market crash and kept millions in profit. Kennedy decided to sell because he overheard shoeshine boys and other novices speculating on stocks. Livermore and Kennedy were individuals are known as the “smart money”, who profit regardless if the market is skyrocketing or plummeting.
The stock market crash of 1929 launched the Great Depression. The Depression was the time from October 1929 to the mid 1930’s. Mass poverty occurred then, as many workers lost their jobs and were forced to live in shanty towns. Former millionaire businessmen were reduced to selling apples and pencils on street corners. One third of Americans were below the poverty line in the Great Depression. The Dow Jones finally surpassed its 1929 high, a full 26 years later in 1955.
The stock market crash of 1929 was identical to any other financial bubble. The classic pattern of extreme euphoria and irrational expectations will always lead to devastating financial crashes. Learning how to identify these timeless patterns will allow you to profit whether the market is rising or falling.
Florida Real Estate Bubble
Florida Real Estate Bubble
The 1920’s, in America, were a time of great prosperity. Skilled and educated working Americans had jobs providing numerous fringe benefits, paid vacations and pensions. In addition, automobiles were becoming commonplace for the wealthy and middle class allowing cross country travel. This good fortune set the stage for the Florida real estate bubble.
Starting in 1920, many Americans became enamored by the materialistic and prosperous lifestyle of the time. During this time, the stock market was moving forward at an extremely fast pace. Many investors were becoming quite wealthy. Florida became a hot spot for these newly rich people, who didn’t enjoy the cold. Many whole families took vacations to Florida. It was at this point that tourism started booming and land prices were skyrocketing. Many astute investors took notice and started buying Florida real estate. The population in Florida was growing exponentially and housing couldn’t meet the demand. Florida became the “playground of the rich and famous”. Illegal casinos and drinking parlors became widespread in Miami.
At this point, almost anybody could invest in Florida, even without much money। Credit was plentiful and soon everybody in Florida was either a real estate investor or a real estate agent. In 1922, the Miami Herald became the heaviest newspaper in the world as a result of its humongous real estate advertisements. People in the North heard about the real estate prices “doubling and tripling”, causing a snowball effect. Capital was rapidly pumped into the real estate market. Whole golf communities were developed, such as Temple Terrace. Resorts and retirement communities were developed almost overnight. Mansions were sprawling in every area, as were swimming pools. As always, waterfront property was the most desirable. Florida was seen as a veritable
Real estate prices quadrupled in less than one year. An elderly man invested $1,700 in property and by 1925 the property was worth over $300,000! It seemed you could do no wrong by just buying any property in Florida and become a millionaire. By 1925, real estate prices had become so exorbitant that buying land wasn’t affordable any longer. New investors failed to arrive and old investors started to sell. Panic arrived, as it always does, and the real estate market crashed. Prices kept moving downwards as heavily indebted investors tried to sell to avoid bankruptcy. In most cases, no buyers arrived, and the investors were bankrupt from the enormous mortgages.
To make matters even worse, a highly destructive hurricane ravaged South Florida in September 1926. The 125 mile an hour winds eventually turned Palm Beach County into swamp lands. After the storm, a huge tidal wave crashed upon the towns of Belle Glade and Moore Haven. Due to these horrible turn of events, over 13,000 homes were destroyed and 415 people died. Additionally, the arrival of the Mediterranean fruit fly obliterated the large citrus industry. It took years for Florida to fully recover, even through the highly prosperous time from 1925 to 1929. Florida was barely affected in the stock market crash of 1929 and the Great Depression, because of its poor financial state from the start.
Market crashes always occur in the same manner. Regardless of the market, the same simple psychological underpinnings are always at work. People who are caught up in a bubble never look back for historical examples. For this folly, they become paupers.
“Those who cannot remember the past are condemned to repeat it.”
The 1920’s, in America, were a time of great prosperity. Skilled and educated working Americans had jobs providing numerous fringe benefits, paid vacations and pensions. In addition, automobiles were becoming commonplace for the wealthy and middle class allowing cross country travel. This good fortune set the stage for the Florida real estate bubble.
