The Speculative Episode

• Supported by the experience of centuries: the speculative episode always ends not with a whimper but with a bang.
• Those involved with the speculation are experiencing an increase in wealth—getting rich or being further enriched. No one wishes to believe that this is fortuitous or undeserved; all wish to think that it is the result of their own superior insight or intuition. The very increase in values thus captures the thoughts and minds of those being rewarded.
• Speculation buys up, in a very practical way, the intelligence of those involved.

The Common Denominators

• Contributing to and supporting this euphoria are two further factors little noted in our time or in past times.

Memory

• The first is the extreme brevity of the financial memory. In consequence, financial disaster is quickly forgotten. In further consequence, when the same or closely similar circumstances occur again, sometimes in only a few years, they are hailed by a new, often youthful, and always supremely self-confident generation as a brilliantly innovative discovery in the financial and larger economic world.

Money x Intelligence

• In all capitalist attitudes there is a strong tendency to believe that the more money, either as income or assets, of which an individual is possessed or with which he is associated, the deeper and more compelling his economic and social perception, the more astute and penetrating his mental processes. The more money, the greater the achievement and the intelligence that supports it.
• In fact, such reverence for the possession of money again indicates the shortness of memory, the ignorance of history,and the consequent capacity for self-and popular delusion just mentioned.
• Having money may mean, as often in the past and frequently in the present, that the person is foolishly indifferent to legal constraints and may, in modern times, be a potential resident of a minimum-security prison. Or the money may have been inherited, and, notoriously, mental acuity does not pass in reliable fashion from parent to offspring. On all these matters, a more careful examination of the presumed financial genius, a sternly detailed interrogation to test his or her intelligence, would frequently and perhaps normally produce a different conclusion.

CEOs x Supremely Intelligent

• Finally and more specifically, we compulsively associate unusual intelligence with the leadership of the great financial institutions—the large banking, investment-banking, insurance, and brokerage houses. In practice, the individual or individuals at the top of these institutions are often there because, as happens regularly in great organizations, theirs was mentally the most predictable and, in consequence, bureaucratically the least inimical of the contending talent. He, she, or they are then endowed with the authority that encourages acquiescence from their subordinates and applause from their acolytes and that excludes adverse opinion or criticism. They are thus admirably protected in what may be a serious commitment to error.
• We will see, and repeatedly, how the investing public is fascinated and captured by the great financial mind. That fascination derives, in turn, from the scale of the financial operations and the feeling that, with so much money involved, the mental resources behind them cannot be less. Only after the speculative collapse does the truth emerge. What was thought to be unusual acuity turns out to be only a fortuitous and unfortunate association with the assets.

There’s nothing new in finance

• As to new financial instruments, however, experience establishes a firm rule. The rule is that financial operations do not lend themselves to innovation. What is recurrently so described and celebrated is, without exception, a small variation on an established design, one that owes its distinctive character to the aforementioned brevity of the financial memory. The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version. All financial innovation involves, in one form or another, the creation of debt secured in greater or lesser adequacy by real assets.
• This was true in one of the earliest seeming marvels: when banks discovered that they could print bank notes and issue them to borrowers in a volume in excess of the hard-money deposits in the banks’ strong rooms. The depositors could be counted upon, it was believed or hoped, not to come all at once for their money. There was no seeming limit to the debt that could thus be leveraged on a given volume of hard cash. A wonderful thing. The limit became apparent, however, when some alarming news, perhaps of the extent of the leverage itself, caused too many of the original depositors to want their money at the same time.
• All subsequent financial innovation has involved similar debt creation leveraged against more limited assets with only modifications in the earlier design. All crises have involved debt that, in one fashion or another, has become dangerously out of scale in relation to the underlying means of payment.

Reality is never the truth

• The final and common feature of the speculative episode—in stock markets, real estate, art, or junk bonds—is what happens after the inevitable crash. This, invariably, will be a time of anger and recrimination and also of profoundly unsubtle introspection. There will also be scrutiny of the previously much-praised financial instruments and practices. There will be talk of regulation and reform. What will not be discussed is the speculation itself or the aberrant optimism that lay behind it.Nothing is more remarkable than this: in the aftermath of speculation, the reality will be all but ignored. There are two reasons for this.

