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Between the stock market, bitcoin, and tech IPOs, today everyone seems in a race to spot the next biggest asset bubbles readying to pop.
The term “asset bubble” indicates that there is a marked, noticeable divergence between the market price of an asset and its fundamental value. In other words, something that people store value in – a coin, a house, a share of stock – is valued much, much higher than the thing itself could possibly be worth.
Bubbles usually end with crashes: double- or triple-digit percentage losses in the price of the inflated asset over a very short time.
Bubbles – called “manias” prior to the 18th century – have probably been around as long as people have wanted to get rich quickly.
The next biggest asset bubble to pop remains to be seen, but in order to break the top five, it has to be incredibly damaging.
Just take a look at the five biggest bubbles to ever exist, and the destruction they inflicted on the economy:
Five Biggest Asset Bubbles Ever
Asset Bubble #1: Tulipmania, 1636-1637. The first asset bubble, the one everyone knows, started in the Netherlands, and the asset involved was the harmless, beautiful tulip. It’s unclear exactly how this bubble got started, but it probably had to do with the novelty of the flower. The tulip had only just been introduced from the court of the Ottoman Sultan and was unique among European flowers, at the time, for its vibrant, unadulterated color. The tulip seems to have been a conspirator in its own bubble. The bulbs take nearly a decade to mature, and only last a few years thereafter. And then there was the “Tulip-breaking virus,” which changes the coloration of tulips, resulting in vivid striations in the normally single-colored bloom. These infected bulbs were the focal point of the speculative bubble. According to Charles Mackay’s Extraordinary Delusions and the Madness of Crowds, a single bulb of the coveted “Viceroy,” with a pattern of imperial purple and white stripes, sold for between 3,000 and 4,100 guilders in 1636. The “Semper Augustus” – tulip growers often gave grandiose names to their rare bulbs – sold for 1,000 guilders in the 1620s and 5,500 guilders in 1637, according to The Economist. A skilled laborer, by contrast, might earn 150 guilders in a year. Economist Earl Thompson showed a 20-fold increase in the price of tulip bulbs between November 1636 and February 1637. In February 1637, though, buyers simply stopped showing up to routine auctions. Prices collapsed, falling 20-fold between February and May 1637. The bubble popped, but the Netherlands would continue to be a financial powerhouse well into the 18th century.
Asset Bubble #2: South Seas Bubble, 1720.The South Seas Bubble – the first bubble actually called a “bubble” at the time – grew out of a government’s inability to manage its money. When war broke out with Spain in 1718, the U.K. Parliament attempted to consolidate about 30 million pounds in debt (about $6 billion in 2013 dollars) through the South Seas Company, a joint-stock company organized to consolidate government debt and, occasionally, trade with South America. The company agreed to do so, giving existing creditors shares in the company in exchange for their debts from the government, receiving as dividends shares of a 5% interest payment Parliament would make to the company. New stock would be issued equal to the face value of the debt. Share price increases above that would go to the company for its profit and to pay a quarterly fee to the government. The scheme was put into place in 1720. The Company rewarded its friends in Parliament, offering them shares. But the company had no shares to offer, as the debts had not yet been converted. Instead, it simply promised the new shareholders the option to sell the nonexistent stock back to the company at any time at market price, pocketing the difference. The directors of the company set about inflating the share price, making wildly exaggerated claims about the value of trade with South America. In 1720, the price of South Seas Company stock went up 680% from 128 pounds to 1,000 pounds and fell to 150 pounds over the course of nine months. The only thing underneath the bubble was the exaggerated claims of the value of the South American trade made by the South Seas Company’s directors. Isaac Newton, who lost around 20,000 pounds, is reported to have said of the bubble, “I can calculate the movement of the stars, but not the madness of men.”