Starting in 1920, many Americans became enamored by the materialistic and prosperous lifestyle of the time. During this time, the stock market was moving forward at an extremely fast pace. Many investors were becoming quite wealthy. Florida became a hot spot for these newly rich people, who didn’t enjoy the cold. Many whole families took vacations to Florida. It was at this point that tourism started booming and land prices were skyrocketing. Many astute investors took notice and started buying Florida real estate. The population in Florida was growing exponentially and housing couldn’t meet the demand. Florida became the “playground of the rich and famous”. Illegal casinos and drinking parlors became widespread in Miami.
At this point, almost anybody could invest in Florida, even without much money। Credit was plentiful and soon everybody in Florida was either a real estate investor or a real estate agent. In 1922, the Miami Herald became the heaviest newspaper in the world as a result of its humongous real estate advertisements. People in the North heard about the real estate prices “doubling and tripling”, causing a snowball effect. Capital was rapidly pumped into the real estate market. Whole golf communities were developed, such as Temple Terrace. Resorts and retirement communities were developed almost overnight. Mansions were sprawling in every area, as were swimming pools. As always, waterfront property was the most desirable. Florida was seen as a veritable
Real estate prices quadrupled in less than one year. An elderly man invested $1,700 in property and by 1925 the property was worth over $300,000! It seemed you could do no wrong by just buying any property in Florida and become a millionaire. By 1925, real estate prices had become so exorbitant that buying land wasn’t affordable any longer. New investors failed to arrive and old investors started to sell. Panic arrived, as it always does, and the real estate market crashed. Prices kept moving downwards as heavily indebted investors tried to sell to avoid bankruptcy. In most cases, no buyers arrived, and the investors were bankrupt from the enormous mortgages.
To make matters even worse, a highly destructive hurricane ravaged South Florida in September 1926. The 125 mile an hour winds eventually turned Palm Beach County into swamp lands. After the storm, a huge tidal wave crashed upon the towns of Belle Glade and Moore Haven. Due to these horrible turn of events, over 13,000 homes were destroyed and 415 people died. Additionally, the arrival of the Mediterranean fruit fly obliterated the large citrus industry. It took years for Florida to fully recover, even through the highly prosperous time from 1925 to 1929. Florida was barely affected in the stock market crash of 1929 and the Great Depression, because of its poor financial state from the start.
Market crashes always occur in the same manner. Regardless of the market, the same simple psychological underpinnings are always at work. People who are caught up in a bubble never look back for historical examples. For this folly, they become paupers.
“Those who cannot remember the past are condemned to repeat it.”
Worlds Financial Crisis (The Mississippi Bubble)
The Mississippi Bubble
In 1720, at the same time as England’s South Sea Bubble, France experienced its very own financial crisis. The Mississippi Bubble shares a striking similarity to the South Sea Bubble.
The crisis began in 1715, when France was bankrupt from war. It had defaulted on its debt as well as cut back on interest payments. High taxes quickly burdened the economy and the value of gold and silver currency fluctuated wildly. Eventually the youthful King Louis XV turned to his trusty advisor, the Duke of Orleans. In turn, the Duke of Orleans sought the help of his friend John Law, a Scottish financier.
John Law was born in Edinburgh, Scotland in 1671 to a goldsmith who lent money on the side. Law became his father’s apprentice and became well versed on the principles of banking. Tragically, Law became involved in a duel, killing his opponent and was convicted of murder. Law eventually managed to escape prison and quickly left England to travel Europe. Due to his keen mathematical abilities, Law earned much of his wages from gambling. John frequented destinations such as Amsterdam, Venice and Genoa. It was in these financial centers that John Law renewed his fascination for high finance. In 1705, Law published a monetary theory that argued against the use of metallic money and favored paper money, in true Keynesian style. Law favored paper money from his belief that its use would stimulate commerce (Smant).
With the desperate Duke of Orleans looking for John Law’s help, Law quickly devised a strategy to stabilize the French economy। In May 1716 Law established the Banque Generale, designed after the successful Wisselbank of Amsterdam (Smant). Banque General took deposits of gold and silver and issued paper money in return. These banknotes were payable in the value of the metallic currency at the time the banknotes were issued. Banque Generale gained equity through the conventional selling of shares as well as converting government debt. To John Law’s credit, the economy had begun to stabilize, helping to increase his rapport and influence within the French government.
Pursuing a new venture in August 1717, John Law acquired the ailing Mississippi Company and merged it with Banque Generale. France had granted the Mississippi Company a trading monopoly with the French colonies, commonly called “French Louisiana.” The trading monopoly carried a high-perceived value as speculation arose over the prospect of the beaver skin trade and of finding precious metals, with Indian slaves to mine them. France was looking to profit enormously, as Spain did with Mexico and Peru.
The Mississippi Company raised capital by selling shares to investors looking to take part in the “spoils of the Indies.” Shares were bought and paid for with bank notes or with government debt. The Mississippi Company increased its authority when it “Expanded to monopolize all French trade outside Europe. In July 1719 the Compagnie purchased the right to mint new coinage. In August 1719 the Compagnie bought the right to collect all French indirect taxes and in October 1719 the Compagnie took over the collection of direct taxes. Finally, a plan was launched to restructure most of the national debt, whereby the remainder of existing government debt would be exchanged for Compagnie shares.” (Smant)
Shares started trading at 500 livres (French currency of the time) in January 1719. The French public gained an insatiable desire for Mississippi Company shares and prices hit 10,000 livres by December 1719, a gain of 190 percent. People of all social classes became investors, and many became millionaires just from their holdings of Company shares. Interestingly, the French word millionaire originated as a result of the Mississippi Bubble speculation. (Moen)
The Mississippi Company gained 80,500,000 livres in revenue from interest paid by the King on loans and by profits from tobacco, the mint and trading (Smant), further bolstering investors’ confidence.
Profit taking started in January 1720, with investors receiving payment in the form of gold coins. John Law tried to curb the sell-off by limiting payments in gold of more than 100 livres (Moen).
The amount of bank notes in circulation had increased 186% in one year, due to the rampant issuance of notes to fund share purchases. As a result, hyperinflation ensued with the prices of goods doubling between July 1719 and December 1720. Much of Mississippi Company share price gains were due to inflation as well, rather than from sheer investor demand (Smant). The majority of Banque Generale notes were no longer backed by precious metals, essentially rendering them worthless.
A scandal struck in May 1720 when John Law decided that Company stock prices were exorbitantly high, causing him to start devaluing shares. Additionally, Banque Generale notes were devalued by 50%. Intense protest resulted in a compromise in which the bank notes’ value was restored but payment in precious metals was stopped. The public was outraged against the Company and the near worthless paper money.
Under intense selling pressure and Law’s devaluation, shares had collapsed from 10,000 livres to 1,000 by December 1720. At the end of 1720, John Law’s enemies confiscated two-thirds of shares, giving them control of the company. Share prices further deflated to 500 livres in 1721 (Moen). Investors were financially devastated and many former millionaires lost their entire fortunes.
The collapse of the Mississippi Company plunged France and Europe into a severe economic depression, laying the groundwork for the upcoming French Revolution. John Law was viewed as a scam-artist and was exiled from France. Law returned to his gambling roots and died in poverty.
Although traditionally called a bubble, the Mississippi Bubble wasn’t actually a bubble, in technical terms. A bubble is caused by widespread mania and speculation, followed by a brutal collapse in asset values. In contrast, the Mississippi Bubble was a failure in monetary policy, which caused excessive growth in money supply and inflation
In 1720, at the same time as England’s South Sea Bubble, France experienced its very own financial crisis. The Mississippi Bubble shares a striking similarity to the South Sea Bubble.
The crisis began in 1715, when France was bankrupt from war. It had defaulted on its debt as well as cut back on interest payments. High taxes quickly burdened the economy and the value of gold and silver currency fluctuated wildly. Eventually the youthful King Louis XV turned to his trusty advisor, the Duke of Orleans. In turn, the Duke of Orleans sought the help of his friend John Law, a Scottish financier.
John Law was born in Edinburgh, Scotland in 1671 to a goldsmith who lent money on the side. Law became his father’s apprentice and became well versed on the principles of banking. Tragically, Law became involved in a duel, killing his opponent and was convicted of murder. Law eventually managed to escape prison and quickly left England to travel Europe. Due to his keen mathematical abilities, Law earned much of his wages from gambling. John frequented destinations such as Amsterdam, Venice and Genoa. It was in these financial centers that John Law renewed his fascination for high finance. In 1705, Law published a monetary theory that argued against the use of metallic money and favored paper money, in true Keynesian style. Law favored paper money from his belief that its use would stimulate commerce (Smant).