1. In the first place, many people and institutions have been involved, and whereas it is acceptable to attribute error, gullibility, and excess to a single individual or even to a particular corporation, it is not deemed fitting to attribute them to a whole community,
2. The second reason that the speculative mood and mania are exempted from blame is theological. In accepted free-enterprise attitudes and doctrine, the market is a neutral and accurate reflection of external influences; it is not supposed to be subject to an inherent and internal dynamic of error.

The Classic Cases, I: The Tulipomania; John Law and the Banque Royale

Tulipomania

• The first modern stock market—modern especially as to the volume of transactions—appeared in Amsterdam at the beginning of the 17th century. And it was in the stable, wide-horizoned land of the Dutch, with its stable and somber people, that there came in the 1630s the first of the great speculative explosions known to history.
• The tulip—Tulipa of the lily family Liliaceae, of which there are around 160 species—grows wild in the eastern Mediterranean countries and on east from there. The bulbs first came to Western Europe in the 16th century; a cargo of them that arrived in Antwerp from Constantinople in 1562 is thought to have been especially important in spreading knowledge and appreciation of the flower.
• Attention came to be concentrated on the possession and display of the more esoteric of the blooms. And appreciation of the more exceptional of the flowers rapidly gave way to a yet deeper appreciation of the increase in the price that their beauty and rarity were commanding. For this the bulbs were now bought, and by the mid-1630s the increase seemed to be without limit. The rush to invest engulfed the whole of Holland. No person of minimal sensitivity of mind felt that he could be left behind. Prices were extravagant; by 1636, a bulb of no previously apparent worth might be exchanged for “a new carriage, two grey horses and a complete harness.”
• The demand for tulips of a rare species increased so much in the year 1636, that regular marts for their sale were established on the Stock Exchange of Amsterdam, in Rotterdam, Harlaem, Leyden, Alkmar, Hoorn, and other towns…. At first, as in all these gambling mania, confidence was at its height, and everybody gained.
• The tulip-jobbers speculated in the rise and fall of the tulip stocks, and made large profits by buying when prices fell, and selling out when they rose. Many individuals grew suddenly rich. Every one imagined that the passion for tulips would last forever, and that the wealthy from every part of the world would send to Holland, and pay whatever prices were asked for them.
• The riches of Europe would be concentrated on the shores of the Zuyder Zee, and poverty banished from the favored clime of Holland.
• In 1637 came the end. Again the controlling rules were in command. The wise and the nervous began to detach, no one knows for what reason; others saw them go; the rush to sell became a panic; the prices dropped as if over a precipice. Those who had purchased, many by pledging property for credit—here the leverage—were suddenly bereft or bankrupt.
• In the aftermath, the bitterness, recrimination, and search for scapegoats—all normal—were extreme, as was the avoidance of mention of the mass mania that was the true cause. Those who had contracted to buy at the enormously inflated prices defaulted en masse. Angry sellers sought enforcement of their contracts of sale; the courts, identifying it as a gambling operation, were unhelpful.
• The collapse of the tulip prices and the resulting impoverishment had a chilling effect on Dutch economic life in the years that followed—there ensued, in modern terminology, an appreciable depression.