Asset Bubble #3: The Florida Land Boom – 1920-1926.Florida is many things: beautiful, warm, populous. But it is not rich in stable, arable land for construction. Much of the state is a swamp, yet in the heady days of post-World War I America, it was the place to make a fortune in land. The boom swept down the east coast of Florida and up the west. Entrepreneurs and hustlers laid out plans for subdivisions, towns, and resorts to take advantage of the state’s undeveloped coast and interior. Stories of people getting rich from Florida real estate flooded out of the state as people flooded in. According to Frederick Allen’s 1931 book Only Yesterday, a plot in the center of Miami Beach bought for $800 in 1920 sold again in 1925 for $150,000. Land bought for $240,000 in 1911 sold in 1920 for $800,000 and was parceled up and sold in 1921 for $1.5 million. The vehicle for this asset inflation speculation was the “binder” – a piece of paper representing a plot shown on a blueprint, and bought for 10% down, with payments for the balance due beginning 30 days from the sale date. These binders changed hands with remarkable velocity – most people apparently bought them with the intention of turning around and selling them well before the first payments came due. Advertisements for real estate sales were so numerous that the Miami Daily News printed an issue 504 pages long. But the rapid growth put a massive strain on the state’s resources. Railroads embargoed imperishable goods for fear that clogged rail lines would cause famine. Then, in January 1926, the schooner Prinz Valdemar sank in Miami harbor, completely blocking sea access for goods and people. This, in turn, halted Florida’s land boom – new construction could not progress without materials, and new “investors” were not stepping off the boat. Further, people still holding “binders” were defaulting on the payments as they came due. In September 1926, a hurricane put the final kibosh on Florida’s boom, wiping out developed property and killing some 400 people.
Asset Bubble #4: The Roaring ‘Twenties – 1922-1929.The stock market bubble and ensuing crash of the 1920s is the enduring benchmark for all asset bubbles, speculative manias, and general financial insanity since. It’s also probably the second-best known on this list – only recently displaced by the subprime housing bubble of 2002-2007. This one kicked off with the end of World War I: Massive pent-up consumer demand drove purchases of radios, refrigerators, automobiles, and other consumer products. An expansion of consumer credit – buying on layaway and installment – increased demand for new products and helped improve corporate earnings, which helped support growing stock market prices. At the same time, the newly created Federal Reserve Bank and relaxed restrictions on margin trading helped fuel rising prices with easier credit for investors. Rising prices encouraged more people to get into the stock market, which drove up share prices. The most popular investments tended to center around new technology, like automobiles, radios, and airplanes. In 1928 alone, radio stocks rose 400%. The stock market reached the peak of this boom in September 1929, with the Dow Jones Industrial Average at 381.17, up 500% from 63 in 1921. Throughout September and October, the Dow would fall fitfully, with occasional, brief recoveries. Then on Black Monday – Oct. 28, 1929 – it fell 12.8% to 260, and fell another 11% the next day to 230.07. Between the peak in September, and the close on Oct. 29, 1929, the Dow lost 40% of its value. The ’29 crash is considered the beginning of the Great Depression, and the Dow would not reach pre-crash levels until well after World War II.
Asset Bubble #5: The Housing/Subprime Bubble. It almost seems cruel to mark out the gory details of the most recent popped bubble, as the global financial system is still on shaky ground, six years after the bubble burst. Instead, here are the simple facts of the case. Between 1997 and 2006, the price of the average American home rose 124%. The ratio of median national home price to median household income expanded from about 3.0 for the two decades prior to 2001 to 4.6 in 2006. Prices peaked in 2006, and, according to the Case-Shiller index, fell 20% by 2008. At the same time, U.S. foreclosures tripled to 300,000 as borrowers were unable to refinance mortgages on properties whose value had fallen, but whose interest rate had increased. Meanwhile, mortgages themselves had been rolled up, monetized as mortgage-backed securities, and sold globally as investment grade instruments, because no one misses mortgage payments, ever. As the investments built around housing started to collapse along with home prices, the complex web of financial bets disintegrated with it, bursting the bubble and bringing the global economy to the brink of destruction.
Asset bubbles, like bad pennies and worse monetary policy, are always with us. They come and they go, leaving both wealth and destitution in their wake. If you want to protect yourself against the next one, read about the one indicator you need to spot a crash before it happens.
- The Economist:
- PBS Frontline:
- Only Yesterday: