Top 10 financial bubbles & panics

Markets have cycles. They can be volatile and prone to sudden drops. But there’s a big difference between the usual ups and downs of financial markets and the extreme highs and lows that come with financial bubbles.

Over history, investors have had a hard time staying away from the promise of big returns when a new and exciting product enters the market. They tend to forget everything they learned in investing 101 and throw caution to the wind for fear of being left out. But time and time again, bubbles and panics have left investors worse off when they focused on hype rather than value.

Here’s a brief look at 10 of the biggest financial panics and bubbles in financial history.

  1. The Tulip Fever (1637)

It may be hard to picture a boom and bust cycle around flowers, but the 17th century tulip mania is actually a perfect example of how investors can get swept up in a shiny new fad and forget all reason.

When tulips appeared in the Netherlands, there was suddenly a market for these costly flowers. Investors began buying tulip bulbs because they believed they could flip them for more money later. While the bulbs were initially only handled by those in the trade, middle-class and poor families began taking out credit or mortgaging their homes to buy bulbs they thought they could make a profit off. At the height of the tulip fever, bulbs were sold many times a day, and for hundreds of today’s dollars.

When people began doubting whether price levels could hold up, they started selling off their holdings and panic ensued, leading to a massive selloff and price collapse, which spelled financial ruin for many novice investors.

  1. The South Sea Bubble (1720)

In the 18th century, FOMO-filled investors bought into the South Sea Company, a U.K.-based trading company that had gotten a monopoly to trade with Spanish colonies in South America and the West Indies in exchange for England’s war debt following the War of the Spanish Succession.

Many British subjects bought into the company, expecting a big payoff. But the company’s main purpose was to fund the government’s war debt. That meant that in order to get shares in the South Sea Company, shareholders assumed £10 million in short-term government debt and were paid an annuity. While trading deals meant to fund interest payments turned out to be smaller than initially thought, the promise of gold and silver in the Americas kept investors buying in – and pushed stock in the South Sea Company to incredible highs, despite government attempts to contain bubbles and speculative investments.

When prices peaked amid accusations of insider trading, bribes and overextended borrowers, a selloff began that burst not only the South Sea Bubble, but also the one stemming from France’s Mississippi Scheme (described below). South Sea stock went from  £1,000 to £150 per share – costing many in the British aristocracy, including Sir Isaac Newton.

  1. The Mississippi Company Bubble (1720)

While the South Sea Company was bubbling up in the U.K., France was dealing with its own bit of colony-based speculation. Under Scottish financier John Law, the Mississippi Company held a business monopoly in the French colonies in North America and the West Indies. Law had previously founded a private bank, which developed the use of paper money, but mostly held government bills and debt that were guaranteed by French King Louis XV.

Law consolidated various rival trading companies into the Mississippi Company, whose revenues (presumably derived from the promised – and much exaggerated – riches of the French colony of Louisiana) were meant to pay down the national debt. These promises led to speculation on shares of the Mississippi Company and meant the bank had to issue more paper bank notes – which was also how investors were paid when profits did arise.

All of this worked quite well until it became evident that there were more paper notes than actual coins in the bank. A bank run followed, but there weren’t enough funds to pay off those notes, so the bank stopped payments, and another bubble burst.

  1. The Panic of 1901

A tug of war for control of Northern Pacific Railway led to the first stock market crash on the New York Stock Exchange in 1901. Heavy speculation and a move to try to monopolize the Chicago rail market led to the panic, as businessman E. H. Harriman, tried to gain control of Northern Pacific by buying up its stock amid a flurry of railway consolidation by both himself and another mogul, James J. Hill (and his banker J.P Morgan).

Stocks in other rail companies began to decline, and panicked investors began to sell. A rumour even surfaced that J.P Morgan broker Arthur Housman had died, forcing Housman to show up on the floor of the New York Stock Exchange to prove JP Morgan was still in the game.

  1. The Great Depression (1929) 

The Great Depression was a decade-long downturn. It’s widely considered to be the worst one in the history of the industrialized world. It began when the stock market crashed in October 1929, sending Wall Street into a panic and bankrupting millions of investors. As a result of this, people stopped spending money, which reduced industrial outputs and led to high levels of unemployment, as now-unprofitable companies began to lay off their workers. Investors were too scared to get back into the markets and banks began to fail.

It may seem unfair to lump this downturn with panics caused by fad investing because it seems so systemic. But the crash actually came about as a result of reckless speculation during the “roaring twenties” – a time when the U.S. economy expanded quickly as people found their wealth increasing amid a flurry of investing. Everyone was determined to jump into markets, despite the fact that wages were low and consumer debt and unemployment were climbing. Stocks kept giving high returns for a time, despite their loss of intrinsic value, making the whole scenario extremely precarious.

As soon as investors began to worry about the unsustainability of this equation and began selling off their overpriced holdings, the whole system started to collapse. A total of 12.9 million shares were traded on October 24, 1929, which came to be known as “Black Thursday.” Another 16 million followed on “Black Tuesday,” or Oct. 29, 1929, making millions of investments worthless – an especially big problem for those who had borrowed to invest.

People lost their jobs and their homes, farmers couldn’t afford to harvest their crops, and because so many countries tied their currency to the U.S., the economic downturn spread well beyond North America. Bank runs became commonplace, with the government needing to bail out major banks. The Federal Deposit Insurance Corporation and the Securities and Exchange Commission were created to provide oversight – directly as a result of the 1929 crash.