John Law and the Banque Royale

• On May 2, 1716, he was accorded the right to establish a bank, which eventually became the Banque Royale, with a capital of six million livres. Included was authorization to issue notes, which were then used by the bank to pay current government expenses and to take over past government debts. The notes, in principle exchangeable into hard coin if one wished, were well received. Some being well received, more were issued. What was needed, obviously, was a source of earnings in hard cash that would bring in revenues to support the note issue.
• This was provided in theory by the organization of the Mississippi Company (the Compagnie d’Occident)—later, with larger trading privileges, the Company of the Indies—to pursue the gold deposits that were presumed to exist in the great North American territory of Louisiana. There was no evidence of the gold, but this, as ever in such episodes, was no time for doubters or doubting. Shares of the company were offered to the public, and the response was sensational. The old bourse in the Rue Quincampoix was the scene of the most intense, even riotous, operations in all the history of financial greed.
• The proceeds of the sale of the stock in the Mississippi Company went not to search for the as yet undiscovered gold, but to the government for its debts. The notes that went out to pay the debt came back to buy more stock. More stock was then issued to satisfy more of the intense demand, the latter having the effect of lifting both the old and the new issues to ever more extravagant heights. All the notes in this highly literal circulation were, it was presumed, backed by coin in the Banque Royale, but the amount of the coin that so sustained the notes was soon miniscule in relation to the volume of paper. Here was leverage in a particular wondrous form.
• In 1720, the end came. The precipitating factor, it is said, was the decision of the Prince de Conti, annoyed by his inability to buy stock, to send his notes to the Banque Royale to be turned in for gold.
• Whatever the facts, there was a run on the bank – people seeking to convert their notes not into the stock of the Mississippi Company but into gold. On one July day in 1720, 15 people lost their lives in the crush in front of the Banque Royale.
• The notes were declared no longer convertible. Values, and not just those of the Mississippi stock, collapsed. Citizens who a week before had been millionaires were now impoverished.
• Next came the predictable anger, the search for the individual or institution to be blamed. Law became the object of the most venomous condemnation.
• It is possible to see here again the constants in these matters. Associated with the wealth of the Banque Royale, Law was a genius—intelligence, as ever, derived from association with money. When the wealth dissolved and disappeared, he was a fugitive mercilessly reviled.
• In the aftermath, as in Holland after the tulips, the French economy was depressed, and economic and financial life was generally disordered.
• But, as in Holland and as with superb consistency throughout this history, blame did not fall on the speculation and its gulled participants. It was, as already indicated, John Law who was deemed responsible, as was his Banque Royale, and for a century in France banks would be regarded with suspicion.

The Classic Cases, II: The Bubble

South Sea Company

• The discovery that justified the boom, or, as always and more precisely, the rediscovery, was of the joint-stock company. Such companies went back a hundred years and more in England; suddenly, nonetheless, they now emerged as the new wonder of finance and the whole economic world.
• “I can measure the motions of bodies,” Sir Isaac Newton once observed, “but I cannot measure human folly.” Nor could he do so as regards his own. He was to lose £ 20,000, now a million dollars and much more, in the speculative orgy that was to come.
• The South Sea Company was born in 1711 at the instigation or, perhaps more precisely, as the inspiration of Robert Harley, Earl of Oxford.
• Its origins closely resembled those of the Banque Royale and the Mississippi Company; it similarly provided a seeming and undeniably welcome solution to the problem of floating and pressing government debt that, as in France, had been incurred in previous years in the War of the Spanish Succession.
• In return for its charter, the South Sea Company took over and consolidated this diverse government debt. It was paid interest by the government at the rate of 6 percent and in return received the right to issue stock and to have “the sole trade and traffick, from 1 August 1711, into unto and from the Kingdoms, Lands etc. of America, on the east side from the river Aranoca, to the southernmost part of the Terra del Fuego….” Added was all trade on the western side of the Americas and “into unto and from all countries in the same limits, reputed to belong to the Crown of Spain, or which shall hereafter be discovered.” This map by cartographer Herman Moll was commissioned by the South Sea Company. The entire region displayed, with the exception of Brazil, was claimed as the company’s trading territory.
• Thoughtfully overlooked was the fact that Spain claimed a monopoly over all truck and trade with this great region, although there was some distant hope that treaty negotiations then under way would accord Britain access to the fabled metallic wealth of Mexico, Peru, and the rest. There would be opportunities in the slave trade; for this, the British operators thought themselves to have a special aptitude.
• In the end, a small—very small—window of opportunity did open. Spain briefly allowed the company exactly one voyage a year, subject to a share in its profits. Hope for something better was then partly sustained by the thought that sovereignty over Gibraltar might be traded for greater access to the Americas.
• It would be hard, in fact, to imagine a commercial project that was more questionable. But here, as in Paris, it was not a time for questions. Further issues of stock in return for further assumptions of the public debt were authorized and offered to the public, and, early in 1720, the whole public debt was assumed. Such were the presumed advantages of the enterprise.
• The legislation was facilitated by the endowment of gifts of the South Sea stock to key ministers of the government, and also by the happy circumstance that several directors of the enterprise sat in Parliament, with an excellent chance, in consequence, to make known therein the great prospects awaiting the company. The latter’s directors were also generous in awarding stock to themselves.
• The stock of the company, which had been at around £128 in January 1720, went to £330 in March, £550 in May, £890 in June, and to around £1,000 later in the summer. Not before in the kingdom, and perhaps not even in Paris or Holland, had so many so suddenly become so rich. As ever, the sight of some becoming so effortlessly affluent brought the rush to participate that further powered the upward thrust.
• Nor was the South Sea Company the only opportunity. Its success spawned at least a hundred imitators and hitchhikers, all hoping to take part in the boom.
• In July of 1720, the government finally called a halt; legislation—the Bubble Act—was passed prohibiting these other promotions.
• However, by this time the end of that company was in sight. The stock went into a tail-spin, partly, without doubt, the result of inspired profit-taking by those inside and at the top.
• Eventually, with some support from the government, shares leveled off at around £140, approximately one-seventh of their peak value. As before and later, once the crash comes, it overrides all efforts to reverse the disaster. There soon followed the search for scapegoats; it was fierce, even brutal. Blunt, by now Sir John Blunt, narrowly escaped death when an assailant, presumably a victim, sought to shoot him down in a London street.

