The best known and most highly regarded book on financial crises
Financial crises and speculative excess can be traced back to the very beginning of trade and commerce. Since its introduction in 1978, this book has charted and followed this volatile world of financial markets. Charles Kindleberger's brilliant, panoramic history revealed how financial crises follow a nature-like rhythm: they peak and purge, swell and storm. Now this newly revised and expanded Fourth Edition probes the most recent "natural disasters" of the markets--from the difficulties in East Asia and the repercussions of the Mexican crisis to the 1992 Sterling crisis. His sharply drawn history confronts a host of key questions.
Charles P. Kindleberger (Boston, MA) was the Ford Professor of Economics at MIT for thirty-three years. He is a financial historian and prolific writer who has published over twenty-four books.
If you're looking for a colorful, narrative history of financial bubbles, this book is not for you. Kindleberger is bone dry, and his goal is mainly to analyze common features of bubble cycles. Towards that end, he tends to pick a feature, then run through ten or twenty examples of how that feature worked during past bubbles. That leads to a lot of repetition, but by the end of the book, you definitely get a clear sense of how the Minsky model views bubbles. I think that's the reason the book has become such a classic-- it's probably assigned in economics classes all over the world.
But a word of caution to the lay-reader: I have an MBA, and a couple of years of economics courses under my belt-- and some of the discussion was definitely above my head. You'll definitely need to hit Wikipedia to refresh your macro-economic knowledge-- especially at the end of the book, during the discussions of Domestic and International Lenders of Last Resort.
This was the second time reading this book. Honestly, the second time around I found this book to be rather boring. The theme of the book is as timely as ever, and I highly recommend reading something like it if you are interested in manias, panics, crashes (and financial fraud). As with the first time around, I appreciated the lack of bias and the common sense historical approach of the author. But this time around, I found elements of the book problematic.
The first problem is the academic tone of the book. As a work of financial history, the book often found it necessary to deal with the theories and ideas of non-historians, particularly economists. Why? I found that historical analysis is often useful on its own merits and does not need to play too much with the theories of economists and their models. I also felt like the book would be better served dealing less with other academic works and more with establishing clearer historical narratives.
The second problem I found was the author's use of historical cases. As the book develops he uses a historical shorthand, reaching across cases to develop his themes. For someone like me not familiar with all the cases in-depth, this became a dizzying affair. The author has laid out a chart in the book of the book. This chart is useful, but it would have been better if the author had established a clear narrative without haphazard jumping between cases. It's a pain to have to jump to an appendix to figure out where and what is going on with a particular example.
And finally, the main thesis of the book: There should exist a lender of last resort, but the market should always be left wondering when and if it will come to the rescue.
When I first read the book, I found this argument to be reasonable and well-argued. But having read this argument, I was looking for more the second time around. Some ideas I missed. Some tidbit that would make me rethink the elements of this book. Unfortunately, I didn't find it.
I'm still interested in the subject matter and hope to find another book that can take me into the elements in way that is engaging and can challenge me a bit more. If possible, too, I would like this book to have a historical approach...but I would like the author to create clearer case studies and develop the patterns of human behavior in a more cogent way.
This work, I believe, takes first prize for the poorest editing of any recent read; it’s downright bad. While the message is important, the work is so choppy, disorganized and repetitive that it was mighty difficult to finish. I had this vision of someone updating this work at the corner bar, after first downing two or three pints of quality ale. Oh, for the poor student that finds this volume required reading. I’d be interested to see how the seventh edition compares to the first.
I feel a brief comment on the current US investment zeitgeist is in order. With interest rates at historic lows, American unemployment at 3.5%, inflation subdued, and a decade of substantial equity market returns, the impression is easily formed that risk and scoundrels have been excised from the system, that economic stability and moderate growth are ensured in perpetuity; the policy wonks have, finally, mastered the calibration of our economic future, having learned from their many prior mistakes. I remember how similarly I felt in the mid 1990s. And then what happened?
Was a bit disappointing, most of the book is about events that happened more than 100 years ago, short coverage of the last 80 years.
The book reads like 10 different people wrote parts of it and didn't know what others were writing.
Some events are covered multiple times, the south sea bubble has 16 entries, often saying the same thing.
Treasury sec Paulson was called Mr. Bailout in 2 separate parts that read the same.
