Financial Bubbles and the lessons they have to teach

Welcome to Finance and Fury, The Furious Friday Edition

This week – see what lessons can be learned from - Last week - Story of Financial alchemy in its early days with the SSC bubble

Been many bubbles since then – The Markets have a Cycle to them History of the last 90 years – exclude wars and a few other drops that weren’t the result of a bubble bursting – you have 1929 crash (-46%), credit squeeze of 1961 (-23%), OPEC stagflation of 1970s (-59%), 1987 crash (-50%) and the 1990 recession that followed (-32%), tech bubble in 2000s (-22%), GFC of 2008/9 (-55%) - Good news - Markets do recover – we are back to all-time highs for the index - but keep repeating the same cycles – debt being flooded into markets – leverage grows, investment prices rise and seeing the artificial price rises, people jump in to not miss the boat – no pun intended – especially as we will be looking at the SSC bubble last week in relation to these common factors over time But like any cycle – what goes up must come down – and there are elements to each stage - Core to the SSC bubble

– wasn’t just an individual (John Blunt) but also a group of individuals who saw a way to make themselves filthy rich – and the general public who didn’t want to miss out

Takes a few elements for a bubble to form and pop – almost like a perfect storm Three major parties involved when it comes to the elements of a bubble cycle – those facilitating it, those driving it (and will profit from it) and those looking to partake to not miss out – a lot of whom do so when it’s too late (those who lose from it) Sometimes the first two are the same entity – or working together For the SSC – Facilitating it was Harley and the Crown, then Blunt saw this as an opportunity to make himself filthy rich, driving the bubble – as he dreamed up a scheme of the market and public perception manipulation This is when the prices went up by a lot – but continues to climb when all three elements come together When everyone is jumping in out of emotions (or greed) to get rich – but got the opposite outcome once the bubble popped Which is when the fundamental price gain factors (leverage) start to run out of benefits – And the amount of money the public has available compared to banks/central banks isn't the same – we cant create or reduce the amount of money at a whim The First Element

– Facilitators – Normally a bigger entity – like a Government through legislation or a Central bank through leverage/money-printing/monetary policy – essentially – the creators of a scheme

The whole scheme for the SSC was thought up by a Government official and a corrupt businessman – John Blunt Blunt's first scheme – use those technically worthless army debentures (loans) and made them attractive – so the price went up Knew that the offer to do a swap at under market value would be massively in demand – and increase the price of the army debentures – so before he announced this scheme – he went out and bought massive amounts of these army debentures – Then he announced so the value of the debentures went through the roof due to people trying to get them to trade for his companies shares – then could trade the technically worthless debentures back to the government for the land that he wanted in Ireland – this was technically illegal – but he was lending the government money – so no action was taken in the end This was technically a mini-bubble But was Similar to the bankers doing swaps on Synthetic CDOs in the GCF – was peddling something worthless and pumping the price up using leveraged strategies – treating some of the highest risk mortgages as AAA credit How many of the masterminds of any bubble go to jail? The banks are some of the Governments biggest donors – so maybe a scapegoat or two – but never the culprits For the SSC – A large part of this bubble was to create a scheme and to never report the truth to the public – but keep confidence high to make sure prices would continue to rise – so those involved could continue to profit If the truth is ever known – the jig is up – So had to keep the population in the dark – and nothing has changed – we are all busy, and economics/finance can be hard to understand unless you devote a large chunk of your life to it - Legislation can be another major element – and the adverse effects Initially – the SSC was created by a Public-Private partnership – to take over all the Crown's debt The only reason that it looked like a good investment was the monopoly trading rights that were provided by the state – created artificial demand for the company – but the underlying profits were non-existent Then – after the price rises - SSC - had its copy cats – others started their own share scheme – started popping up everywhere – crazy ones – like flying machines – so money going into SSC started to cease Bubble Act was put into place in 1720 – which forbade the creation of joint-stock companies without royal charter, was promoted by the South Sea Company itself before its collapse All of this had another unintended effect/consequence – as other schemes which people thought could make them more money instead were starting to take off – Essentially the banning of every other scheme except the SSC – but due to this act – had opposite effect – which was those who invested in the now banned schemes lost their money - so had to sell their SSC stock to make it up – as they were otherwise broke In the modern-day – many bits of monetary policy or legislation create bubbles Lesson - Don’t trust the government is legislating in your best interest – or monetary policy is being conducted for your benefit - Looking at the payments that politicians get after they leave office when they pass favourable bits of legislation Clinton – was getting $500k a pop for a 20 minute speech from the same banks that he allowed to be deregulated In 1995 Clinton loosened housing rules by rewriting the Community Reinvestment Act, which put added pressure on banks to lend in low-income neighbourhoods – the HUD departments regulations also changed where Fannie mae/Freddie mac had to provide a minimum of 30% of loans to low-income households – which banks knew they would lose money on these through defaults so wanted some way to make money off them along with having guarantees that if these loans went belly up (as they would) – banks liquidity would be safe – Then a few years later – under pressure from the same banks - Passed the The Gramm–Leach–Bliley Act, also known as the Financial Services Modernization Act of 1999 - provided the removal of the Glass-Steagall act (allowing investment and commercial banks to operate together) and also exempted credit-default swaps from regulation - allowed banks expand off balance sheet derivative positions with no reporting obligations Then – Central banks – and monetary policy – anyone who owned property or shares since 2009 has done very well out of these policies to fix the problem by buying assets and increasing prices artificially – but those that don’t still have to flip the bill in taxes and are priced out of affordability – ill cover the new Fed plan in the next crash in another episode soon Thing to learn from the first element of bubbles – Governments aren’t your friend – but those who pay them the most and can provide the most benefit – Obviously, they won’t say this to your face – the perception is that they are here to help to get votes – but the outcome is the complete opposite Requires some level headed thinking when things seem too good to be true The Second Element

