Ingredients for Mania
The Florida Land
Boom of the 1920's and the South Sea Company trading rights in the
early 1700's are two examples of financial mania - untold growth
and quick and easy gains. There
are many others such as the famous Dutch tulip mania in the
seventeenth century, John Law's Mississippi scheme, and the bull
market in the 1920's. No
two instances are identical, but they all share some common
characteristics. We do need to stress that even though these experiences all
represent extremes, they are nevertheless indicative of the
day-to-day market psychology.
The principal difference between a mania and a more common
emotional fluctuation is that the mania lasts much longer and goes
to a far greater extreme.
The elements that
make up a mania can be summarized as follows under two headings -
"The Bubble Inflates" and "The Bubble Bursts".
A believable concept offers a
revolutionary and unlimited path to growth and riches.
A surplus of funds exists
alongside a shortage of opportunities.
This channels the attention of a sufficient number of
people with money to trigger the immediate and
attention-getting rise in price.
These are the germs that spread the contagion.
The idea cannot be irrefutably
disproved by the facts but is sufficiently complex that it is
necessary for the average person to ask the opinions of others
to justify its validity.
Once the mania gets underway,
the idea has sufficient power and compelling belief to spread
from a minority to the majority as the crowd seeks to imitate
The price fluctuates from
traditional levels of overvaluation to entirely new ground.
The new price levels are
sanctioned by individuals considered by society to be leaders
or experts, thereby giving the bubble an official imprimatur.
There is a fear of missing out.
The flagship or centerpiece of the bubble is copied or
cloned as new schemes and projects attempt to ride on the
coattails of the original.
They are readily embraced, especially by those who have
not yet participated.
Lending practices by banks and
other financial institutions deteriorate as loans are made
is valued at inflated and unsustainably high values.
A vulnerable debt pyramid is a necessary catalyst for
the bust when it eventually begins.
A cult figure emerges, symbolic
of the bubble. In
the Mississippi scheme, it was John Law himself; in the 1920s,
famous stock operators such as Jesse Livermore. In the late 1960s, Bernie Cornfield symbolized the
so-called mutual fund "gunslingers," and more
recently Michael Milken represented the late-1980's LBO craze.
bubble lasts longer than the expectations of virtually
who warned of trouble in 1928 were initially taken seriously
but were way too early and were discredited in the early part
An atmosphere of fast, easy
gains almost invariably results in shady business practices
and fraud being practiced by the perpetrators of the original
scheme, for example, the insider scandals associated with the
1980s LBO mania.
At the height of the bubble, the
possibility exists that even the most objective person can
come up with a simple but eye-catching statistic proving that
the madness is unsustainable.
In our own time, we note that in the late 1980s, the
value of the land encompassing the Emperor's Palace in Tokyo
was equivalent to the total value of all New York.
Just before the Japanese stock market peak in 1990,
price/earnings ratios reached historic proportions, not just
by Western standards but by Japanese ones as well.
is a rise in prices sufficient to encourage an influx of new
supply. In the
case of the stock market, new issues are offered to investors
at an increasing rate. If
viable companies cannot be found, money is raised for
concepts. We saw
this kind of activity in 1720 but it was just as relevant at
the end of the new issues boom in 1968-1969.
The scale may have been smaller but the principles were
identical. In effect,
it is possible to lower investment standards because an
increasingly gullible public is demanding new vehicles for
instant wealth. A
different example occurred in 1980 at the height of the silver
boom. In this
instance, increased supply took the form of ordinary people
finding prices far too attractive as they rushed to sell the
family silver to be melted down into bars that could then be
sold at higher prices.
cause comes from a rise in the cost of interest, either as a
result of the increasing demand for credit or from the
curtailment of supply from an increasingly skeptical
government or both.
do not just fall, they collapse.
The "concept" stocks are exposed for what
they are - concepts. Collateral
for loans evaporates overnight.
Bankers not only are reluctant to expand credit for new
ventures but also try to protect themselves by calling in
existing loans. The result is a self-feeding downward price spiral as
everyone heads for the exit at the same time.
fraud and other shady dealings are exposed. These sometimes represent a cornerstone of the debt
pyramid, the removal of which is a primary cause of the price
other times, they are ancillary or contributing factors that
adversely affect the general level of confidence.
government or other quasi-government agencies occasionally
intervene to try to short up confidence.
Such activity merely gives cooler heads the chance to
unload before the real price decline sets in.
We saw this in November 1929 when a group of major
banks headed by J.P.Morgan attempted to support the market.
Anticipating the bursting of his own bubble, John Law
staged an elaborate parade in Paris but only kept the bubble
afloat for a few days. In
more recent times during lesser crises, we have grown
accustomed to government jawboning.
Such actions and words can only be aimed at the
symptoms of the problem, since the problem itself has usually
progressed beyond the point at which it can be corrected other
than by a painful adjustment in prices.
"Investment Psychology Explained"
Don't forget to check out the glossary - it has over 300 technical