Economic Collapse (Prepping for Tomorrow Book 2)

by Bobby Akart

  The first issue of stock available to the public was sold in days. Stories began to circulate that the company would be delivering goods to the Americas, which fueled the speculative activity. The South Sea Company issued more shares, which were quickly bought up by investors. When it was formally announced that the South Sea Company was granted a monopoly in trade with Spain's colonies in South America and the West Indies as part of a treaty made after the War of the Spanish Succession, investors were whipped into a fever pitch. They bid the South Sea Company's shares and the shares of similar trading companies to incredible heights in a typical speculative bubble fashion.

  This spurred similar stock issues in companies that promised to reclaim sunshine from vegetables and to build floating mansions to extend Britain's landmass. The perceived successes of these new ventures stirred British pride, and, believing that British companies could not fail, investors were desperate to invest their money.

  Not long after virtually all classes of British society were thoroughly engaged in wild stock speculation, the South Sea Bubble popped and stock prices violently collapsed, financially ruining their investors. Eventually, the officers and directors of the South Sea Company realized that the value of their personal shares in no way reflected the actual value of the company. In the summer of 1720, they sold their stocks and hoped no one would leak the failure of the company to the other shareholders. Like all bad news, however, the knowledge of the actions of management spread, and the panic selling of worthless certificates ensued. The value of the South Sea Company came crashing down.

  A complete market crash was avoided due to the resilient economic position of the British Empire and the government's help in stabilizing the banking industry. As a result of the South Sea Bubble, the British government outlawed the issuing of stock certificates, a law that was not repealed for a hundred years.

  The Florida Swamp Land: 1926, United States

  In the 1920s, Florida was the site of a real estate bubble fueled by easy credit and advertisers promoting a lifestyle of sunshine and relaxation. The US economy was at the top of its game, growing on a par with the British Empire, two hundred years prior. It was natural that people were beginning to believe such prosperity was here to stay. Unlike the South Sea Company bubble, it wasn't the stock market that was the recipient of overinflated values. It was the real estate market.

  By 1920, Florida became the popular U.S. destination for people who wanted to flee the cold of winter—the snowbirds. The population was growing steadily, and housing couldn't match the demand, causing prices to double and triple in some cases, which was not exactly unjustified at this point. But, news of anything doubling and tripling in price always attracts speculators. So, once people began pumping huge amounts of money into the Florida real estate market, it exploded. Soon everyone in Florida was either a real estate investor or a real estate agent.

  Historical news reports describe a collective madness that consumed Florida land investors. Lots in Miami were bought and sold as many as ten times in a single day. Property that could be bought for $800,000 could, within a year, be resold for $4 million. People from the north were buying swamp land.

  Land prices quadrupled in less than a year. Eventually, however, there became a shortage of investors for the Florida swamp land, and prices for the ridiculously overvalued properties began to adjust. Land speculators began to recognize that there was a limit to the craze and sold their properties to collect profits while they could. Other speculators also saw the writing on the wall, and panic selling ensued. With thousands of sellers and very few buyers, prices came down with a sickening thud.

  The perceived wisdom holds that a 1926 hurricane helped burst the bubble, but house price indicators and historical construction data suggest that the boom and bust were in fact a nationwide phenomenon. The housing price downturn in 1926 led to a rise in the foreclosure rate of residential properties which also increased in 1926, rising steadily through the stock market bubble and peaking in 1933.

  The Market Crash of 1987: United States

  The Stock Market Crash of October 19th, 1987—Black Monday—was the largest one-day market crash in history. The Dow lost nearly twenty-three percent of its value, or $500 billion dollars.

  Stock market investors enjoyed record profits in 1986 and 1987. These years were an extension of an incredibly powerful bull market that had started in the summer of 1982. This bull market had been fueled by low-interest rates, leveraged buyouts, and merger mania.

  Institutional investors and large companies were scrambling to raise capital to buy each other out. The philosophy of the time was that businesses could grow exponentially simply by constantly acquiring other companies. In a leveraged buyout, a company would raise a massive amount of capital by selling junk bonds to the public. Junk bonds are bonds that pay high-interest rates due to their high risk of default. The capital raised through selling junk bonds would go toward the purchase of the desired company.

  IPOs were also becoming a commonplace driver of market excitement. An IPO or Initial Public Offering is when a company issues stock to the public for the first time.

  The investing public eventually became caught up in a contagious euphoria which made investors, as usual, believe that the stock market would continue to rise. Then, in early 1987, there was a rash of SEC investigations into insider trading. For the most part, people were aware of the tendency of Wall Street to look out for itself, but the barrage of SEC investigations rattled investors. By October, investors decided to move out of the stock market and into the more stable environment offered by bonds or, in some cases, junk bonds.

  During this time frame, inflation and an overheating economy became a concern due to the high rate of economic and credit growth. The Federal Reserve rapidly raised short-term interest rates to temper inflation, which had the desired effect of lowering some of stock investors' enthusiasm.