  1. The 1987 Stock Market Crash/Black Monday

Despite the lessons learned after the Great Depression and the government’s attempts to regulate the financial sector, 1929 wasn’t the last stock market crash investors would suffer through.

Another massive downturn came in October 19, 1987, when the Dow Jones Industrial Average fell 22.6 per cent or 508 points – the largest one-day percentage drop in history. The selloff was eventually linked back to a variety of factors, including a widening trade deficit, higher interest rates, failing oil prices and tensions between the U.S. and Iran.

Most notably, though, this crash was the first one made worse by technology. It was the first one of the modern financial system and exacerbated by computerized trading. When nervous investors began dumping holdings, the trading volume was so high that computer systems couldn’t keep up, and large transfers were delayed for hours.

All major world markets experienced declines, leading to fears of another major downturn, or even the threat of another Great Depression. In the U.S., the decline was short-lived because the U.S. Federal Reserve moved quickly to provide liquidity to avoid debt defaults.

  1.  The Asian Financial Crisis (1997)

The Asian Financial Crisis began in Thailand on July 2, 1997, when Bangkok unpegged its currency, the Thai baht, from the U.S. dollar because of speculative attacks. This set off a series of currency devaluations and trigged a loss of confidence throughout neighbouring economies, with investors pushing to get out of Asian currencies and forcing other countries to devaluate as well.

Indonesia and South Korea were the other two countries most impacted by the crisis, leading the International Monetary Fund to step in to try to mange the crisis, Hong Kong, Malaysia, Laos and the Philippines also bore much of the brunt of the currency devaluation. Some link the causes of the Asian Crisis to bubbles in Thailand, Malaysia and Indonesia, as well as changes to monetary policy in the U.S., which made that country a more attractive investment destination.

Whatever the case, the availability of too much credit (which once again created a highly-leveraged economic climate, pushing asset prices to unsustainably high levels) meant that once these prices began to collapse, over-extended investors and companies had to default on their obligations, and yet another speculative bubble burst.

  1. The Dot-Com Bubble (2000)

Undeterred by this growing number of historical examples, investors once again gleefully got on board another burst-bubble-waiting-to-happen in late 1999 and early 2000. The focus of their speculation was technology stocks.

As the Internet became more of a focal point in people’s lives, they got excited about the possibilities for companies and for online commerce. Investors poured millions into Internet companies, or dot-coms, expecting to become dot-com millionaires. But few start-ups lived up to expectations.

Speculation dove up the prices of the companies that did perform well, such as Amazon and eBay, making their stock massively overvalued. In all the excitement, investors overlooked basic rules of investing, such as looking at the companies’ business plans, revenues or price/earning ratios. People were investing in tech companies (and these companies were raising money through IPOs) often without yet making profits. There were warnings that tech stocks had created a bubble that couldn’t be sustained, and as interest rates began to climb in 2000 and accounting scandals at companies like Enron began to surface, many began to rethink their tech investments.

Companies began to collapse, markets began to fall, and in the end, tech stocks found themselves down $5 trillion in market capitalization from the peak.

  1. Credit Crisis (2008) 

The 2008 credit crisis was triggered when big U.S. banks had to take huge losses on mortgage-backed securities because they had lent money to homebuyers who didn’t have the means to pay back those loans.

Before the crash, banks were providing all kinds of cheap debt, supported by these securities, which were covered by insurance companies’ credit default swaps. Mortgage loans were pooled and sold into the market, fuelled by real estate prices that seemed like they could only go up. When market conditions began to change and homeowners couldn’t afford their mortgage payments, banks foreclosed on those homes.

But the banks had also overextended themselves, and all these financial products institutions had been trading among themselves with little oversight began to lose value. Bear Sterns was the first investment firm to take a big hit in March of 2008. Lehman Brothers filed for bankruptcy six months later, and many others, like Goldman Sachs, Merrill Lynch and Freddie Mac were also implicated in the scandal. Central banks had to step in to bail out the financial system with programs such as quantitative easing, which they are only really began to unwind more than a decade after the crisis.

In the aftermath of the credit crunch, regulatory changes were ushered in to ensure banks maintain a certain level of capital available and borrowers don’t take on bigger loans than they can handle.

  1. Bitcoin and Pot Stocks Manias (2018-on) 

The rapid rise of bitcoin and pot stocks was, not unlike tech stocks or tulips, tied to investors’ excitement about the next best thing. Both were unproven concepts, with companies that weren’t generating revenue or had any intrinsic value beyond investors’ wish to buy in.

In the case of bitcoin, a digital currency created as users solve cryptographic problems on a public decentralized ledger, it was a massive surge in digital currency prices fuelled by hype and a move toward cashless payments drove the market capitalization of the overall cryptocurrency universe somewhere around the $700 billion mark.

By early 2018, however, the cryptocurrency had fallen more than 65 per cent since peaking in December 2017 at $19,511.

Pot stocks, likewise, reached “peak hype” as recreational cannabis neared legalization in October of 2018, with retail investors betting on yet another growth industry without really understanding its worth, or having reliable numbers to assess the shares’ value.

As more growers flooded the market, companies faced regulatory backlogs, stores waited for licences and questions arose some company’s accounting practices, pot became a less valuable commodity. A year after the much-anticipated legalization, most cannabis stock had fallen by 50 per cent.

8 months ago