With the desperate Duke of Orleans looking for John Law’s help, Law quickly devised a strategy to stabilize the French economy। In May 1716 Law established the Banque Generale, designed after the successful Wisselbank of Amsterdam (Smant). Banque General took deposits of gold and silver and issued paper money in return. These banknotes were payable in the value of the metallic currency at the time the banknotes were issued. Banque Generale gained equity through the conventional selling of shares as well as converting government debt. To John Law’s credit, the economy had begun to stabilize, helping to increase his rapport and influence within the French government.
Pursuing a new venture in August 1717, John Law acquired the ailing Mississippi Company and merged it with Banque Generale. France had granted the Mississippi Company a trading monopoly with the French colonies, commonly called “French Louisiana.” The trading monopoly carried a high-perceived value as speculation arose over the prospect of the beaver skin trade and of finding precious metals, with Indian slaves to mine them. France was looking to profit enormously, as Spain did with Mexico and Peru.
The Mississippi Company raised capital by selling shares to investors looking to take part in the “spoils of the Indies.” Shares were bought and paid for with bank notes or with government debt. The Mississippi Company increased its authority when it “Expanded to monopolize all French trade outside Europe. In July 1719 the Compagnie purchased the right to mint new coinage. In August 1719 the Compagnie bought the right to collect all French indirect taxes and in October 1719 the Compagnie took over the collection of direct taxes. Finally, a plan was launched to restructure most of the national debt, whereby the remainder of existing government debt would be exchanged for Compagnie shares.” (Smant)
Shares started trading at 500 livres (French currency of the time) in January 1719. The French public gained an insatiable desire for Mississippi Company shares and prices hit 10,000 livres by December 1719, a gain of 190 percent. People of all social classes became investors, and many became millionaires just from their holdings of Company shares. Interestingly, the French word millionaire originated as a result of the Mississippi Bubble speculation. (Moen)
The Mississippi Company gained 80,500,000 livres in revenue from interest paid by the King on loans and by profits from tobacco, the mint and trading (Smant), further bolstering investors’ confidence.
Profit taking started in January 1720, with investors receiving payment in the form of gold coins. John Law tried to curb the sell-off by limiting payments in gold of more than 100 livres (Moen).
The amount of bank notes in circulation had increased 186% in one year, due to the rampant issuance of notes to fund share purchases. As a result, hyperinflation ensued with the prices of goods doubling between July 1719 and December 1720. Much of Mississippi Company share price gains were due to inflation as well, rather than from sheer investor demand (Smant). The majority of Banque Generale notes were no longer backed by precious metals, essentially rendering them worthless.
A scandal struck in May 1720 when John Law decided that Company stock prices were exorbitantly high, causing him to start devaluing shares. Additionally, Banque Generale notes were devalued by 50%. Intense protest resulted in a compromise in which the bank notes’ value was restored but payment in precious metals was stopped. The public was outraged against the Company and the near worthless paper money.
Under intense selling pressure and Law’s devaluation, shares had collapsed from 10,000 livres to 1,000 by December 1720. At the end of 1720, John Law’s enemies confiscated two-thirds of shares, giving them control of the company. Share prices further deflated to 500 livres in 1721 (Moen). Investors were financially devastated and many former millionaires lost their entire fortunes.
The collapse of the Mississippi Company plunged France and Europe into a severe economic depression, laying the groundwork for the upcoming French Revolution. John Law was viewed as a scam-artist and was exiled from France. Law returned to his gambling roots and died in poverty.