The American Tradition

• The financial memory is brief, but subjective public attitudes can be more durable. As John Law created a suspicion of banks in France that endured for a century or longer, so the South Sea Bubble warned Britain against joint-stock companies. The Bubble Act restricted for many succeeding decades the formation of limited companies, what we now denote corporations. However, by 1824, these enterprises had once again gained sufficient respectability to allow another wave of London stock promotions.
• Later in the century there were further speculative episodes in response to opportunities in the New World, with South America once again serving as a special magnet for the imagination. In 1890, the Bank of England had to pull the great house of Baring Brothers back from bankruptcy caused by its perilous involvement in Argentine loans. No one should suppose that the modern misadventures in Third World loans are at all new.
• The commitment to monetary magic began in colonial times. Again, as so reliably in financial matters, those involved were persuaded of their own innovative genius; as before and as ever, they were reinventing the wheel.
• The Southern colonies—Maryland, Virginia, and Carolina as it then was called—issued notes against the security of tobacco and greatly deplored any demand for gold or silver as a means of payment, on occasion proscribing their use. In Maryland, notes based on tobacco served as currency for nearly two centuries, longer by a considerable margin than the gold standard was to last.
• Influenced initially by the still-fresh memory of the inflation brought about by the Continental currency, the hugely available supply of paper chasing a necessarily limited supply of goods—shoes in Virginia at $5,000 a pair, more than $1,000,000 for a full outfit of clothing—the new country’s financial policy was conservative. The Constitution forbade the federal government and, needless to say, also the states to issue paper money. Business would be done with gold and silver and bank notes redeemable in metal.
• A central bank, the First Bank of the United States, was created to enforce discipline on the small scattering of state-chartered banks by refusing to accept the notes of those that did not pay out in specie on demand. The by-now conservative Northeast approved this action; the new and financially more needful South and West most certainly did not. Easy credit from amply available bank notes was there greatly valued. In 1810, under attack for its financial rigor, the charter of the Bank was not renewed.
• With the stimulus of the War of 1812 and the need to finance it by extensive public borrowing, prices rose. State banks, relieved of the burden of the forced redemption, were now chartered with abandon; every location large enough to have “a church, a tavern, or a blacksmith shop was deemed a suitable place for setting up a bank.” These banks issued notes, and other, more surprising enterprises, imitating the banks, did likewise. “Even barbers and bartenders competed with the banks in this respect….” The assets back of these notes were, it need hardly be said, minuscule and evanescent. Leverage once again.
• In the years following the end of the war, land and other property values throughout the country rose wonderfully; as is always the case, the rising values attracted those who were persuaded that there would be yet further increases and from this persuasion ensured that there would be yet greater increases to come.
• The Second Bank of the United States was chartered in 1816—the feeling that such higher regulatory authority was needed had persisted. However, initially it added to the boom; the Bank involved itself enthusiastically in real estate loans.
• In 1819, the boom collapsed. Prices and property values fell drastically; loans were foreclosed; the number of bankruptcies went up. This was the first of the speculative episodes with resulting collapse that were to characterize American economic and financial history for the rest of the century. The word panic as it pertained to money entered the language.
• Nearly a century would pass before a central bank would again be tolerated in the United States.