  As interest rates rose, many institutional money managers scrambled to hedge their portfolios at the same time. On Black Monday, the stock index futures market was flooded with billions of dollars' worth of sell orders within minutes, causing both the futures and stock markets to crash. Also, many common stock investors attempted to sell simultaneously, which completely overwhelmed the stock exchanges.

  $500 billion in market capitalization was evaporated from the Dow Jones stock index. Exchanges in nearly every country around the world plunged in a similar fashion. When individual investors heard that a massive stock market crash was occurring, they rushed to call their brokers to sell their stocks. This was unsuccessful because each broker had many clients.

  Many people lost millions of dollars instantly. News reports began to surface of some unstable individuals who had lost significant amounts of money who went to their broker's office with a gun and started shooting. A few brokers were killed despite the fact they had no control over the markets.

  The majority of investors who were selling did not know why they were selling except for the fact that everyone else was selling. This emotionally-charged behavior is one of the main reasons that the stock market crashed so dramatically. After the Black Monday plunge, many futures and stock exchanges were shut down for a day to allow reasonable minds to return.

  Japan, The Lost Decade: 1989 - ?, Southeast Asia

  Around the turn of the twenty-first century, the phrase lost decade began to be applied to Japan's economic performance over the course of the 1990s. The lost decade started with the popping of one of the greatest stock market bubbles in history.

  The Japanese economy gained extreme strength after its long recovery from World War II. By joining other emerging Southeast Asian economies to form an unstoppable economic force, Japan seemed to have created an economic powerhouse. The phrase Japan Inc. was coined to describe how the Japanese economy, business, and government were intertwined. Businesses from all over the world were sending representatives to try and find out how Japan was gaining its success. In true business fashion, the Jap
anese built an industry around visitors with company expense accounts and profited off the corporate spies. Soon, the Asian economy became an alternative for investors who were recently bruised by the US market crash of 1987.

  For decades, land prices in Japan appreciated by seventy times and stocks increased a hundred times over. Stock trading became a hobby for every Japanese investor, and the Japanese jumped into the market with more blind confidence than that of the Americans of the 1920s. During the eighties, large Tokyo trading firms were worth more individually than all their American counterparts combined.

  Investors began to suspect Japan was becoming a market bubble, but it was thought that the high level of collusion between the Tokyo government and business interests could sustain the growth. Balance sheet manipulation began in the form of large real estate holding companies using the book value of their land to buy stocks that they, in turn, used to finance the purchase of American assets.

  As the affluence of the Roman Empire, the prosperity of Japan proved to be its undoing as corruption began to spread throughout the political and business world.

  The government sought to put a halt to the unrealistic growth of stocks and real estate by raising interest rates. This didn't have the slow, calming effect on the market that the Tokyo government hoped. Instead, it plunged the Nikkei index down over thirty thousand points. Japan's Nikkei 225 Index hit an all-time high of 38,916 in December 1989, and then began a sickening 80% crash to a low of 7,831 in April 2003.

  The bursting of the Asian bubble nearly took out the American economy as well, but SEC measures enacted after 1987 stopped the avalanche of program trading.

  But the lost decade included more than just stock market losses. Japan also saw crashing property values, falling interest rates, rising unemployment, declining and stagnant GDP, and the worst demographic profile of any major economy. In short, Japan exhibited all of the hallmarks of a depression of the kind not seen since the 1930s in the U.S.

  As the term lost decade became widely used by economists, an interesting thing happened. Another decade passed and the Japanese economy was still in recession. Today, a full twenty-five years after the bubble burst in Japan, that country continues to struggle with deflation, zero interest rates, under-capitalized banks, adverse demographics, and periodic bouts of negative growth. Japan has endured a twenty-five year recession, and there is no end in sight.

  The Dotcom Crash: 2000 - 2002, United States

  During this period, the value of equity markets grew exponentially, with the technology-dominated Nasdaq index rising from under 1,000 in 1995, to 5,000 by the year 2000.

  The dotcom bubble grew out of a combination of the presence of speculative, emotion-based investing, the abundance of venture capital funding for startups and the failure of dotcoms to turn a profit. Investors poured money into internet startups during the 1990s in the hope that those companies would one day become profitable, and many investors and venture capitalists abandoned a cautious approach for fear of not being able to cash in on the growing use of the internet.

  The media filled investors with a rabid hunger for more. The IPOs of internet companies emerged with ferocity and frequency, sweeping the nation up in euphoria. Investors were blindly grabbing every new issue without even looking at a business plan to find out, for example, how long the company would take before making a profit, if ever.

  In the year 1999, there were 457 IPOs, most of which were internet and technology related. Of those 457 IPOs, 117 doubled in price on the first day of trading. In 2001, the number of IPOs dwindled to 76, and none of them doubled on the first day of trading.