Although traditionally called a bubble, the Mississippi Bubble wasn’t actually a bubble, in technical terms. A bubble is caused by widespread mania and speculation, followed by a brutal collapse in asset values. In contrast, the Mississippi Bubble was a failure in monetary policy, which caused excessive growth in money supply and inflation
World financial crisis(South Sea Bubble)
South Sea Bubble
Dubbed the “Enron of England”, the South Sea Bubble was one of history’s worst financial bubbles
The mania started in 1711, after a war which left Britain in debt by 10 million pounds. Britain proposed a deal to a financial institution, the South Sea Company, where Britain’s debt would be financed in return for 6% interest. Britain added another benefit to sweeten the deal: exclusive trading rights in the South Seas. The South Sea Company quickly agreed, because of the proximity to wealthy South American colonies. The company planned on developing a monopoly in the slave trade. Additionally it was thought that the Mexicans and South Americans would eagerly trade their gold and jewels for the wool and fleece clothing of the British.
The South Sea Company issued stock to finance operations and gain investors. Investors quickly saw what they perceived as value in the monopoly of the South Seas. Shares were quickly snatched up from the start. The South Sea Company, seeing the success of the first issue of shares, quickly issued even more. This stock was rapidly consumed by the voracious appetite of the investors. Investors had no quibble, despite having a highly inexperienced management team. All they saw was that the stock was going to the stratosphere. Many investors were enamored by the lavish corporate offices that had been set up. This painted an image of success and wealth in the eyes of shareholders. At this point in England’s inudstrial revolution, investment capital was plentiful. It became extremely fashionable to own South Sea Company shares.
The management team of this company started hyping the stock, spouting illusions of grandeur to the investors. Speculation became rampant as the share price kept skyrocketing. It was thought that this company “could never fail”. The management developed rumors that the South Sea Company had been granted full use of Latin American ports, by Spain. The truth was, however, that Spain only allowed 3 ships per year. Unrealistic expectations were the norm among South Sea’s investors and speculators.
Much like Enron, widespread corruption occurred among directors, company officials and their political friends. Ipo’s started everywhere as other companies tried to profit from the stock boom, as well. These companies proclaimed everything from building floating mansions to distilling sunshine from vegetables. These shares were snatched up by speculators as well. Many people became aristocracy almost overnight. Sir Isaac Newton, the scientist, had foreseen a coming stock market crash and sold his shares early with a profit of 7,000 pounds. Aftwerwards, however, Newton saw the bubble keep inflating and bought more shares.
In 1718, Britain and Spain went to war again, stopping all chances for trade. Investors were not daunted, as they kept buying. Investors from other European countries started frantically scrambling for South Sea’s shares, as well.At this point the company leaders realized that the South Sea Company wasn’t generating any profit from its operations. More emphasis was placed on making money from issuing stock than from actual commerce. For example, large shipments of wool were left to decay as a result of careless shipping mistakes. It was at this point that management realized that the shares were incredibly overvalued relative to the profits. They decided to sell while other investors were still unaware that the company was profitless.
Eventually word broke out that the management team had sold out completely. Investors were left holding the bag. Panic selling of the worthless shares immediately ensued. Fortunes were lost in a heartbeat. The stock market crash had started and all other stocks prices were obliterated, as well. Isaac Newton lost over 20,000 pounds of his fortune. As a result of this crisis, he stated “I can calculate the motions of heavenly bodies, but not the madness of people”. Jonathan Swift, who also lost a fortune, was inspired to write Gulliver’s Travels, which is a satire about British society. The British government avoided a banking crisis due to its standing as the financial powerhouse of the world. The government worked to stabilize the banking industry. The issuing of shares was outlawed to prevent any future bubbles. This law was in effect until 1825. Despite all of the efforts of the government, Britain’s economy was in shambles. The economy didn’t fully recover until one century later. Several generations were adversely affected by the stock market crash. The corporate management con artists fled to other countries with their fortunes.
Every bubble and market crash has the same important elements. Greed and unrealistic expectations will continue to foul people’s judgment as it always has.
Dubbed the “Enron of England”, the South Sea Bubble was one of history’s worst financial bubbles
The mania started in 1711, after a war which left Britain in debt by 10 million pounds. Britain proposed a deal to a financial institution, the South Sea Company, where Britain’s debt would be financed in return for 6% interest. Britain added another benefit to sweeten the deal: exclusive trading rights in the South Seas. The South Sea Company quickly agreed, because of the proximity to wealthy South American colonies. The company planned on developing a monopoly in the slave trade. Additionally it was thought that the Mexicans and South Americans would eagerly trade their gold and jewels for the wool and fleece clothing of the British.
