Understanding Systemic Risk in Global Financial Markets. Gottesman Aron

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СКАЧАТЬ activity. As mentioned previously, bubbles in stock markets and real estate are often closely linked with three prominent examples of linkages and connections between these two asset markets:15

      1. In many countries, and especially smaller nations and those in early stages of industrialization, a substantial amount of the stock market valuation consists of real estate companies and construction companies and firms in other industries that are closely associated with real estate, including banks.

      2. Another connection is that individuals whose wealth has increased sharply because of the increase in real estate values want to keep their wealth diversified and so they buy stocks.

      3. The third connection is the mirror-image of the second: the individual investors who have profited extensively tend to buy larger and more expensive homes.

      Dutch Tulip Crisis: One of the earliest financial crises that was documented extensively is often referred to as the Dutch Tulip Crisis or Mania, when the prices of tulip bulbs increased by several hundred percent in the autumn of 1636. For more exotic and rare bulbs, price increases were even more dramatic.

      In the mid-16th century tulips were introduced to Holland via the Ottoman Empire and quickly became a status symbol among its citizens, setting off a frenzy of speculative behavior across the country. The speculation became rampant in September 1636 as the bulbs were in their normal planting cycle and therefore could no longer be physically inspected by potential buyers who had to commit to purchases long before the spring bloom. This led to many investors purchasing bulbs at extraordinary prices that they had never seen.

      Nobles, citizens, farmers, mechanics, footman, maid-servants, even chimney sweeps and old clothe woman dabbled in tulips. 16

      This frenzy was accompanied by the introduction of call options that further fueled speculative buying, resulting in a 20-fold increase in prices between November 1636 and February 1637.

      As traditional bank financing was not fully developed at that time, most investors used in-kind down payments, which included things such as tracts of land, houses, furniture, silver and gold vessels, paintings, and so on. When the prices of tulip bulbs crashed, it led to the complete loss of savings of many citizens and fueled an overall decline in the European economy with the Dutch economy suffering into the 1640s.

      Dot-Com Bubble of 2000: Another more recent example of the bursting of an asset bubble was the dramatic rise and fall of Internet stocks in the late 1990s. Per one index that tracked the performance of Internet stocks, prices of this sector rose 1,000 % from October 1998 to February 2000.17 Prices started to drop in February 2000 and ultimately lost 80 % of their peak value by the end of 2000, equating to approximately $8 trillion in lost market value. The Internet bubble exhibited similar characteristics of previous bubbles, including over-inflated prices driven by speculative buying, subsequent selling by insiders, short selling made easier by significant increases in asset float, and an eventual crash in prices.

      Speculative Manias: Many crises throughout history can be traced to the rampant speculation by investors in any number of assets or investment opportunities. Herbert Simpson in a 1933 paper discusses the urban boom and collapse in the period 1921–30:

      The economic history of this country is colorful with recurring speculative epochs and episodes, growing out of varying conditions and with varying effects upon our economic structure and welfare. We have had periods of gigantic speculation in western lands; periods of oil and mining speculation; periods of bank speculation; and of railroad speculation. 18

      The term mania implies that investors are behaving irrationally. This contrasts with the rational expectations assumption, which holds that investors behave rationally and react to changes to economic variables as if they are fully aware of the long-term implications of such changes. This is an example of the long-used axiom that all available information about a company is fully reflected in its security price, as investors theoretically react immediately to any new news about the company. Many theories exist as to why investment manias occur. One example is groupthink, when all investors in a market change their views simultaneously and act together.

      The South Sea Company of 1720: An example of an event that can be categorized as a speculative mania, which in turn led to an asset bubble, occurred in Britain in 1720. The South Sea Company had been given special rights by the British government to trade with Spain's American colonies, which resulted in an effective monopolistic position. The price of the company's stock rose 330 % in a five-month period to £550. Following its success, several other companies attempted to enter this market and trade in the same stock market. The South Sea Company successfully convinced Parliament to approve what was called the Bubble Act of 1720, which prevented such firms from becoming publicly traded, further boosting their stock price to over £1,000. Insiders of South Sea Company realized the company's business opportunities did not support a price so high and started to sell, fueling a dramatic decline in the share price to below £100 before end of the year. Consider the following comment by Adam Smith about the South Sea Company crisis:

      The evils of reckless trading are always apt to spread beyond the persons immediately concerned. When rumors attached to a bank's credit they make a wild stampede to exchange any of its notes which they may hold; their trust has been ignorant, their distrust was ignorance and fierce. Such a rush often caused a bank to fail which might have paid them gradually. The failure of one caused distrust to rage around others and to bring down banks that were really solid. 19

      The Great Depression: The 1921–30 period of investment speculation in the United States was fueled mainly by growth of urban populations and wealth. The rural sections of the country had been in a state of depression throughout most of this period, and the very cities in which active real estate speculation had been carried on had been surrounded by rural populations in severe distress. It was the agricultural depression that led to shifting population, income, and wealth to the cities, in addition to the numerous other factors contributing to the urban growth of this period. The urban population of the United States increased 14.5 million in the decade 1920–30. It was this growth of urban population and wealth that provided the basis for real estate speculation.

      As such, real estate, real estate securities, and real estate affiliations in some form were the largest single factor in the failure of the thousands of banks that closed their doors during the Great Depression. We discuss the Great Depression in detail in Chapter 14.

Banking Crises

      Systemic events often occur not because of a single idiosyncratic event, but rather the linkages or spillovers that occur among several different segments of the financial system or global economy. A good example of such a common linkage is the prior discussions about asset booms in real estate, often fueled by speculative behavior on the part of investors, which is financed by the banking sector.

      Banking crises may be defined as either the failure, takeover, or forced merger of one of the largest banks in a given nation or, absent such corporate events, a large-scale government bailout of a group of large banks in that nation. Using this definition, there have been a tremendous number of banking crises that have occurred globally throughout history. Dating back to the year 1800, 136 countries have experienced some form of banking crisis.20

      A high rate of banking failures occurred during the Great Depression of the 1930s in the United States. Following this period of extreme global banking stress, there was a prolonged hiatus of failures between 1940 and the 1970s, after which several events such СКАЧАТЬ