I totally disagree that Lehmann bro should have been bailed out. They piled on billions of dollars of extra debt the last 10 months trying to become a "too big to fail" bank.
Fuld should have gone to prison for that and other things.
The author seems to think "money flows" were more important than the corrupt rating agencies giving AAA to junk bonds. Baloney
page 120 claims CPA's count the number of beans that firms claim. NOT true, that's the sole responsibility of management. Accountants see that GAAP's are used and that accounting principles are the same from one year to the next.
p135 NYSE is owned by its members & provides a trading floor Both not true.
p 265 claims that when many firms collapse at the same time its because of the mismanagement of the economy by the monetary authorities. Baloney, the FED didn't rate junk AAA, or make liar loans, or bundle junk, call it AAA and sell to foreigners who didn't realize how corrupt wall street is.
p 269 makes the asinine claim that the cost of Lehmann not being bailed out was the total budget deficit of the US gov the following year !!!!!!!!!
p299 claims the US housing bubble was from an "increase in the supply of credit"
The banks will screw up again, what we need to do is increase the required capital to 20% from the very risky 6% at present.
Kindleberger's "Manias, Panics and Crashes" is a must read for anyone active in the markets. If you want to learn how to identify downcycles early, and to understand their progression and eventual end, look no further than Kindleberger's work.
While other worthy tomes, such as "History of Financial Disasters in 3 Volumes" cover much of the same material, the original organization of Kindleberger's work is what commends it. He disentangles the narrative of many financial disasters into their component parts, then works to educate the reader how to identify which phase of the financial cycle the reader finds himself. It is a remarkable feat of simplification.
I remember very vividly loaning my copy to a friend one evening, noting the chapter title "The Emergence of Swindles" as a cautionary tale for us to expect the revelation of a major financial fraud, only to see the very next day the emergence of the Bernie Madoff Ponzi scheme. My friend was amazed at the power of this book, and you should be too. But Kindleberger had done the work and knew what was next. And he was right!
If there was only one book I could recommend on how to understand and navigate financial crises, it would be this book. Ignore it at your peril. Begin your journey here to better knowledge of financial crises.
This is a classic book in the financial world, but I was somewhat disappointed with it. Kindleberger uses Hyman Minsky's "anatomy" of financial crises to discuss commonalities between a number of different financial panics from different countries at different times in history. I had been hoping for more of a straightforward narrative description of each crisis, many of which, after all, occurred in unfamiliar settings. But in fact, Kindleberger uses the generic "crisis anatomy" as the structure of the book, touching on each episode only as it relates to a given part of the anatomy. This can be disorienting for the reader who is not already familiar with the episodes, which description I imagine fits virtually all readers.
For those interested in the generic anatomy of crises, I think it's better to read Minsky himself, who is pretty accessible. For those looking for detailed descriptions of specific crises, something like Bagehot's "Lombard Street" is more entertaining. This book ends up being neither here nor there.
This is not the easiest book to read without some prior knowledge of economic history. That said it is probably the most complete book on the history and causes of economic upheavals from the 17th century to 2010 available to the non-economist.
In particular the authors have identified what they call the 4 waves of international financial disaster in the last 40 years. Perhaps the most striking conclusion one can draw from their study is how similar the causes of each wave has been. If you take the time to work your way through this book you will come away with a more sophisticated understanding of words such as "credit" , "liquidity" and "asset prices" and how they are interrelated. You will also come to understand how basic human nature rather than complex financial strategies underlie decisions which repeatedly cycle from beneficial to disastrous consequences for humanity.
This book was referred to by another book I've been reading. This copy as gifted to me by my alma mater at an event where Professor Aliber, the co-author of this edition, spoke.
One of the most dense and therefore challenging books I've read. Every paragraph is jammed with facts. I think the book would be better if it had a few graphs and ignored corruption. There's plenty to digest here without getting into Ponzi, Madoff, or Enron. I also think some more perspective on why credit bubbles get inflated would have been helpful.
I think it would have been a lot more fun to sit down and talk with Kindleberger about his theories than to read this book. He clearly knew a lot on the subject, and I generally agreed with his ideas, but I found the way the book was organized hard to follow. A case of, "I'd have done it differently if I was writing it."
