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Manias Panics Crashes

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					    Manias, Panics &
    Crashes

Written by: Charles
Kindleberger & Robert Aliber
Presented by: Thomas Herbison, Janelle
Tibbatts, Matthew Wood, & Justina
WIlliams
Agenda
 Overview of Manias, Crashes &
  Panics
 Explanation of Key Terms & Timeline

 Rational vs. Irrational Exuberance

 Video

 Lenders of Last Resort

 Frauds & Scandals

 Current Events

 Concluding Remarks
Overview

   Charles Kindleberger (1910-2003)
     Ford Professor of Economics at MIT
     5th Edition of “Manias…”
 Historical perspective
 Human nature
 Relevance of topics throughout history
       “History is philosophy learned through
        examples” Thucydides, 420 BC
Bubbles

   Bubble: non-sustainable pattern of
    price changes or cash flows
     Refers to increases in asset prices in
      the mania phase of the cycle
     In this book, a bubble is an upward
      price movement over period of 15 to
      40 months
   Booms and bubbles are fueled by the
    expansion of credit
Big Ten Financial Bubbles
1.    Dutch Tulip Bulb Bubble – 1636
2.    South Sea Bubble – 1720
3.    Mississippi Bubble – 1720
4.    Late 1920s Stock Price Bubble – 1927-29
5.    Surge in Bank Loans to Mexico, Developing
      Countries – 1970s
6.    Real Estate and Stocks in Japan – 1985-89
7.    Real Estate and Stocks in Scandinavia –
      1985-89
8.    Real Estate and Stocks in SE Asia – 1992-97
9.    Foreign Investment in Mexico – 1990-93
10.   OTC Markets in the United States – 1995-
      2000
Manias

 Economic euphoria – money seems
  “free”
 Associated with expansion phase of
  business cycle
       Virtually every mania is associated
        with a robust economic expansion, but
        only a few economic expansions are
        associated with a mania
Manias

 Increases in real estate, stocks,
  and/or commodities leads to
  increases in consumption and
  spending, accelerates economic
  growth
 Investors and lenders are optimistic
  about the future and asset prices
  increase more rapidly
Panics & Crashes
   Displacement
      Outside event or shock that changes horizons,
       expectations, anticipated profit opportunities,
       behaviour
      Ex. War – August 1914
   Can come as a result of distress sales
      Price of assets decline below their purchase price,
       therefore investors sell these assets and prices
       decline further
   Often precipitated by revelation of misfeasance,
    malfeasance, or malversation that occurred during
    mania
      Frauds & Scandals
Minsky Model
   Hedge Finance
       Anticipated operating income greater than
        the interest and scheduled reduction of its
        indebtedness
   Speculative Finance
       Anticipated operating income covers interest
        payments, must use cash from new loans to
        repay portion of maturing loans
   Ponzi Finance
       Anticipated operating income insufficient to
        pay obligations – firm must either increase
        indebtedness or sell some assets to
        generate cash
 Currency versus Banking
 Schools of Thought
Currency School               Banking School
 Advocate a firm limit on     Believe that increases
  the expansion of the          in the supply of money
  money supply to avoid         would not lead to
  inflation                     inflation as long as
 Wanted a simple rule          these increases were
  to fix the growth rate of     associated with
  the money supply at 2         business transactions
  or 4 or 5 percent            Increase of the money
                                supply at the start of an
                                economic expansion
           Timeline
Economic
Growth
                   Boom, Bubble
                                             Boom, Bubble
                             Panic        Mania       Panic
           Mania                                         Crash
                                  Crash




                                                            Time
Summary

 Manias are times of euphoria, which
  can lead to a bubble. When a
  displacement occurs to “pop” the
  bubble, panic may ensue and can
  lead to a crash in the market
 Minsky Model

 Schools of Thought
Rational vs. Irrational
    Exuberance
Rational versus Irrational
Exuberance
Rational
 Buying based upon genuine, fundamental
   value
Irrational
 Increase that is based upon a speculative
   bubble - “unsustainable increase in prices
   brought on by investors‟ buying behaviour”
 Need to understand the value investors
   have imputed in the market so we can
   adjust and plan accordingly if the value
   shouldn‟t be there
Irrational Exuberance

   Many parts that play a role in irrational
    exuberance for the financial world:
     Structural
     Cultural
     Psychological

   There are also many ways to
    rationalize exuberance
Structural Factors

1.   The arrival of the Internet at a time of solid
     earnings growth
2.   Triumphalism and the decline of foreign
     economic rivals
3.   Cultural changes favouring business
     success or the Appearance Thereof
4.   A Republican Congress and capital gains
     tax cut
5.   The baby boom and its perceived effects on
     the market
6.   An expansion in media reporting of
     business news
Structural Factors

