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Boom, gloom and doom: The story of yesterday, today and tomorrow
Share Shah
The ramification of the 1996 stock market crash may remain in our ethos for long time. But the question is none has really tried to understand the anatomy of those years or really tried to learn a lesson from it. It is shocking to note that in the history of many crashes that have taken place across the globe, ours remains unsung. None has written about the many factors leading to the rise of the market except detailing that there was a manipulation. The facts remain unknown and may never be officially published or determined. The history and the facts of those years have been pushed back into the Pandora’s Box of official convenience. Was this a conspiracy or a cover up is more than a certainty. It was a failure of a person in power and an institution which was kept hostage in order to subvert the truth. Thus not much can be said about it except the facts of recorded history in the stock exchanges.
In modern times financial crazes have succeeded religious crazes, inquisitions, witch burning of the past. The tulip mania is perhaps the strangest of them all. In 1634 the Dutch suddenly became possessed with a desire to acquire tulips, flower which had been brought to Europe by the Crusaders from the Middle East. The interest in tulips was such that people forgot ordinary industry of the country and the population at all levels neglected work and genuine trade and instead embarked in the tulip trade. The intensity of the demand increased and tulip rose rapidly in value, and when the mania was in full swing some daring speculators invested as much as large sums to purchase a few ounces of roots of the flower. The bulbs were as precious as diamonds and were sold by their weight as if they were precious jewels. Regular markets for the sale of roots were established in all the large towns of Holland. The jobbers dealt largely in tulips, and their profits were enormous. Many regulatory rules and regulations were made to conduct the markets and monitor the jobbers. Many speculators grew suddenly rich.
The epidemic of tulip mania raged with intense fury, the enthusiasm of speculation filled every heart, and confidence was at its height. A golden dream hung temptingly out before the people and one after the other they rushed to the tulip markets like flies around a honey-pot. Every one imagined and many believed that the passion for tulips would last forever, and that the wealthy from every part of the world would send money to Holland and pay whatever prices were asked for them. The riches of Europe and perhaps the world would be concentrated on the shores of the Holland. Every class of people- the aristocracy, professionals, ordinary citizens, merchants, farmers, mechanics, seamen, servants and chimney sweeps dabbled in tulips. Houses and lands were offered for sale at ridiculous prices, or assigned in payment of bargains made at the tulip market. So contagious was the epidemic that foreigners became smitten with the same frenzy and money poured into Holland from all directions.
This speculative mania did not last long as social realization and sanity began to prevail in the opposite direction, and a universal panic suddenly seized the minds of the Dutch. A day came when instead of buying every one was trying to sell. Tulips fell below their normal value. Thousands of merchants were utterly ruined, and a cry of lamentation rose in the land.
In the same class may be placed the Mississippi Bubble, the South Sea Bubble, and the railway manias of USA, real estate booms and financial panics so frequent in the past and present centuries. History has shown us that often movements to fields of opportunity show something of the stampede. There was the California gold fever, the Klondike Gold Rush, and the frequent mass migrations at the rumour of a rich strike in the mining country leading to a contagion affect. When the skeptics learn in quick succession that his partner, his brother, his neighbour, his doctor, and his brother-in-law are off to seek their fortunes, he also becomes restless. The fever is in his blood. Something is pulling him, and the pull becomes stronger with every new story he hears about the success of others. He refuses to believe in failures. When at length he joins the army of gold seekers, his example helps break down the resistance of someone else and thus there is a rush as we have seen in 1996.
The madness takes time to develop to gain heights. Irrationality needs something to fire it like the political success of the previous government. Craze needs to be reinforced by the people in authority as was done by the past Finance Minister and the media, which also suckered in the people. The question is if 1996 stock market mania was different from Holland’s tulip mania less than four hundred years ago. Everybody wanted to invest in the stock market in 1996. Prices of most shares at the peek were twenty times of what they are today. Prices of some specific blue chip shares rose to fantastic level, as did the price of the black tulip. The panic of 1996 reached its height in November, but socio-psychological phenomena of despair began to manifest themselves only after December of that year and continued for many years. As such the regulators and those in authority today should not talk of confidence unless they have some secret to hide. Because when they talk of confidence they are really talking of over confidence. And everybody will agree that is something we do not want. Let people pay for shares what ever they feel it is worth. Let market behave the way they should and not be forced into over confidence.