• Soon new banks and bank notes flooded onto the scene. The stage was set for the next speculative episode, which was to end in the crash of 1837. This speculative bubble was once again in real estate, especially in the West and including claims on the public lands, but it extended to manufacturing enterprises and commodities as well.
• Internal improvements, as they were called, became a major investment opportunity. These, notably canals and turnpikes, addressed the great distances and formidable landscape over which it was necessary for the products of farm, mine, and factory to travel in the new republic. The states took up the task of finding the funds; these proved to be available in volume from Britain. Money moved in unprecedented amounts across the Atlantic, and without question it contributed affirmatively to the construction of transportation facilities. But it also contributed to an explosive boom in business and employment and to a rush to share in the appreciating property values. In 1837 came the inevitable disenchantment and collapse. A period of marked depression again ensued.
• This episode did, however, have two new features—one of them of continuing significance today. It clearly left behind the improvements, notably the canals, which had been the source of the speculative enthusiasm. And it introduced a distinctly modern attitude toward the loans that were outstanding: in the somber conditions following the crash, these were viewed with indignation and simply not repaid.
• Mississippi, Louisiana, Maryland, Pennsylvania, Indiana, and Michigan all repudiated their debts.
• Only the pathological weakness of the financial memory, something that recurs so reliably in this history, or perhaps our indifference to financial history itself, allows us to believe that the modern experience of Third World debt, that now of Argentina, Brazil, Mexico, and the other Latin American countries, is in any way a new phenomenon.
• State regulation required banks to hold reserves of hard coin against their outstanding notes. This was to limit in a sensible way the length of the lever.
• At the outer extreme of compliance, a group of Michigan banks joined to cooperate in the ownership of the same reserves. These were transferred from one institution to the next in advance of the examiner as he made his rounds.And on this or other occasions, there was further economy; the top layer of gold coins in the container was given a more impressive height by a larger layer of ten-penny nails below.
• The Civil War did not alter the sequence of speculative boom and bust, but it shortened the interval between episodes. As the wounds of war healed in the late 1860s and early 1870s, there came one of the greatest of speculative booms portending the economically and politically devastating panic of 1873.
• The preceding years were ones of generally increasing and pyramiding values and generally euphoric conditions in manufacturing, farming, and public construction. Increasing values again brought increasing values. As with the canals and turnpikes, it was transportation, this time the railroads, that was the focus of the speculation. Here the horizons seemed truly without limit. Who could lose on what was so obviously needed?
• Again, British loans became available in huge volume, these sustained by the financial amnesia that had now erased all effective memory of the defaulted loans of 40 years before. Soon the reality. The new railroads, and some old ones, could not pay. The respected banking house of Jay Cooke & Company, heavily involved with railroad financing, failed in September of 1873. Two large banks also went under. The New York Stock Exchange was closed for 10 days. Banks in New York and elsewhere suspended payment in hard coin.
• From the neatly timed sequence of boom and bust in the last century came, in later years, another design to conceal the euphoric episode. That, in effect, was to normalize it. Boom and bust were said to be predictable manifestations of the business cycle. Mania there might be, as Joseph Schumpeter thus characterized it, but mania was a detail in a larger process, and the benign role of the ensuing contraction and depression was to restore normal sanity and extrude the poison, as some other scholars put it, from the system.

