This Is What All Great Stock Market Bubbles And Crashes Have in Common

excited about our new series. Yeah. So, in our grand tradition I guess of dealing in the worst of human character, we are going to be all about fear and greed in our next series. We're gonna be talking about bubbles. This is gonna be a great I'm really excited. Let's just be honest. Bubbles are when markets are at the most fun. I mean, there may be markets at their worst, but when markets are just trading on pure emotion, fear

and greed, totally divorced from fundamentals. Panic, everyone wanted to get rich. It's hard to argue that that isn't when markets are there at their most interesting. No, I totally agree, and you hit the nail on the head, because if you think markets are reflection of human emotions and human nature, then the extremes are probably the most interesting facets of that.

And I mean, I have to say the other thing about bubbles, and I think the real reason that everyone is always perpetually fascinated with them is that you can get rich during the bubble if you can time it perfectly right. And who doesn't want to get rich? So what bubble are we starting with? Are we starting with today? All right? We're going to start out with the quintessential bubble, in my opinion, um, and that has to be the sort of nineteen twenties stock bubble and the subsequent crash.

And we're also going to be discussed saying some other stock market bubbles that happened along the way, including of course seven and we might even get to two thousand seven, two eight. I can't wait. I mean, obviously there's bubbles in many things, in many things. We've had some episodes in fact about bubbles, including beanie babies and catfish and probably some others. But I do think that when people

think bubble, they probably first think stock market bubbles. So I think, you know, the sort of some of the history of the big ones in the United States is a great way to start. We're starting out very very classical, alright. So here with us to talk about various stock bubbles is Scott Nations. Uh. He is the author of a book called A History of the United States in five crashes,

stock market meltdowns that defined a nation. I actually know him from his other job, which is president of Nations Shares. It's a company that's been building a lot of indexes, including some interesting volatility indexes, so we might even ask him about those later in the show as well. Scott, thanks so much for coming on. It's great to be here. So Scott, you know your book I think is probably the perfect one for us to begin this series. But just to set the scene for us, I want to

start with crash. If you could pinpoint one thing that sort of sparked the euphoria that led to that initial nine twenties stock bubble, what would it be. It would

have to be a friendship. And I know that sounds goofy, but it was a friendship between the head of the Federal Reserve Bank in New York and the governor of the Bank of England, and these two wonderful guys, Montague Norman and Benjamin Strong had a wonderful friendship, and they were trying to help each other, and in doing so, Benjamin Strong kept interest rates in the United States ridiculously low.

It's not the first time the Fed has done that, but he kept interest rates in the United States ridiculously low, even lower than they had been during the emergency level of World War One. And that is really what fed the bubble that became the nineteen twenties and then ultimately the nineteen nine crash. And it's it's easy to think about these crashes in numbers, but their dramas. Each of them is a drama. Each one of them is a fascinating drama. And in nine it's a little bit like

the story of the Titanic. We know how it ends, and it ends badly, but it's a fascinating story. I don't want to skip ahead to another bubble, so I'm not going to. But in when when I've read about the nineteen twenties, something that struck me was, you know, analogies to the late nineties bubble, because in addition to the good financial conditions you characterized, there were a lot of genuine, the genuine reasons to be excited about things.

It was peace, There was the increasing wide spreadness of the automobile, the radio, the new communications technology was taking off. But there was just a all kinds of non financial reasons for people to start start to get excited. Absolutely all of Europe had been devastated by World War One. The American industrial base had been untouched. People were buying automobiles. There was another invention, relatively new invention that everybody had

to have. It was the radio. Our ci a Radio Corporation of America started the decade as a two dollar stock and after splits it into the decade while almost into the decade at about five seventy dollars, So you're absolutely right. Everybody felt great about America and America's place in the world. Interest rates were low. The Treasury had also made the country a country of investors by selling them war bonds, and that bled into them buying stocks

once the war was over. So you have this mix of low interest rates, relatively positive economic growth, a lot of optimism about the future of fairly steady geopolitical landscape. When did the wheels start to come off and what were the signs that trouble was potentially ahead. Unfortunately, in nine we really didn't get any clues until very late