I read Kindleberger’s classic textbook in its seventh edition, as updated by Aliber. It really gave me much intellectual pleasure to read it and opened my eyes to certain patterns and variables to take into account when perusing financial bubbles which I wasn’t aware of. The main thesis of the book relates to the connection between investment inflows (and outflows), price of currency and price of securities and other assets (mainly, real states). It plays with two main concepts: overshooting and undershooting and the “pains” of in-between adjustments. At certain points, it is kind of scary the likeness between certain pre-burst periods and the current time of manias/euphoria. Another success of the book is its non-US-centric approach, collecting and analyzing extensive data from South American and Asian countries. The part which I disagreed the most with was the chapter on the “Lehman affair”. I believe that the book was too basic when facing the moral hazard argument and almost completely ignored the lack of a clear legal framework to act on Lehman, along with the political heating which highly discouraged the officers in charge to pursue a path of bailing out Lehman. This part of the book clearly needed more density. However, this doesn’t contradict the conclusion that this is a marvelous economics book, accessible and readable by everyone with a pretty basic understanding of the subject-matter.
There are countless opinions about whether it's preferable to have a top-down or a bottom-up approach to investing. Typical value investors embrace the bottom-up approach where they mainly look at company fundamentals while others have a more open approach of considering factors as the business cycle and various macro factors. The top-down investor risks falling into the trap of predicting the unpredictable and the bottom-up approach got criticism after the financial crisis which hurt many value investors badly. Many have recovered well since then though. It is in my view useful for all investors to study financial history in order to learn from events of the past as it often repeats itself. In the words of George Santayana "Those who don't remember the past are condemned to repeat it".
Charles P. Kindleberger's Manias, Panics and Crashes is an oft-cited book in the realm of financial history and used in MBA programs across the world. Kindleberger was an economic historian and author of over thirty books and he originally published Manias, Panics and Crashes in 1978. During his career, he held senior roles within the US Treasury, the Federal Reserve and Bank for International Settlements. He finished his career as Professor of International Economics at MIT where he worked for more than thirty years. Robert Z. Aliber, who has updated the last three editions of the book, is a professor emeritus of International Economics and Finance at the University of Chicago.
The first couple of chapters presents a background of historical financial manias and typical patterns of how a mania evolves and how it turns to a panic and eventually a crash. Fraudulent behavior that is a typical theme towards the end of a mania is described with the examples of Charles Ponzi and Bernie Madoff as well as with instances of corporate frauds including Enron. The author summarizes some of the worst financial panics from the tulip mania in the 17th century, through the Great Depression in 1929 to the latest financial crisis in 2008 among others. The last couple of chapters of the book are primarily written for policy makers, advising on how to understand financial calamities in order to decide on the right policy from a fiscal and monetary perspective.
To sum up the main thesis of the book there are some typical factors that usually leads to a forthcoming mania and crash. The two most important factors have been increases of cross-border investment inflows as well as credit. The increases have typically led to rising stock- and real estate prices which have led to further increases in cross-border investment inflows and credit and in turn further increases in asset prices in a positive feedback cycle supported by behavioral phenomena. To cite from the book: "Asset bubbles - most asset bubbles - are a monetary phenomenon and result from the rapid growth of the supply of credit". The party has typically stopped when the creditors have got worried that debtors won't be able to pay back the loans and have in turn stopped issuing new loans. The debtors have relied on new loans to cover the interest payments and when the flow stops bankruptcies erupt.
As there are regularities in the financial crises the reading gets a bit monotonous at times. Also, I felt it was difficult to get a flow in the reading but that can probably be explained by it being a book written by academics for academics. It is not a must to read this book from cover to cover. The book is still a great source for investors who want to learn history in order to be able to be on alert for future occurrences. It's also a great start for those who want to dig into a specific event.
This is a book that is beneficial for both bottom-up and top-down investors. Just as individual companies, the stock market and currencies follow the investment market’s pendulum swings of euphoria to depression and overpricing to underpricing to use some of the terms often used by the legendary value investor Howard Marks.
Written by an eminent economic historian, this book outlines what I believe is the standard view of bubbles, crashes and financial panics -- three closely related but not identical topics. The author's account goes something like this:
From time to time the price of some class of assets starts to rise and people get excited. Often there is some good reason for this -- railroads, canals, tech companies and so forth are real productive assets and people realize at some point that they have been previously underestimating just how productive. Tulip bulbs with exciting pretty patterns also qualify -- a bulb that produces a new kind of flower is a capital asset, since you can produce many such flowers by cutting. The first third of the book documents this process.