The South Sea Company issued stock to finance operations and gain investors. Investors quickly saw what they perceived as value in the monopoly of the South Seas. Shares were quickly snatched up from the start. The South Sea Company, seeing the success of the first issue of shares, quickly issued even more. This stock was rapidly consumed by the voracious appetite of the investors. Investors had no quibble, despite having a highly inexperienced management team. All they saw was that the stock was going to the stratosphere. Many investors were enamored by the lavish corporate offices that had been set up. This painted an image of success and wealth in the eyes of shareholders. At this point in England’s inudstrial revolution, investment capital was plentiful. It became extremely fashionable to own South Sea Company shares.
The management team of this company started hyping the stock, spouting illusions of grandeur to the investors. Speculation became rampant as the share price kept skyrocketing. It was thought that this company “could never fail”. The management developed rumors that the South Sea Company had been granted full use of Latin American ports, by Spain. The truth was, however, that Spain only allowed 3 ships per year. Unrealistic expectations were the norm among South Sea’s investors and speculators.
Much like Enron, widespread corruption occurred among directors, company officials and their political friends. Ipo’s started everywhere as other companies tried to profit from the stock boom, as well. These companies proclaimed everything from building floating mansions to distilling sunshine from vegetables. These shares were snatched up by speculators as well. Many people became aristocracy almost overnight. Sir Isaac Newton, the scientist, had foreseen a coming stock market crash and sold his shares early with a profit of 7,000 pounds. Aftwerwards, however, Newton saw the bubble keep inflating and bought more shares.
In 1718, Britain and Spain went to war again, stopping all chances for trade. Investors were not daunted, as they kept buying. Investors from other European countries started frantically scrambling for South Sea’s shares, as well.At this point the company leaders realized that the South Sea Company wasn’t generating any profit from its operations. More emphasis was placed on making money from issuing stock than from actual commerce. For example, large shipments of wool were left to decay as a result of careless shipping mistakes. It was at this point that management realized that the shares were incredibly overvalued relative to the profits. They decided to sell while other investors were still unaware that the company was profitless.
Eventually word broke out that the management team had sold out completely. Investors were left holding the bag. Panic selling of the worthless shares immediately ensued. Fortunes were lost in a heartbeat. The stock market crash had started and all other stocks prices were obliterated, as well. Isaac Newton lost over 20,000 pounds of his fortune. As a result of this crisis, he stated “I can calculate the motions of heavenly bodies, but not the madness of people”. Jonathan Swift, who also lost a fortune, was inspired to write Gulliver’s Travels, which is a satire about British society. The British government avoided a banking crisis due to its standing as the financial powerhouse of the world. The government worked to stabilize the banking industry. The issuing of shares was outlawed to prevent any future bubbles. This law was in effect until 1825. Despite all of the efforts of the government, Britain’s economy was in shambles. The economy didn’t fully recover until one century later. Several generations were adversely affected by the stock market crash. The corporate management con artists fled to other countries with their fortunes.
Every bubble and market crash has the same important elements. Greed and unrealistic expectations will continue to foul people’s judgment as it always has.
Financial Crisis History ( Tulip Bulb Mania )
Tulip Bulb Mania
Could a mere tulip bulb be worth $76,000? It is if people are willing to pay for it! It may sound preposterous, but this is exactly what happened in Holland in the 1630’s.
The seeds of this craze were planted in 1593. A man by the name of Conrad Guestner imported the first tulip bulb into Holland from Constantinople, in present day Turkey. After a few years, tulip bulbs became a status symbol and a novelty for the rich and famous. Eventually, tulip bulbs became a hot ticket item in neighboring Germany, as well. After some time, a few tulip bulbs contracted a non-harmful plant virus called mosaic. The effects of this mosaic virus were tulip petals with beautiful “flames” of color. This unique effect furthermore increased the value of the already rare and highly exclusive tulip bulb.