in the game. There were certainly some people that were worried, but it wasn't really until September of nineteen nine that people started to worry and and and talk about their worry out loud. The striking thing about each of the five crashes that I talked about is that each has a catalyst that has very little to do often very little or nothing to do with finance. And it had

a little to do with finance. There was a fraud ster in London by the name of Clarence Hatchery who uh simply started counterfeiting stock certificates and in a day when everything was on paper, he managed to completely undermine the stock market. And he wasn't found out until September of nine, and that's when the wheels tracing your in

your phrase really started coming off. One thing I like about crashes is it really is, I think impossible to pinpoint what caused the crash because you can point to a million things. I know one of the is so minor, but I think, uh, one of the things people point to was some regulator in Massachusetts preventing a utility company stock from splitting, the most minor thing in the world.

But it freaked out utility investors, pointing to if this one minor regulatory body in Massachusetts can freak out investors, how fragile the whole edifice. Because you make a great point. Until then, this financial regulator had allowed any any utility that wanted to split its stock. They had allowed them to do so. Uh. They were essentially a rubber stamp. But then a utility in Massachusetts came to home and said, we'd like to split our stock for for one their

reason was because it's the fashion of the day. No more reason than that, it's the fashion of the day. And finally the regulator had had enough and they said, nope, your stock is already trading much higher than any intrinsic value. If we allow you to split, it will get even worse. And this is our line in the sand. And was finally somebody who had said, somebody, an authority who had said this is not right and this needs to stop.

I love the idea that maybe a regulator in Massachusetts of utility companies could possibly be responsible for the stock market crash on the subsequent create depression. Well, they they certainly helped. They certainly helped things on their way. Okay, so you get these sort of idiosyncratic things happening and people start to get a little bit nervous and stocks, uh, I guess they really start coming down on Black Tuesday, right, I always got it mixed up with Black Thursday. But

Black Tuesday was the first big drop, is that right? Well, there were two, there were two nearly identical drops. They and the twenty nine that it actually started just after Labor Day, that was the day after Labor Day was the peak of the market. But you're right, the twenty ninth of October when the market both of those days, the market was down about twelve and a half or that's when it that's when it really really really got bad.

So how do people how are people reacting in that time period, because whenever we see stocks drop nowadays, you know, we always get the chorus of people talking about how

this is a healthy correction, to use the cliche. I wonder if the same thing happened in I don't think people understood, well, certainly people didn't recognize what the nineteen thirties were gonna look like and there's no way they could a I think what they were doing was they were looking back to what had happened in nineteen o seven. The panic of nineteen o seven is the first crash I talked about, and that was a panic, and each of the each of the crashes have heroes and villains.

The hero in nineteen o seven was undeniably JP Morgan, and I mean the man, not the bank, because he nearly single handedly stopped the crash. Well. In nineteen there were a bunch of financiers who thought that they could be the modern day JP Morgan, and they tried to

do that. They tried to step in, raise some capital, buy some stocks, and so I think that for most of October of nine, I think most people thought this is bad, but it will stop and then we'll go back up and it will be like every other break that we've had in the market. They didn't realize that they were going to end up making things worse than

it was going to get. As bad as it did, I feel like we could actually probably just do the whole episode one because it's so rich and we should move on to and one other right nugget I really like from it I remember during the two thousand and eight crash. You know, there was that famous um Warren Buffett up ed in the New York Times. I think he's like, buy stocks. I know I am. And there was something similar. John Rockefeller had did a similar thing.

