The World’s Greatest Financial Catastrophes

FinancialCrisis.jpg

Last week we looked at the lives of legendary bankers and investors, seeing how their successes forged the history of finance.

This week, we’re doing the opposite, diving into the world’s greatest financial failures, each of which, in its own way, shaped the world we live in today.

* * * * *

Tulipmania – 1637

In 1593, in the midst of an economic and cultural boom, Turkish tulips arrived in Holland. Exotic, rare, collectible bulbs immediately began trading over asking prices on the Amsterdam Stock Exchange. Noting how a frenzied market was responding to scarcity, speculators began using rudimentary derivatives to negate the seasonality of the product. As mania grew, a sixty-fold price hike occurred between 1634 and 1637. Successful traders were making 60,000 florins a month – about $60,000 in current prices.

It was too good to be true. In the winter of 1637, the market for tulips collapsed, with sellers flooding the market and buyers nowhere to be found. Within days, tulips were worth a hundredth of their former price.

Consequently, Holland fell into a long depression.

The first emerging markets crisis – 1825

In the early 1800s, South American countries broke free from Spanish rule. At this time, a global bond market was emerging and London had displaced Amsterdam as the trading capital of the world. Thus, there was no shortage of options for Londoners wanting to gamble on something exotic. Colombia, Chile, Peru and Mexico all sold huge quantities of bonds, and British mining companies operating in South America cashed in by selling shares.

It soon became clear the immense debt these emerging economies had issued could not be financed, some of it was fraudulent, and, with Spain on the brink of default, no nation was willing to play backstop. Panic spread, prices plummeted and, by 1825, there were runs on British banks, as investors pulled money from negative positions.

As a result, in 1826, one in ten British banks failed.

The Wall Street Crash – 1929

In his 1928 State of the Union, President Coolidge stated America had never, “met with a more pleasing prospect than that which appears at the present time.” Fuelled by the rise of the automobile and a boom in construction, the American economy soared. But there was a problem, one that has caused investors trouble throughout history: debt. In order to take advantage of the huge opportunities, speculators borrowed to place bets. Two in every five dollars placed into the stock market were borrowed.

By September 1929, the market had peaked. House purchases slowed, industrial production and consumer prices shrank, stock prices fell, and sentiment turned. Stock prices plummeted as investors lost faith, and owners of debt scrambled to reconcile their positions. What followed was financial panic like never before. By October 28th, the market was in a free-fall that didn’t stop until $25 billion (over $300 billion in today’s value) had been wiped off the value of shares. Unemployment spiked, wages sank, banks folded. The biggest economy the world had ever known was plunged into the greatest depression the world had ever seen.

The world’s largest economy didn’t recover from its tailspin until the mid-1950s.

The largest one-day percentage loss in history – 1987

Monday 19th October 1987 was the most expensive day in financial history.

In the run up to this disaster, things seemed too good to be true. ‘86 and ‘87 were heady days for investors, enjoying a bull market that had run since 1982, fuelled by aggressive corporate finance methods, such as LBOs, mergers and acquisitions and IPOs, most legal, some shady. The growth of industry led investors to believe that this time it was different – the market would only go up.

On October 19th 1987, the booming market was flooded with billions of sell orders as fear spread following the FED’s hiking of short term rates in an effort to stave of inflation. Panic spread like wild fire, as futures and common stock holders from Hong Kong to London to New York, tried to sell everything.

In a single, catastrophic day, $500 billion was wiped off the Dow Jones.

Dot-com bubble bursts – 2000

Like tulips in the 1600s, Internet stocks in the 1990s were new, sexy and extremely exciting for investors. And like tulips, when the bubble burst, the effects were catastrophic.

It all began with the commercialisaion of the Internet that led to the invention of the ‘dot-com business’, which boomed from 1997 onwards, fuelling immense investment into ideas that no longer needed bricks and mortar storefronts.

The bubble that formed in the late ‘90s was fuelled by cheap money, lax regulation and a mentality for getting very rich, very quick, basing company valuations on future earnings, rather than present value. As WIRED observes, “the bubble … rested on wild stock speculation and freewheeling VC investment that resulted in the often ludicrous overvaluation of sketchy Internet companies.”

The market peaked in March 2000, when technology giants grew wary of market over-inflation, placing sell orders on their stock, causing ripples of panic. Dot-com companies, reliant on investor capital, began to fail. Markets crashed, companies folded and the boom of the dot-com era came to a shuddering halt. In the month of March 2000, a trillion dollars was wiped off the NASDAQ.

* * * * *

We hope you enjoyed this whistle-stop tour of financial disaster. The history of finance is potted with catastrophe, and the only thing we can be sure of is that history will continue to repeat itself. Tulips, Latin America, Internet stocks all looked like bottomless pits of profit. But when things seem too good to be true, they usually are.

* * * * *

This article was created in association with Origin Markets, directly connecting dealers and issuers in the primary marketplace for the first time. 

Edward Playfair