As speculators pile in, the price of the asset grows higher than can be justified based on future cash flows. In addition to sincere promoters of the new asset, there are incompetents and frauds promising returns they can't reliably deliver, or have no intention to deliver. Insiders notice this and cash out. At some point the cycle goes into reverse -- often due to some prominent failure, sometimes due to simply a lack of new investors. Prices falter and fall. When people notice the decline, there's a feedback loop where everybody wants to sell "before the crowd" -- hence, the crash. The author traces this pattern with examples going back to the tulips, with special emphasis on English, French, and American panics from the South Sea bubble through 1929. Reading the book at the time I did, it was impossible not to think of Bitcoin. The second third of the book describes the crash and shows that it feels remarkably similar whether it's stock in the South Sea Company or a 2000-era Dotcom company.
Sometimes, a bubble can burst without drastic effect (e.g., the Dot-com bubble.) But sometimes the bubble is big enough, or has sensitive-enough investors, that it causes larger scale disruption. In particular, if people or banks had been borrowing against the now-worthless asset, the individual or bank will now be under water. At this point, creditors notice that they need to get their money out before the insolvent party goes bankrupt -- and there's a rush to call in loans and de-leverage. This cycle, if it grows big enough, is a panic. Anybody who was paying attention in the fall of 2008 knows what this looks like.
The last third of the book is devoted to discussing responses to panics. The author looks particularly at doing nothing, at declaring bank holidays, central bank cash infusions, and international rescues. The author notes that "bank holidays" [and their shorter-timescale equivalent, the trading circuit-breakers] rarely work -- those devices leave investors more anxious to get out quickly, while they still can, the next time. "Do nothing" is questionable: some problems do go away on their own as investors take their losses and move on; other times, the scale of financial deleveraging does a great deal of unnecessary damage. Rescues (domestic or foreign) do work, but have corresponding challenges -- they risk moral hazard,, and sometimes the rescuer doesn't have enough money to go through with it. The author at length concludes that we are little advanced over Walter Bagehot, the mid-19th-century economic journalist -- it's good to do rescues, when we can, but without being too consistent or predictable about it.
The book is written for both a professional-economist and lay readership. The author is at pains to draw contrasts between his view and either Marxists who assert that all investment and money is a sham or radical neoclassical types who assert that there are no bubbles, investors are always rational and things that look like bubbles and crashes are a misreading of the evidence. I found the book generally easy reading though was confused about technicalities at some points.
I read the 1st edition written in 1977, published 1978. I understand that the book has been updated in later editions, the 6th written in 2006. It was written during the height of the California housing bubble which saw Bay-area studio apartment rent go as high as $1000 per month when 3-bedroom home mortgages elsewhere were running in the $400-$500 range. It is an eerie foreshadowing of the true mania that seized the country in 2004 when the government communicated its intent to effectively free the financial markets of regulatory oversight. Given the events of the last 10 years, which so closely mapped to the de-emphasis of financial regulation by President Bush and the resulting toxic mortgage derivative scams that triggered both the mania of 2004-2006 and the panic that culminated in US financial collapse in 2008-2009, I seriously doubt that Kindleberger’s conclusions could have changed, as the model he revealed matches the current events with surreal accuracy.
All of his conclusions are drawn from analysis of historical events dating back to 1720, and give a clear and consistent picture of how bubbles and crashes work. I mention events of the past 10 years because Kindleberger could not have foreseen the changes in the financial practices that lead to what has happened, but it has clearly followed his model as if he had been writing today.
I gave him 4 stars because some of the historical stuff (especially in chapter 8) got into plain list mode, without enough explanation, as if he felt he was part of a larger discussion the reader was not privy too. Otherwise I would have given 5 stars.
”The last 400 years have been replete with financial crises, which often followed increases in the supplies of credit, greater investor optimism, and more rapid economic growth.”
“There have been 4 waves of banking crises; a large number of lenders in 3,4, or more countries collapsed at about the same time as the prices of real estate and securities in these countries and the prices of their currencies fell sharply. Each country that experienced a banking crisis also had a recession as household wealth declined in response to the sharp fall in the prices of securities and real estate, and as the banks become much more reluctant suppliers of credit as their own capital was depleted. The Great Recession that began in 2008 was the most severe and the most global since the Great Depression of the 1930s.”