He sort of came out of seclusion. He's like, I'm buying American shares. It's a good it's a good deal. Like all these attempts by the sort of business legends to just instill confidence with their words alone. Well, John D. Rockefeller in nine said my son and I are buying stocks. And he at the time he mentioned some outlandish number he had spent, a number that only Jape that that

Rockefeller could spend. But for the most part, people weren't really afraid in a way that that Rockefeller could could calm. I mean they were, they were They ultimately were really afraid. They were afraid that they were gonna lose everything. Yeah, And it's funny we still see that happening. I mean all the way up to two thousand and eight, when Warren Buffett came in and invested in Goldman Sack Shares,

a right in the middle of the banking crisis. I have a feeling that Joe wants to move on to a later stock market bubble and crash, and that would be the events of night seven. That sounds good, Let's talk about eight seven. Um, you know, uh, Well, it's interesting because we hear so much about quants these days, and people are sort of nervous that the quant machine are going to malfunction. We're gonna get this like wave of uncontrollable selling from computers and everything's gonna melt down.

Seven was kind of a precursor to these fears. It's interesting there. The five crashes that I discussed pan more. They span more than a century, but each one is abetted by some sort of I call and financial contraption that is new, it's novel, it's poorly understood, and it's untested under stress. And in seven, probably the prototypical contract

option was portfolio insurance. It seemed like a like an ingenious invention by a couple of academics at cal Berkeley, and it was a way they way they expressed it as a way for investors, institutional investors to make certain that their stock portfolio never fell below a certain value. It required regular regimented selling of stocks as they fell. The problem is that we and we know now we should have known then that when we demand liquidity is

when it evaporates. And that's what happened. It was the typical, prototypical, really financial contraption. The interesting thing is that in the worst of the crash, of the guys that had created this Leland, O'Brien and Rubinstein were running a business that would sell futures to affect this insurance, and their trader, at one point on October seven, refused to sell anymore futures. His quote was, if I sell all the futures that I'm supposed to, I'm certain I will drive the market

to zero. Wow. So did he save the world. Well, I'm not sorry he saved the world, but he he helped stop the bleeding. If somebody saved the world, it might it might have been Alan Greenspan the next morning with a wonderfully terse um comment that consistent with its position is the Central Bank, the FED is ready to essentially give anybody anything they want. And then the Federal Reserve got on the line with banks and said we'll

give you anything you want. Now I don't I'm worried we're cheating a little bit here because we talked about the crash of but this is the bubble series. Was their exuberance? What was the pre October seven vibe in the market where people are just thinking that things would just go straight up? Exuberance doesn't even begin to cover it. The first thirteen days, the doll did something it had never done before and it has never done since. It

gained thirteen straight days in a row. At the market's top in August, it was up forty three for the year. I think that would have made it the sixth or the eighth best year ever if it could have just held onto that. So exuberance doesn't even begin to describe it. Much of it was a function of corporate raiders who had started to recognize the unrecognized value previously unrecognized value and a lot of stocks, and they were buying them up.

And so we gotten into a situation where everybody felt like they could buy a stock confident that some raider would come along and bid it even higher. Yeah. Really, the era of greed is good. To Joe's earlier point, I'm wondering, you know, nowadays we talk a lot about the potential for quant funds or systematic funds or risk parity funds to spark a broad sell off in the style of portfolio insurance in the eighties. Was anyone talking about the risks of portfolio insurance or you know, the

downsides of black shoals before it actually happened. Even the inventors of portfolio insurance realized that it had some limitations when they go into when they went into sales meetings, they would say that this will work until something like in the analogy they used was the Soviets invade Iran. There were some other people who were talking about it, but you really had to be pretty geeky in order

to have gotten that message. It was actually precisely a week before the crash that an article appeared in the Wall Street Journal by Beatrice Garcia that really introduced people to the fear of portfolio insurance. Alright, I want to uh skip ahead to actually what I think is. I don't know if it's my favorite crash, but it's the one that I feel like I know the best because I sort of came of age during it, and that is the late nineties bubble. As a student in high school.

I got really tessed with the market then and I think it is a good chance that due to that timing is the reason I'm in financial media today because I just found the whole thing, uh fascinating. What in your when did that bubble start? In your view, that's a great question. Once I don't talk about what happened in two thousand, two thousand, two thousand and two in my book. I don't consider that quite a crash. It

took place over actually several years. It had several down legs, first of all, starting in March up two thousand and then with nine eleven. Uh. But when did when did the bubble of of the es start? I think it would have to I look at it as something that started with the the Apple Super Bowl ad that ran one time, because that really started to put the personal computer and personal technology front and center in people's thinking. And that's I think when that market really started taking off.