1929

• Overshadowing all previous speculative episodes was the great stock-market boom of the later 1920s.
• Not since John Law or the Bubble had mania seized so deeply so large and influential a sector of the population. Here on display were all the basic features of financial euphoria. Here too was an end to the Schumpeterian notion that the ensuing contraction was normal, tolerable, and, as he urged, benign.
• The first manifestation of the euphoric mood of the 1920s was seen not on Wall Street but in Florida—the great Florida real estate boom of the middle of that decade. Lots could be purchased for a cash payment of around 10 percent. Each wave of purchases then justified itself and stimulated the next. As the speculation got fully under way in 1924 and 1925, prices could be expected to double in a matter of weeks. Who need worry about a debt that would so quickly be extinguished?
• In 1926 came the inevitable collapse. The supply of new buyers needed to sustain the upward thrust dried up; there was a futile rush to get out.
• Not the built-in culminating end of speculation but two especially vicious hurricanes from the Caribbean in the autumn of 1926 were held to be at fault. Thousands were, indeed, left homeless. The responsibility for the debacle was thus shifted from man and his capacity for financial delusion to God and the weather.
• Prices of common stock on the New York Stock Exchange had begun rising in 1924. The increase continued in 1925; suffered some setback in 1926, possibly in sympathetic reaction to the collapse of the Florida land boom; rose again in 1927; and, as it may properly be said, took clear leave of reality in 1928 and particularly in 1929.
• Prices were going up because private investors or institutions and their advisers were persuaded that they were going up more, and this persuasion then produced the increase. Leverage was magnificently available, indeed a special marvel of the time. In its most commonplace form, it allowed the purchase of stock on a 10 percent margin—10 percent from the aspiring owner, 90 percent from the obliging lender. It wasn’t cheap; by that summer the borrower paid at the then incredible interest rates of from 7 to 12 percent and once as high as 15. The closed-end investment trusts of United Founders Corporation, Goldman, Sachs, and many other similar enterprises were especially celebrated for their genius in discovering and using leverage. The United Founders group, tracing back to an original promotion in 1921, foundered and was rescued with a $500 infusion of capital from a friend. It then borrowed money and sold securities to finance investment in other securities for an eventual total of around a billion dollars. This—assets worth a billion dollars from an original investment of $ 500—could have been the most notable exercise of leverage of all time, those Michigan banks and the notes leveraged against the ten-penny nails possibly excepted.
• The most prominent and most to be regretted of the academic sages was Irving Fisher of Yale—as already indicated, the most innovative economist of his time. In the autumn of 1929, he gained enduring fame for the widely reported conclusion that “stock prices have reached what looks like a permanently high plateau.”
• How little, it will perhaps be agreed, was either original or otherwise remarkable about this history. Prices driven up by the expectation that they would go up, the expectation realized by the resulting purchases. Then the inevitable reversal of these expectations because of some seemingly damaging event or development or perhaps merely because the supply of intellectually vulnerable buyers was exhausted.
• Predictable also in the ensuing explanations of events was the evasion of the hard reality. This was in close parallel with what had occurred in previous episodes and was to have remarkable, sometimes fanciful, replication in 1987 and after.
• The market in October 1929 was said only to be reflecting external influences. During the previous summer there had been, it was belatedly discovered, a weakening in industrial production and other of the few currently available economic indices. To these the market, in its rational way, had responded.
• Not at fault were the speculation and its inevitable aftermath; rather, it was those deeper, wholly external influences. Professional economists were especially cooperative in advancing and defending this illusion. A few, when dealing with the history, still are. They were not, however, completely persuasive.
• Some steps were taken—the creation of the Securities and Exchange Commission; restraints on holding-company pyramiding, which had been particularly great in electric utilities; the control of margin requirements—and these were not without value.
• The crash in 1929, however, did have one therapeutic effect: it, somewhat exceptionally, lingered in the financial memory. For the next quarter of a century securities markets were generally orderly and dull.