7. Analysts‟ increasingly optimistic forecasts
8. The expansion of defined contribution
    pension plans
9. The growth of mutual funds
10.The decline of inflation and the effects of
    money illusion
11. Expansion of the volume of trade
12. The rise of gambling opportunities
Amplification Mechanisms
 Type of naturally occurring Ponzi
  process
 “Investors, their confidence and
  expectations buoyed by past price
  increases, bid up stock prices further,
  thereby enticing more investors to do
  the same, so that the cycle repeats
  again and again, resulting in amplified
  response to the original precipitating
  factors.”
       Robert Shiller (2000)
Psychological Factors
   Quantitative anchors – people are weighing
    numbers against prices when they decide
    whether stocks (or other assets) are priced
    right
       Example: Wheel of Fortune type game
   Moral anchors – people compare the
    intuitive or emotional strength of the
    argument for investing in the market against
    their wealth and their perceived need for
    money to spend now
   Social pressures – such as “group think”
   Herd behaviour
          Attempts to Rationalize
          Exuberance
   Fama‟s efficient markets theory
       The appearance of prices being too high or too low is
        just an illusion
       Differing abilities do not produce differing investment
        performance
   Mispricing
       Priced for the long-run (Jeremy Seigel‟s book Stocks
        for the Long Run)
       The 1636 Tulip Mania
   Stock prices roughly track earnings over time –
    despite great fluctuations in earnings, price-earnings
    ratios have stayed within a comparatively narrow
    range
        Evidence for or against the
        efficient market theory?
   Many anomalies have been discovered within
    the efficient markets theory
     January effect (stock prices tend to go up
      between December and January)
     Small-firm effect (small firms‟ stocks tend to
      have higher returns)
     Day-of-the-week effect (stock market tends to
      do poorly on Mondays)
Summary

   Irrational exuberance comes due to
    many factors:
     Structural changes
     Cultural diversification
     Psychological patterns

   Society tries to rationalize exuberance
    through efficient markets theory and
    other methods
Video
Lenders of Last
    Resort
Domestic and International
Lenders of Last Resort

    2 Types
    1)   Domestic lender of last resort
         •   Reduce likelihood that a shortage of
             domestic liquidity will cause
             bankruptcies that wouldn‟t have
             occurred in the absence of distress and
             precautionary selling
    2)   International lender of last resort
         •   Provide liquidity to improve the extent of
             necessary exchange rates and prevent
             those changes that aren‟t required
Lenders of Last Resort

    Should there be a lender of last resort?
        If investors are confident that they‟ll be
         bailed out by a lender of last resort, their
         self-reliance may be weakened.
    Who should the lender be?
    1)   Domestic lender of last resort
         •   Central Bank
         •   Government (Treasury)
    2)   International lender of last resort
         •   International Monetary Fund
         •   World Bank
Advantages & Disadvantages
to the Lender of Last Resort
   Advantages
     Crisis or panic can be avoided
     Bankruptcies can be prevented

   Disadvantages
     Expensive
     Investors become less self-reliant
Summary

   Lenders of Last Resort
     Domestic
     International

 Can help to avoid financial panics and
  crashes
 Expensive, investors may be less
  responsible in the marketplace
Frauds & Scandals

    White Collar Crime
Frauds
 Frauds and illegal activity are closely
  associated with euphoric periods as
  some people succumb to greed and
  try to maximize wealth by all means
  necessary.
 As individual wealth increases in
  times of euphoria and gains of 30-
  40% are realized, trends show an
  increase in fraudulent behaviour to
  incur even more rapid gains to their
  personal wealth.
Swindles and the Credit
Cycle
 Swindles, fraudulent behaviour ,
  defalcations, and elaborate hustles
  are part of life in market economies,
  more so in some countries than in
  others. (transparency International)
 During crashes and tightening of
  the credit supply, fraudulent
  behaviour is prevalent as people try
  to avert large losses and “double-
  down,” which in many cases causes
  financial disaster. (Nick Leeson)
Fraud and Euphoria
   Most fraud occurs in the mania phase and is obscured by
    the growth of the bubble.
        Individuals become greedy for a share of the increase in
         wealth and swindlers come forward to exploit that greed.
   “There‟s a sucker born every minute.”
   The amount of swindlers increase relative to the amount
    of “gullible” people entering the market and taking
    chances. In a euphoria there is a pervasive air of
    optimism and people believe the market will continue to
    go up and maintain high returns. Because of an overly
    positive view of the market, some investors will more
    easily part with their money and be caught off guard by
    swindlers.
   Most often the „low class‟ swindles involve Ponzi finance.
   Kozlowski & Conrad Black - Greed grew faster than
    wealth.
White Collar Crime
   “The 1920‟s in the United States has been called „the
    greatest era of crooked high finance the world has ever
    known‟ – but that was before the 1990‟s.”
      Enron, WorldCom, Adelphia, Tyco, Global Crossing,
       Martha Stewart
   Reasons
        1. Decline in adherence to moral standards
        2. Risk-Reward trade-off skewed – stock options provide
         greater pay for financial success/greed.
        3. Companies pay for audit services and can lean on
         accountants or bribe to produce desired results.
   Crash and Panic - Try to forestall bankruptcy or financial
    disaster– Nick Leeson
   Those who commit white collar crime get off relatively
    lightly and spend limited time in jail and keep large
    portions of illegal earnings. i.e. Michael Milken
Summary

 Frauds arise during boom periods,
  when people want to “keep up with
  the Jones‟ ”
 Relatively mild repercussions for
  committing white collar crimes, if you
  are charged
Current Events
Shanghai Exchange
   In January, Chinese exchange traders increased 134% or
    1.38 million from a month earlier and stock turnover was
    up 700% from a year earlier.
   Contributed to a huge stock surge and a ‘small’ bubble.
   Bubble popped by Chinese authorities as they launched a
    ‘special task force’ to decrease the amount of domestic
    speculative investing and crimping the source of
    subsidized capital.
   First time China has become trendsetter in the global
    market and affected other exchanges because of the
    decisions made.
      Shanghai exchange more than tripled in value in 2006
        to over $900 billion.
      Chinas market capitalization was too small to effect
        global markets two years ago. It now totals around
        $1.3 Trillion.
Current Real Estate Bubble
   North American Bubble
   European Bubble
Conclusions
Thank you for your
      time

				
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