T H E P S YC H O LO GY O F T H E M A R K E T S

MANIAS, BUBBLES, AND PANICS IN WORLD HISTORY

BUBBLE QUOTES

“There is nothing as disturbing to one’s well-being and judgment as to see a friend get rich.”

Charles P. Kindleberger

“The four most expensive words in the English language are, this time it’s different.”

Attributed to Sir John Templeton

ECONOMIC ANALYSIS ASSUMES PEOPLE ARE RATIONAL AND RESPOND TO INCENTIVES

LOGICALLY

• TULIP MANIA• SOUTH SEA BUBBLE• RHODIUM BUBBLE• RAILWAY MANIA• ROMANIAN PROPERTY BUBBLE• MISSISSIPPI BUBBLE• FLORIDA LAND BOOM• POSEIDON BUBBLE• DOT-COM BUBBLE• URANIUM BUBBLE• JAPANESE ASSET BUBBLE• ROARING TWENTIES• GLOBAL HOUSING BUBBLEA BUBBLE IS A PERIOD OF SPECULATIVE MANIA

SURROUNDING A PHYSICAL OR FINANCIAL ASSET

THE WORK OF HYMAN MINSKY

A TYPICAL BUBBLE EVENT ARRIVES IN THESE PHASES

1.DISPLACEMENT2.BOOM3.EUPHORIA4.PROFIT-TAKING5.PANIC6.BAILOUT

DISPLACEMENTAN OUTSIDE SHOCK TO

THE ECONOMY:1. WAR2. NEW INVENTION3. POLITICAL EVENT4. FINANCIAL SUCCESS5. CHANGE IN POLICY6. ANYTHING THAT

ALTERS THE ECONOMIC OUTLOOK

BOOMTHE OPTIMISM FROM THE CHANGE LEADS TO A RAPID RISE IN PRICES OF A PHYSICAL OR FINANCIAL ASSET AS INVESTORS AND SPECULATORS ATTEMPT TO EARN PROFITS

EUPHORIA• LENDERS OFFER MORE

CREDIT AT LOWER RATES• PEOPLE TAKE INVESTMENT

RISKS• DEMAND INCREASES,

DRIVING UP PRICES AND PROFITS WHICH DRIVES UP DEMAND-PRICES-PROFITS

• NEW FINANCIAL INSTRUMENTS ARE CREATED

• PEOPLE SEE OTHERS MAKING MONEY AND ARE DRAWN IN

• THE BUBBLE IS INFLATED

PROFIT TAKING• A FEW INSIDERS BEGIN TO TAKE THEIR PROFITS AND PRICES BEGIN TO LEVEL OFF• LARGE INVESTORS BEGIN TO REALIZE THEY MAY BE OVER- EXTENDED AND ARE TAKING UNDUE RISK

PANIC• A LARGE

INSTITUTION FAILS, A SWINDLE IS DISCOVERED OR AN INCREASE IN SUPPLY RETURNS PEOPLE TO THEIR SENSES• PEOPLE START

SELLING IN AN ORDERLY FASHION BUT SOON CHAOS REIGNS• PEOPLE SCRAMBLE

TO SELL AND PRICES FALL RAPIDLY

BAILOUT• A CENTRAL BANK MAY

BEGIN TO EXPAND THE MONEY SUPPLY TO SAVE THE FINANCIAL SYSTEM

• THE ENTIRE ECONOMY PAYS FOR THOSE DIRECTLY INVOLVED IN THE BUBBLE CYCLE

• THE ANTICIPATION OF A BAILOUT MAY LEAD TO PEOPLE TAKING BIGGER RISKS

• THIS DISREGARD FOR CONSEQUENCES IS KNOWN AS A MORAL HAZARD

JOHN KENNETH GALBRAITH SAID:

“Investors have a short financial memory (or ignorance of history) that makes them oblivious to previous financial disasters.”

“ Investors have a tendencyto attribute greaterintelligence to individuals,the more incomeor assets they control.”

WHAT WAS THE EVENT THAT CREATED THE CLIMATE FOR SPECULATION IN THE

HOUSING MARKET?

• PURSUIT OF SAFER INVESTMENTS AFTER THE DOT-COM BUBBLE BURST• THE ILLUSION THAT HOUSING PRICES ALWAYS RISE• THE BROAD AVAILABILITY OF CHEAP CREDIT

WHY DID THE COUNTRY FALL SO QUICKLY FOR ANOTHER SPECULATIVE

FASCINATION?

• THE REDUCTION OF INTEREST

RATES• THE ENCOURAGEMENT OF HOME OWNERSHIP BY THE WHITE HOUSE• THE FINANCIAL

INNOVATIONS THAT EXPANDED ACCESS TO CREDIT• THE APPARENT

WILLINGNESS OF WALL STREET TO BET HEAVILY ON HOUSING• THE FACT THAT SOME OF

OUR NEIGHBORS WERE GETTING RICH AND WE WERE NOT

WHY DO INVESTORS IGNORE THE WARNINGS FROM ALAN GREENSPAN AND OTHER ECONOMISTS ABOUT “IRRATIONAL

EXUBERANCE”?• THE GENERAL BELIEF

THAT “THIS TIME IS DIFFERENT”

• YOU DON’T WANT THE DOOR OF OPPORTUNITY SLAMMED IN YOUR FACE

• THE CONTRADICTION OF RISING VALUES DESPITE THE ALARMS

• TYPICALLY THE DOOMSAYERS ARE FAR OUTNUMBERED BY THE OPTIMISTS

WHAT CAUSED THE REALIZATION THAT THIS TIME WAS NO DIFFERENT THAN

ANY OTHER?

• RISING INTEREST RATES

• THE INCREASING SUPPLY OF HOUSES

• THE GROWING NUMBER OF MORTGAGE DEFAULTS

• THE FAILURE OF HIGH PROFILE FINANCIAL INSTITUTIONS, SUCH AS LEHMAN BROTHERS AND BEAR STEARNS

WHY IS IT LIKELY THAT ANOTHER SPECULATION BOOM AWAITS US?

• HUMAN NATURE SEEMS TO LEAD US DOWN THE PATH TO EUPHORIA• THE NATURAL

PURSUIT OF SELF-INTEREST• OUR EAGERNESS TO

EARN PROFITS WE SEE OTHERS EARNING• DESIGNING AND

ENFORCING EFFECTIVE REGULATION IS DIFFICULT