The stock market has shown us that something happens- an inside tract, rumour real of imaginary brings change in the price of a share or a product. This tipping affect leads to the increase in the price of the share. Eventually the truth comes out and either price sustains or the bubble burst. When the bubble covers the entire market one can then perceive that real madness has captured the stock market.
The late Professor Hyman Minsky (1919-1996) was probably the first economist to understand exactly the dilemma raised by today’s explosive markets. He developed a simple universal framework for understanding all bubbles. The circumstances of each bubble may differ, but each one goes through seven stages.
Early Stage – Displacement: Every financial crisis starts with a disturbance. It might be the invention of a new technology, such as the internet. It could be a shift in economic policy. For example, interest rates might be reduced unexpectedly. Whatever it is, the world changes for one sector of the economy. People see the sector differently. In our present circumstances one may say that the banking company shares were the tipping point. By volume and their perceived return on the stock market, shares of our banking companies were the key factor in attracting droves of investors during late 2005 and thus initiate a new bull market. Both index and volumes increased. Following this displacement, prices in the displaced sector start to rise. Initially, the price increase is barely noticed. Usually, these higher prices reflect some underlying improvement in fundamentals. As the price increases gain momentum, people start to notice. This is generally attributed as the second stage when in reality strong fundamental begin to justify and attract real investors. The early birds take advantage of the situation.
Easy Credit: But the increasing prices are not enough for a bubble. Every financial crisis needs fuel and there is only one thing that works the best in stock markets is- cheap credit. Without it there can be no speculation. Without it, the consequences of the displacement peter out and the sector returns to normal. When a bubble starts, the market is invaded by outsiders. Without cheap credit, the outsiders cannot join in. Cheap credit is the entrance ticket for outsiders. As one may observe in the real estate business in the USA, the banks were prepared to give loans to people with poor credit to hold condos in the hope that they sold in the short term at a profit.
The rise in easy credit is also often associated with financial innovation. Often, a new type of financial instrument is developed that miss-prices risk. Indeed, easy credit and financial innovation is a dangerous cocktail. The South-Sea Bubble started life as a legal innovation called the limited liability joint stock company. In 1929, stock prices were propelled with the help of margin calls. Housing prices in USA accelerated as interest-only mortgages emerged as a viable means for financing overpriced real estate purchases.
Over-trading: The effects of easy credit work as the motivating force in the market and thus people start to overtrade. Overtrading stimulates volumes and shortages emerge. Prices start to accelerate, and easy profits are made. More outsiders are attracted, and prices run out of control. Accelerating prices attract the foolish, greedy and the desperate to enter the market. As a fire needs more fuel to burn brighter, a bubble needs more outsiders.
The margin lending by our merchant banks has been appalling because it has totally disregarded the accepted principals of lending. Banks lend to people or firms on this basis of their cash flow and graduated declining of the principal sum. They generally do not fund speculative borrowers who borrow on the belief that they can service interest on the loan but must continually roll over the principal sum into new investments. The other form of recent lending behaviour by banks in matters of securities can be best described as Ponzi borrowers. Such borrower relies on the appreciation of the value of their investments to refinance or pay off their debts but does not have the means to repay the original loan otherwise.
An instrument which is motivating our stock market currently, are listed closed ended mutual funds. Some of the funds have not behaved as closed ended funds and have used ploys to increase fund generation from investors. These funds do not have adequate accountability or transparency. Billions of takas have been raised by fund managers who have little independent control insufficient expertise and inadequate capital coverage. These funds are expected to be utilized in buying overpriced scrips or cover new issues at high prices. These funds are acting like hedge funds with little supervision by the regulators. One has to only look at the net asset value of these mutual funds vis-à-vis the market/traded prices of these shares in order to really understand the state of euphoric speculation. The present danger is that some of the larger mutual funds may in the near future face what is generally know as the “UTI” syndrome; in other words the fund managers may resort to making biased investment decisions influenced by private greed or political motivations.