  Obviously, there was a problem. The first pinpricks of this bubble came from the companies themselves. Many recipients of these hot IPOs reported huge losses and some folded outright within months of their offering. Many analysts argued that the dotcom boom and bust was a case of too much too fast. Companies were given millions of dollars and told to grow to Microsoft size by tomorrow.

  The stock market crash of 2000–2002 caused the loss of $5 trillion in the market value of companies. The September 11, 2001, attacks accelerated the stock market drop causing the NYSE to suspend trading for four sessions.

  Turning to the long-term legacy of the bubble, Fred Wilson, who was a venture capitalist during the rise and fall of the dotcom bubble, said:

  "A friend of mine has a great line. He says 'Nothing important has ever been built without irrational exuberance'. Meaning that you need some of this mania to cause investors to open up their pocketbooks and finance the building of the railroads or the automobile or aerospace industry or whatever. And in this case, much of the capital invested was lost, but also, much of it was invested in a very high throughput backbone for the Internet, and lots of software that works, and databases and server structure. All that stuff has allowed what we have today, which has changed all our lives, that's what all this speculative mania built".

  The Great Recession, Housing Bubble, & Credit Crisis: 2007, United States

  The S&P 500 declined 57% from its high in October 2007 of 1576 to its low in March 2009 of 676.

  Following the bursting of the tech bubble and the recession of the early 2000s, the Federal Reserve kept short-term interest rates low for an extended period of time. This coincided with a global savings glut, as developing countries and commodity producing nations accumulated large financial reserves. As these excess savings were invested, global interest rates declined to record low levels. Frustrated with low returns, investors began to assume more risk by seeking higher returns wherever they could be found. For several years, global financial markets entered a period which came to be called the Great Moderation due to the above-average returns and below-average volatility demonstrated by a wide variety of asset classes.

  In the United States, the Great Moderation coincided with a housing boom, as prices soared (particularly on the two coasts and in cities such as Phoenix and Las Vegas.) Rising home prices led to rampant real estate speculation, and also fueled excessive consumer spending as people began to view their homes as a piggy bank that they could extract cash from to fuel discretionary purchases. As home prices soared and many homeowners stretched to make their mortgage payments, the possibility of a collapse grew. However, the true extent of the danger was hidden because so many mortgages had been securitized and turned into AAA-rated securities called derivatives.

  When the long-held belief that home prices do not decline proved to be inaccurate, prices on mortgage-backed securities plunged, prompting massive losses for banks and other financial institutions. These losses soon spread to other asset classes, fueling a crisis of confidence in the health of many of the world's largest banks. Events reached their climax with the bankruptcy of Lehman Brothers in September 2008, which resulted in a credit freeze that brought the global financial system to the brink of complete collapse.

  Unprecedented central bank actions combined with fiscal stimulus (notably in the US and China) helped ease some of the panic in the marketplace, but by late winter 2009, widespread rumors surfaced that Citigroup, Bank of America, and other large banks would have to be nationalized if the global economy was to survive. Fortunately, the aggressive actions by governments around the world eventually helped avoid financial collapse, but the credit freeze forced the global economy into the worst recession since World War 2.

  The credit crisis and accompanying recession caused unprecedented volatility in financial markets. Stocks fell fifty percent or more from their highs through March 2009 before rallying more than fifty percent once the crisis began to ease. In addition to stocks, most fixed income markets also displayed unprecedented volatility, with many corporate bond markets at one point forecasting bankruptcies at a level not seen since the Great Depression. Oil fell seventy percent, then doubled as the financial system stabilized.

  The events of the housing bubble and credit crisis are likely to resonate with consumers and investors for years to come. In many countries (including the
U.S.) consumers remain heavily leveraged, and many homeowners are underwater. As consumers deleverage and repair their finances, their purchasing patterns will be permanently altered. Many developed market countries have also seen a substantial deterioration in their fiscal position. While government actions helped prevent worst-case outcomes from the credit crisis, massive budget deficits now represent a structural problem that may take decades to solve.

  Finally, investors have experienced the most volatile and frightening markets of their lives. Positive lessons, such as the importance of diversification and independent analysis can be taken from the crisis, but there are also emotional effects that must be considered. Investors that can incorporate the lessons of the credit crisis without having their emotions unduly influenced will be best positioned for future investment success.

  As hindsight is always 20/20, we should take the time to highlight what we can learn from these past tragedies.

  First off, we should point out that most market volatility is all our fault. In reality, people create most of the risk in the marketplace by inflating stock prices beyond the value of the underlying company. When stocks are flying through the stratosphere like rockets, it is usually a sign of a bubble. That's not to say that stocks cannot legitimately enjoy a huge leap in value, but this leap should be justified by the prospects of the underlying companies, not just by a mass of investors following each other. The unreasonable belief in the possibility of getting rich quick is the primary reason people get burned by market crashes. Remember that if you put your money into investments that have a high potential for returns, you must also be willing to bear a great chance of losing it all.