I've conceptual question, which is, uh, you know, after bubbles burst, we always talk about the pricing is having been irrational, But the run up to all these bubbles actually often has a rational explanation. There's usually a narrative to accompany it, right, Oh, yeah, there's always an explanation. Unfortunately, So in terms of those explanations, I mean, what is it about human nature that we always buy into those explanations and we're never more skeptical

of the story that we're hearing. It's a phrase that we've used before, and the phrases it's different this time. It is so easy to convince ourselves that it is different this time in we had not really seen we've seen a single modern stock market crash in nine seven. In seven, it had been so long since we've had a crash fifty years that I think people just forgot that they could happen, and they thought we are much

more sophisticated, much smarter now than we were then. I think it's just the hubrists of humankind where we just think we're smarter and it's different this time. I have another human nature question, and it concerns the post crisis period, because since two thousand and nine, we've essentially been in this NonStop bowl market. Uh, there's been a few blips

along the way. That being said, throughout this rally, numerous people have been talking about bubbles or the crash is going to come back anytime soon, and so in a way, rather than this period being characterized as care freeness are buying into a new story. There's been this underlying deep pessimism that's prevented a lot of people from actually participating in this rally, and this belief that the next two

thousand and eight could happen any minute from now. Well, and a lot of those people have something that they want to sell, and they want to sell you a news utter. They think that you should be buying gold or whatever. But I think you make a great point, and that is, if there's so much skepticism, it's hard to think that we're going to have a crash. Now we know the market can pull back substantially. Nobody is

saying that it can't. But with interest rates as low as they are, if interest rates would go substantially higher over the next couple of years, uh, in, the market could very well be in trouble. But I I just think that you're absolutely right. There's so much skepticism that it's tough to think we're really going to get say, bubble shous. There's skepticism. But on the other hand, uh, you know, I really like the way city analysts once phrased or once characterized a bubble. They said it was

something that I get fired for not owning. And in that sense, you can complain about valuations as much as you want, but if you have to invest money, well, then you have to put it somewhere other than cash. And so it's either going into stocks or credit. Um. But Scott to uh, to Joe's point, if there was one thing that you could pinpoint as a suspicious sign when it comes to identifying a true bubble, what would

it be? That's a great question. I in my experience, in my in my book, I talked about several similarities that each of the crashes share. UM. There is there's always some new financial contraption. I think that if we can see something that is starting to um capture too much, too many assets, uh, then that would be a problem. Uh it interest rates too low for too long are

the reason. And then two thousand and eight happened. So if you want to look now and say, boy, interest rates have been too low for too long, and the Federal Reserve seems just terrified of raising Fed funds rate past one or of starting to shrink the balance sheet, that might be the thing that would scare people right now. And as Tracey you mentioned in the beginning. One of the really well, let's be honest, one of the cool things about bubbles is that you could get rich in

a really short period of time. And the only thing you have to do to get rich during a bubble is to sell before everybody else sells. As long as you could do that, that bubbles are great. So when you look at these crashes and you know, your book is a history of the United States and five crashes, are there any common themes out there that sort of foretell the imminent collapse so that people know to uh, you know, get out the door before everybody else does. Well.

The problem, it's a it's a fascinating question. The problem is that and I mentioned these catalysts, and there's always a catalyst. The problem is that the time between the catalysts and the crash is collapsing. It was a year between the catalysts for the nineteen o seven panic and the actual panic. Um it was a year. Uh. In nine, it was about a month between hatchery and the crash. In seven, it seemed the friday before the crash seemed

like we'd finally gone to war with a ran. So that was a weekend and we haven't talked about two thousand and tend the flash crash, but the catalyst for that happened the day before the crash. So we've gone from waiting a year and then a month, and then a weekend, and now a day. The problem is as the time between the catalysts and the crash collapses, then there's less opportunity for people to do what you're suggesting. Real quickly, Well, you mentioned the catalyst for flash crash.