Several years ago Unit Trust of India’s US-64 scheme declared substantial erosion in its N.A.V (net asset value) threatening a financial crisis. The Government of India decided that UTI was too big to fail and pumped in Rs 33 billion bailout. But the bearish Indian stock market conditions and the huge technology stock meltdown ruined the strategy and the US-64 holdings dipped once again by Rs 10 billion by the end of 2001. The problems at that point of time were compounded by the fact that unlike most schemes, the US-64 did not declare its NAV on a daily basis and was not marked to the market.
The committee was set up to investigate into the business affairs of UTI. It was revealed that there were several inconsistencies linked to investments. Often investments were made in companies, which Trust’s own internal research team had ruled against. In some cases, investments in companies were increased after the erosion in share prices. The committee ruled that many individual investment decisions of the Trust were imprudent and actually turned out to be wrong. The 2001 stock debacle finally brought to light the ugly nexus of the UTI and other Mutual Funds. The mutual fund is believed to have been the backbone for huge purchases in the technology stocks. The meltdown in technology stocks only resulted in sharp redemption for the scheme earlier in 2002. In the weakening equity market conditions many investors pulled out of their investments and thus the UTI faced huge redemption pressures. This put pressure on most of their earlier monthly income plans, which were structured to function as assured return schemes. In the June 2002 period, the Securities and Exchange Board of India figures show that the UTI has faced redemption of over Rs 63 billion against a mobilization of Rs 6.5 billion.
Eventually the price bubble will enter its most tragic stage. Some wise voices will stand up and say that the bubble can no longer continue. Prof. Rahman Sobhan has already talked about the unabated casino capitalism and pointed the absurd price of Taka seven for Grameen Phone shares which have a par value of one taka and an unbelievably low earning per share. The many institutional investors who have subscribed the pre-IPO placements put together a convincing argument based upon long run fundamentals and sound economic logic. After all the money is not from their pockets. However, these arguments evaporate in the heat of the one over-riding fact – the price is still upwards. The wise are shouted down by market gurus, who justify insane prices by the euphoric claim that the world is different and this new world means higher prices.
Indeed the world is different each day, but that does not mean that prices can run out of control. The guru’s wins the day and unjustified optimism takes over. At this point, they bolster their optimism with the cruelest of all lies; when prices finally reach their new long run level, there will be a “soft landing”. The idea of a gentle deceleration of prices calms the nerves. The outsiders are trapped in knowing denial. They know that prices cannot keep rising forever, but they rarely act on that knowledge. Everything is safe so long as they quit one day before the bubble bursts. Those that did not enter the market are stuck in a terrible dilemma. They cannot enter but neither can they stay out. They know that they have missed the beginning of the bubble. They are bombarded daily with stories of easy riches and friends making massive profits. The strong stay out and reconcile themselves to the missed opportunity. The weak enter the fire and are eventually damned.
All of us want to believe in a new brighter future but a bubble takes that desire and turns it upside down. A bubble demands that everyone believes in a brighter future, and so long as this euphoria continues, the bubble is sustained. However, as madness takes hold of the late birds, the early birds remember the adage that a bird in hand is better than two in the bush. They understand their market, and they know that it has all gone too far. Early birds start to cash out.
Sometimes, panic of the early birds infects the other investors. Other times, it is the end of cheap credit as is the present case. But whatever may be, euphoria is replaced with revulsion. The building is on fire and everyone starts to run for the door. Mom-pop investors start to sell, but there are no buyers. Panic sets in; prices start to tumble downwards, credit dries up, and losses start to accumulate. Many investors know that prices will eventually collapse. It might be tomorrow, or it might be two years from now. One thing however is certain, the longer it takes for the bubble to burst, the more painful it will be. There will be more denials followed by more and more persecution of offenders. The blame game will begin and surrogate hostages shall be discovered. Perhaps this unpleasant and very painful task will be for the new government which takes over the reign next month.
Wall St after the crash of 1929.
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