- Those driving the bubbles – By again, providing confidence and price gains for the public’s perception

Government guarantees – backing – for SSC – back in 1717 – King George became the SSC leader – then politicians were bribed with cash ($2-3m each today's dollars) along with getting shares for free – then due to political involvement the company became too big to fail – if the company failed - prestige would fail and the powers that be would lose money – sound familiar to the 2009 crash? – but it was after this public perception the SSC price started to rise – but by breaking the agreements and letting their prices rise beyond the government debt backing it – but the government officials didn’t care – they were going to get rich – The driving factor is confidence – whether it be fake or real – doesn’t matter – has the same effect of stimulating demand Confidence is key for bubbles – But the effects of public officials getting into the shares and King George taking over leadership of the company gave the public the perception that the shares must be a good thing - a lot of confidence in the shares Effect - share price rose from £114 to £330 – but the next month the shares went down to £310 So confidence was slightly lost – and demand went down – which couldn’t happen Leverage buy ins - new scheme – buy the shares with 20% down and regular payments every 2 months (similar to how warrants work today) – created leverage on leverage – allowed people to buy way more than they could afford – Effect - Could by 5 times the number of shares today with only 20% down - very leveraged and driven by greed – if people saw the price go down then people may stop buying Price quickly rose to £550 – but then soon after prices dropped again to £510 Lending to people to buy - – Loan people the money to buy the shares – loans from SSC to individuals – then they would buy their own shares back off them and push the prices higher Effect - Prices went to £600 – seeing this – people wanted to get in – greed took over rational sense Lesson – price gains are not a sign of a good investment – especially when leverage/debt is the factor that creates the growth Saw last week – SSC went from £100 - £1,000 within around a year – was it due to the spectacular performance? No - the company was technically losing money from operating – Was due to the last element – the public demand on top of the first two elements The Last Element

– The general public - Those who mostly get caught out – but also are pushing the prices higher

The first two elements have the same effect – to artificially stimulate demand – This creates a situation where the public has Confidence in investments continuing to rise – through conflating a rising asset price to a good investment – If the shares of a company go up by 20%, 60%, 100% - you might think that the company is doing really well But the share price doesn’t reflect the company’s performance – just the demand for the share Can be out of expected performance – or just blind faith and that people don’t want to miss the future gains – like in the case of the SSC – and also a lot of the largest shares listed in the US markets For the SSC - in England at the time – not enough money in whole country to prop up prices – so the - £60m to the market cap of £300m – due to the leveraged nature of the funds Modern day derivates and price elevations are a good example of this The Inevitable Consequence

- The bubble busting – Too good to be true turns out to be true –  fear and panic spreading

For SSC - Risk was that when the real information gets out to public and confidence is lost – to those paying attention – due to them not making any money – mass sale orders come through – then the prices drop – then the rest of the market out of fear - loss aversion – sell as well – hence the bubble bursts – For SSC – the offers that were too good to be true were the issue of shares at the top of the market at £1,000 – created a massive sale for profit-taking – those who bought the shares with 20% down at £500 – or earlier But also - What broke the bubble – Blunt offered a 30% p.a. dividend – which woke up the people – losing confidence – fell hundreds of pounds – In 3 weeks – went from over £1,000 to £150 – bankruptcies and suicides were rampant The economic effects were widespread – required BOE to buy the shares back – at the market prices This trend becomes Inevitable – a threshold of people catch on and sell – or a monetary body – either a group of banks or central bank restrict credit – For example - 1929 was a group of banks recalling margin loans all at once- 1961 was Aus central bank tightening credit growth due to property prices going up

Over time – I will do a deeper dive into each of these bubble events – but for today – that’s all – thanks for listening

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