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.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Dutch Tulip Bulb Bubble – 1636
South Sea Bubble – 1720
Mississippi Bubble – 1720
Late 1920s Stock Price Bubble – 1927-29
Surge in Bank Loans to Mexico, Developing
Countries – 1970s
Real Estate and Stocks in Japan – 1985-89
Real Estate and Stocks in Scandinavia –
1985-89
Real Estate and Stocks in SE Asia – 1992-97
Foreign Investment in Mexico – 1990-93
OTC Markets in the United States – 19952000
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


Speculative Finance


Anticipated operating income greater than
the interest and scheduled reduction of its
indebtedness
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
 Advocate a firm limit on
the expansion of the
money supply to avoid
inflation
 Wanted a simple rule
to fix the growth rate of
the money supply at 2
or 4 or 5 percent
Banking School
 Believe that increases
in the supply of money
would not lead to
inflation as long as
these increases were
associated with
business transactions
 Increase of the money
supply at the start of an
economic expansion
Timeline
Economic
Growth
Boom, Bubble
Panic
Mania
Crash
Boom, Bubble
Mania
Panic
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.
2.
3.
4.
5.
6.
The arrival of the Internet at a time of solid
earnings growth
Triumphalism and the decline of foreign
economic rivals
Cultural changes favouring business
success or the Appearance Thereof
A Republican Congress and capital gains
tax cut
The baby boom and its perceived effects on
the market
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



Mispricing



The appearance of prices being too high or too low is
just an illusion
Differing abilities do not produce differing investment
performance
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
•
2)
Reduce likelihood that a shortage of
domestic liquidity will cause
bankruptcies that wouldn’t have
occurred in the absence of distress and
precautionary selling
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
•
•
2)
Central Bank
Government (Treasury)
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 3040% 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 “doubledown,” 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