An Extreme Instance Of How Crowds Can Go Crazy
Two unrelated items for weekend reading, starting with MarketWatch. “It says a lot about human nature that the scientist responsible for the law of gravity was sucked into an investment that for a time defied gravity. Throughout history, people — especially those at the top rung of society — have been greedy and gullible participants in financial bubbles. And Sir Isaac Newton was only human, after all. But the infamous bubble that ensnared Newton, involving a newly established stock market with a company at its center that was fueled by rumors and information gleaned in coffee shops, holds investment lessons to this day.”
“Coming just a few years after the spectacular Dutch Tulip Bulb mania and crash, the South Sea Bubble of 1720 centered on a company that got its start in slave trading, and which had been promised a monopoly of trade by the British government in what is now known as South America for taking over and consolidating the national debt raised by the war against France.”
“After the South Sea Company got the green light on debt, its shares began soaring, pumped by rumor-spreading and inexperienced executives. Investors at this time had to rely on coffee-shop ‘grapevines’ and the press for share information, and the two were interdependent as Richard Dale, pointed out in his book ‘The First Crash: Lessons from the South Sea Bubble.’ The South Sea bubble eventually took down the French company, though the latter was blamed more on faulty monetary policies.”
“In many ways, Newton and other investors of the South Sea Bubble were not too dissimilar to those taken in by more modern bubbles — convincing themselves they were onto a sure thing only to have it blow up. MarketWatch spoke to him about the South Sea Bubble and what investors nowadays can learn from it: MarketWatch: How did the bubble eventually burst for the South Sea Company?”
“Richard Dale: The South Sea Company did not go bust in the sense of having negative net worth. It suffered a catastrophic liquidity crisis because it was spending so much money on supporting its share price. It had to be bailed out by a combination of debt forgiveness and injections of liquidity by the Bank of England. It survived as a financial holding company.”
“MarketWatch: How did Isaac Newton get lured into such a disastrous investment? Dale: Newton invested around £3,500 in early 1720 and sold out in late April of that year having doubled his money. However, like so many others, he was induced to get back into the market in the summer of 1720 at the height of the bubble and ended up losing £20,000, around £3 million in today’s money.”
“MarketWatch: What modern-day financial bubble is most similar to the South Sea Bubble? Dale: From the standpoint of the South Sea directors, the bubble represented a giant Ponzi scheme (e.g. Bernie Madoff) in that it proposed to pay dividends not from profits but from sales of new shares for cash. From the point of view of investment behavior, the bubble resembles the dot.com boom/bust when the valuations of dot.com companies lost any connection with underlying value or realistic profit projections. (The Bank for International Settlements pointed this out at the time).”
“Although this was far ago, the period of history the market was in was not so terribly different from today, such as options-forward markets and people buying on margin and so on. These were quite sophisticated markets. Ok, you didn’t have the framework of financial regulation and didn’t have long-term investors, it was a very short term market, allowing for those differences….I think you can draw parallels from today’s markets. I don’t think anything’s changed. I think it is a lesson to us all, a particular extreme instance of how crowds can go crazy.”
The Maryville Daily Forum by Eric Sheehan. “When we decided to move to this happy little Ville almost a decade ago we toured a bunch of houses. One in particular caught our eye. It was a turn of the century (1900) beauty with so much character only a fool could pass it up. Sure it needed a lot of cosmetic work and updates but that is part of being a homeowner, right?”
“We moved in and rolled up our sleeves. Layer upon layer of wallpaper was steamed and scraped to expose the beautiful plaster walls beneath. Sure there were cracks but that was just part of the character of a century old house. We had a check list and started to go room by room doing the what we could while the house built equity so we could afford the larger renovations like remodeling the 70’s kitchen and 80’s bath. Then the housing bubble popped. Our home’s value deflated like a helium balloon left out in the cold. Suddenly the biggest investment of our lives was becoming our biggest mistake.”
“I was bemoaning this predicament with a friend when he stopped me and said, ‘What you have there is a Money Pit.’ I paused and stared blankly at him. ‘You know, Money Pit, with Tom Hanks, came out in the 80’s,’ he clarified, ‘and Neighbors, the family that has a frat move in right next door to them….that’s you buddy.’”
“He was right, our home had become a financial vacuum and to compound things all the houses on our block had become rentals and not just family rentals, pack ‘em and stack ‘em college rentals. Our neighborhood has also become money making property for the most part. This caused a noticeable decrease in our resale value but there are also other benefits. A couple years back my son and mother got to see one of the neighbor kids streak around the house. We have had at least one young man pass out in the driveway and yet another try to come in our back door insisting that it was his house, they are so adorable at that age. Lucky for us since the central air is out it is almost impossible to hear the late night revelry over the window unit and three fans that cool our bedroom.”
“It hasn’t all been bad though. So many memories are held within the walls of that grand old house. She really has served us well, we just happened along 30 years late. Our next home will be a townhouse if I get my way and it will be rented. It’s not that home ownership is all bad, I just don’t think we’re cut out for it.”
“While I’m on the subject any one interested in one heck of an investment property? You could probably get eight kids in it, finish the attic and make that 12 and if they can swim you could fit three more in the basement … don’t worry I fixed all that stuff I mentioned.”