What do you identify that as? Oh? I think it was clearly the rioting, arson and murder in the streets of Athens on May five, two and ten. It seemed just absolutely obvious that that all of the Greeks, all of Greek society, was going to come apart, and that as a result of the Eurozone was going to come apart.

It seemed absolutely certain A million people were in the streets of Athens, a bank had been firebombed, three people had been killed, um not just killed, murdered, three young people who would come back to Athens to continue their careers when they didn't need to come back to Athens. And that and the fact that on the on the seventh we were going to get a non farm payroll number, the writing in Athens, which is obviously the catalyst for

what happened. Scott Nations, the author of a history of the United States in five crashes stock market meltdowns that defined a nation. Thank you so much for joining us. Fascinating conversation. I'd love to have you back one day. Did you just like talk more about because we could do like two hours on it. But that was great and a great start to our bubble series. Thanks so much. It's been tremendous fund to be here, Joe. I thought,

as you said, that was a fantastic start to our series. Um, I love drawing analogies between previous bubbles, and I have to say, the idea that the window that you have to get out first from a bubble ahead of an imminent crash, the idea that that is shrinking rapidly, that really resonates, especially when we think about the way markets are more computerized nowadays, but also just the way information

gets disseminated so quickly nowadays. Yeah. I hadn't even thought about that, but that is a great a great point, I thought, and it was one that hadn't clicked to me at all. But it seems easy to say on the way up, and it was like, Yeah, I know, it's kind of a rational it's a bubble, but I'll just be prudent. But if the you know, the crash can happen that fast, probably there are a lot of people who imagine they'll be prudent and not actually be

able to act on it. Yeah, exactly, all right, Um, should we tease some of the other bubbles that we're going to be discussing during this series. Wait, I just want to make one more point too that I really from Scott and that is the sort of what is he characterized that the new financial contraption at any given moment, because I think it's you know, and I think we

look at you could sort of tell that you need. Obviously, there's the financial conditions puzzle, often characterized by low interest rates. There's the sort of optimism part of the puzzle, the idea that some new technology like the internet or the

radio is going to get people excited. But this other thing that there's some new tool for investing, whether it's the c d O or the online broker and the nineties or whatever it is, or the mutual funds in the twenties, that there has and of course now you know, people are very concerned about e t f s and other things like that we don't know exactly. Seems like a very important point I had I'd never really like

put together before. Yeah, it's interesting that those new creations often come from I don't want to say like a good place. But if you think about the Investment Trust of the nineteen twenties, that was really supposed to uh democratize finance and make it easier to invest in the same thing for e t f s now right, you know you're supposed to be able to get easy and cheap access to stocks. Uh. You could even argue the housing bubble um going into two thousand eight. You know,

the government was trying to increase home ownership. Um anyway, Alright, but I think there's a quote about the road to good intentions or something like that, or the road to hell, but I applies here. So let's real quickly. Uh. Yeah, as you mentioned tease ahead to some of our future episodes, what are you excited to talk about? Well, you know, I said was the quintessential bubble and crash, but there's one that is even more classic, and that has to

be the Tulip Bubble. I'm very excited to talk about that one, although I've I am very much too. I know there's a lot of debate about that one, about how much of it was real and how much it was a myth, but it is the number one thing that when people think bubble, it's tulips again, and so I feel like I can't wait to really dive into that.

Also because I'm super into U the twenties, I'm excited we're gonna talk about the nine twenties Florida real estate bubble, which is sort of a precursor to the overall crash, and there are just some fabulous stories that came out of that. So I am very excited about continuing this series. Yeah, alright, so everyone should keep on listening because those episodes and many more will be coming out in the coming weeks. But that is it for the first edition of our

Bubbles series. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway, and I'm Joe wi isn't All. You can follow me on Twitter at the Stalwart, and you can follow Scott on Twitter at Scott Nations. And our producer, Sarah Patterson Sarah pat with two teas. This has been another episode of the Odd Lots podcast. Thanks for listening.