Initially, only the true connoisseurs bought tulip bulbs, but the rapidly rising price quickly attracted speculators looking to profit. It didn’t take long before the tulip bulbs were traded on local market exchanges, which were not unlike today’s stock exchanges. By 1634, tulip mania had feverishly spread to the Dutch middle class. Pretty soon everybody was dealing in tulip bulbs, looking to make a quick fortune. The majority of the tulip bulb buyers had no intentions of even planting these bulbs! The name of the game was to buy low and sell high, just like in any other market. The whole Dutch nation was caught in a sweeping mania, as people traded in their land, livestock, farms and life savings all to acquire 1 single tulip bulb!
In less than one month, the price of tulip bulbs went up twenty-fold! To put that into perspective, if you had invested $1,000 and came back on month later, your investment would have ballooned to $20,000! Now you can understand the mad rush to buy tulip bulbs at any cost. Tulip bulb mania affected the public psyche to an extreme. One drunk man in a bar started peeling and eating what he thought was an onion, while it was in fact it was the bar owner's tulip bulb on display. This man was jailed for many months!
All common sense and logic was thrown to the wind, and even scoffed at. This is exemplified by how many USEFUL items it cost to buy 1 single tulip bulb:
• four tons of wheat• eight tons of rye• one bed• four oxen• eight pigs• 12 sheep• one suit of clothes• two casks of wine• four tons of beer• two tons of butter• 1,000 pounds of cheese• one silver drinking cup.
Mind you, these valuable items COMBINED only equaled the value of 1 tulip bulb! The modern day value of these items is over $40,000!
In 1636, tulips were trading hands on the Amsterdam stock exchange as well as on exchanges in Rotterdam, Harlem, Levytown, Horne and many other exchanges in other nearby European countries. These exchanges started to offer option contracts to speculators. These option contracts allowed tulip bulbs to be speculated upon for a fraction of the price of a real tulip bulb. This allowed people of lower means to speculate in the tulip market. Additionally, options allowed for leverage. Due to leverage, option buyers were able to control larger amounts of tulip bulbs, allowing a greater profit. In a previous example, we showed how a $1,000 dollar investment would have yielded $20,000 in one month. As if this weren’t enough, option leverage allowed this same investment of $1,000 to balloon into $100,000! Unfortunately, leverage is a double-edged sword. If the tulip bulb price moved downwards ever so slightly, the option buyer’s investment would be lost and they might even owe money! Talk about risky. But at this point, it was commonly believed that the tulip market was immune to crashing and that it would “always go up”.
After some time, the Dutch government started to develop regulation to help control the tulip craze. It was at this point that a few informed speculators started liquidating their tulips bulbs and contracts. It was these people, or the smart money, that secured large profits that were now in the form of cold hard cash. In addition, more tulip bulbs were added to the supply due to people harvesting new tulip bulbs. Suddenly tulip bulbs weren’t as quite as rare as before. The tulip market began a slight down trend, but shortly after started to plummet much faster than prices went up. Suddenly the market began a widespread panic when everyone started realizing that tulips were not worth the prices people were paying for them. In less than 6 weeks, tulip prices crashed by over 90%. Fortunes were lost. Wealthy became paupers. Bankruptcies were everywhere due to the negative side of option leverage. People that traded in farms and live savings for a tulip bulb were left holding a worthless plant seed. Many defaults occurred, where speculators couldn’t pay off their debts.
The Dutch government avoided intervening, only to advise tulip speculators and owners to form a council to attempt to stabilize prices and mend public confidence. Every one of these plans failed miserably, as tulip prices plummeted even lower than before.
Assembled deputies of Amsterdam nullified all of the contracts purchased at the height of the mania. The supreme judges of Amsterdam declared all tulip speculation to be gambling, and refused to honor these contracts. As a result, payments were not enforced by any of Holland’s courts. This further fueled the market crash.
The financial devastation that followed the tulip bulb crash lasted for decades, crippling Dutch commerce. The price of tulips at the height of the mania was $76,000; 6 weeks later they were valued at less than one dollar! The only people who prospered from the insanity were the smart money who liquidated at the top.
In market manias, the investors are acting irrationally. Excessive greed causes people to feel financially invincible and make decisions that cause financial devastation. This process occurs regardless of if the market is a commodity market or a paper market like stocks. The moral is clear; the only way to survive is to be the smart money.
Subscribe to:
Posts (Atom)