October Redux

• For practical purposes, the financial memory should be assumed to last, at a maximum, no more than 20 years.
• There are, however, exceptions to any rule. While the 20-year cycle from illusion to disillusion and back to illusion had a superb regularity in the United States in the last century, some of the more violent episodes of irrationality—those of John Law, the South Sea Bubble, and the crash of 1929 being examples—did remain more vividly in the financial as well as the general public memory.
• By the mid-1950s, however, Americans were ceasing to regard the stock market with the misgiving… In 1954 and 1955, a quarter of a century after the terrible October days, there was a modest boom. Later in that decade and throughout the 1960s, there were further speculative upsurges and ensuing breaks. These were years of good, frequently brilliant, performance by the American and other industrial economies—low unemployment, steady and ample economic growth, and low rates of inflation.
• Investors Overseas Services (IOS) was the brainchild—some would say brainstorm—of an indubitably energetic group of young men led by Bernard Cornfeld and Edward Cowett—the first a former social worker, the second an unquestionably accomplished lawyer.
• IOS was the guiding force for a large group of mutual funds; of mutual funds investing in other mutual funds (the Fund of Funds), including incestuous investment in funds of the IOS itself; and of firms to sell mutual funds and to manage mutual funds and, at a somewhat ethereal level, banks, insurance companies, and other financial entities.
• But, most of all, it was a vast sales organization in which securities salesmen recruited other salesmen and received a commission on their sales, and those so recruited, in turn, recruited yet other vendors and got commissions.
• The pyramid in Germany was eventually some six stories high, and only a fraction of the original investment found its way into the securities it was meant to buy. The rest went into all those commissions. One would have difficulty imagining a fiscally more improbable enterprise for the investor.
• In 1969, declining sales and securities prices worked their way back through the sales organization with highly leveraged reverse effect. Desperate efforts to hold up values by inside purchase failed, as was inevitable given the flooding disenchantment.
• The more limited episodes of the 1960s and 1970s and their unhappy consequences sufficiently established that financial aberration was still the norm. The full revelation remained, however, for the 1980s, leading on to the spectacular debacle of October 19, 1987.
• All of the elements were again and predictably in place. Leverage came back in the form of corporate takeovers and leveraged buyouts, small ownership and control made possible by large debt. There was the requisite new financial instrument that was thought to be of stunning novelty: bonds with a high risk and thus carrying a high interest rate. Their novelty, as noted, resided only in their deeply valid name—junk bonds.
• In early 1987, I dealt with it and the parallels with 1929 in the Atlantic and spoke of a “day of reckoning… when the market goes down seemingly without limit,” adding reference to a truth here more than sufficiently celebrated: “Then will be rediscovered the oldest rule of Wall Street: Financial genius is before the fall.” I also suggested in the article, however, that the crash, when it came, would be less devastating in its economic effect than that of 1929. Here there had been change. A welfare system, farm-income supports in what was no longer a predominantly agricultural economy, trade-union support to wages, deposit insurance for banks (and similarly for the S& Ls), and a broad Keynesian commitment by the government to sustain economic activity—things all absent after the 1929 crash—had lent a resilience to the economy. There was, in consequence, a lessened vulnerability to serious and prolonged depression.
• Index and option trading had added casino effects to the market. Found innocent, however, were those individuals, speculative funds, pension funds, and other institutions that had so unwisely, in naiveté and high expectation, repaired to the casino.
• In March 1990, Japanese stocks took a large and wholly unexpected dive—major stock indices on the Tokyo market went down by nearly a quarter.
• A Washington Post dispatch told of what had been previously expected: “It has been a matter of received wisdom… that the Japanese stock market, manipulated by the government and big investment houses, can only go up, generating funds for the nation’s export assaults overseas.”

Reprise

• The lessons of history can, however, be disturbingly ambiguous, and perhaps especially so in economics. That is because economic life is in a process of continuous transformation, and, in consequence, what was observed by earlier scholars—Adam Smith, John Stuart Mill, Karl Marx, Alfred Marshall—is an uncertain guide to the present or the future.

Summary of a crisis:

Individuals and institutions are captured by the wondrous satisfaction from accruing wealth. The associated illusion of insight is protected, in turn, by the oft-noted public impression that intelligence, one’s own and that of others, marches in close step with the possession of money. Out of that belief, thus instilled, then comes action—the bidding up of values, whether in land, securities, or, as recently, art. The upward movement confirms the commitment to personal and group wisdom. And so on to the moment of mass disillusion and the crash. This last, it will now be sufficiently evident, never comes gently. It is always accompanied by a desperate and largely unsuccessful effort to get out. Inherent in this sequence are the elements by which, in a comprehensive way, it is misunderstood. Those who are involved never wish to attribute stupidity to themselves. Markets also are theologically sacrosanct.

• The least important questions are the ones most emphasized: What triggered the crash? Were there some special factors that made it so dramatic or drastic? Who should be punished?
• The final question that remains is what, if anything, should be done? Recurrent descent into insanity is not a wholly attractive feature of capitalism. The human cost is not negligible, nor is the economic and social effect.
• Yet beyond a better perception of the speculative tendency and process itself, there probably is not a great deal that can be done. Regulation outlawing financial incredulity or mass euphoria is not a practical possibility.
• The only remedy, in fact, is an enhanced skepticism that would resolutely associate too evident optimism with probable foolishness and that would not associate intelligence with the acquisition, the deployment, or, for that matter, the administration of large sums of money.
• When will come the next great speculative episode, and in what venue will it recur—real estate, securities markets, art, antique automobiles? To these there are no answers; no one knows, and anyone who presumes to answer does not know he doesn’t know.