General interesting quotes in this context:
“The Chinese use two brush strokes to write the word 'crisis. ' One brush stroke stands for danger; the other for opportunity. In a crisis, be aware of the danger--but recognize the opportunity.” /JFK
”It is said an Eastern monarch once charged his wise men to invent him a sentence, to be ever in view, and which should be true and appropriate in all times and situations. They presented him the words: "And this, too, shall pass away." How much it expresses! How chastening in the hour of pride! How consoling in the depths of affliction!” /Abraham Lincoln
There have been many attempts to explain the GFC – greed, irrational behaviours, bell curve, derivatives, excessive leverage, failures by rating agencies, regulatory failure, etc, which all can be groups as a demand side shock. This book artfully presents (or had presented) another factor, excess capital floating around in the world built by the current account surpluses from the economic imbalance since 60’s. This is more of a supply side shock, which no one has control over after the collapse of the Bretton Woods system. We don’t even know the volume of this excess capital, let alone the movement. This indicates, the next financial crisis will occur where this excess capital ends up triggered by whatever the demand side shock mentioned above meaning as long as there is this excess capital, another crisis is inevitable. There may be a way to track the flows of this capital but the financial transaction tax being largely rebuffed by free market capitalists, there does not appear to be any other means to predict or curtail the next crisis but just wait it to happen.
A good introductory book to the history of financial cycles, but only for people with some background in economics. I didn't like the style. Many times it felt like an endless list of historical examples that illustrate an idea. The idea that financial crises across the world are connected is repeated ad nauseam. Lehman Brothers didn't deserve its own chapter. It doesn't read as a treatise on the economics causes and consequences of financial cycles, panics, etc., and it doesn't read as an economic history book. It tries to be both, and it fails at both. I don't like the organization of the content by chapters. I still recommend the book, if you are very interested in the topic. If you're in a rush and want to get the gist, read the last chapter. I wonder how this compares to "This time is different." I will find out this year.
The 2000 edition reads like a playbook for the collapse and bailout of of 2008. Both the descriptions and proscriptions of this book, especially its focus on the lender of last resort, seem to be amazingly prescient though it probably just that this iconic text was on the bookshelf of every major player in the fed at the time. The book is not written for a general audience and some of the econ jargon gave me trouble as a non-specialist but it's not insurmountable. It is a historical and non-quantitative book so it's still a very interesting overview of the many global financial crises since ~1600.
The following is an excerpt from a discussion post for my MSF grad program. I thought I would post it here because the ideas are largely taken from Kindleberger, particularly the link between credit expansion and speculation.
I can’t remember if it was in our portfolio management class or our estate planning class, but I remember cautioning that some crypto exchanges would treat their customers as creditors in the event of bankruptcy. This is precisely what is happening in the FTX-SBF fiasco. I hope none of you were affected.
I’ve been following this story since it started, and it highlights a few things and poses certain questions. I would like to share them here:
1. The fiscal and monetary response to Covid led to capital misallocation. E.g., the stimulus creates artificial demand (demand in excess of what it would have otherwise been), which confuses entrepreneurs. The objective of the entrepreneur is to match supply with demand; this requires that he correctly ascertain and forecast demand, as his capital investments depend on the accuracy of his forecasts. When his forecasts prove to be incorrect—when they overestimate future demand—his capital allocations are revealed to be malinvestments. This is a critique of low-interest rates often made by Austrian economists. If you’re interested in this topic, google Austrian business-cycle theory.
2. Financial bubbles are invariably preceded by low interest rates. “[W]ithout easy credit creation a true bubble cannot occur” (Furguson, 2008, p. 122). And Kindleberger (2015): “You can’t have a real estate bubble without the rapid expansion of credit” (p. 78). Note that though Kindleberger specifically mentions real estate, his point applies to asset prices more generally. As a rule, a monetary expansion will first result in asset price inflation (e.g., commodity prices, equities, housing, etc.), then it hits consumer prices (e.g., 8% CPI).
I’ve been reading everything I can find on this, as I plan to be an equity analyst, and my main takeaway is that one must understand the business cycle and one’s current position in it. The typical trajectory: crisis, monetary/fiscal stimulus, economic expansion, inflation and bubbles and mania, Fed tightens credit, economic contraction, boom goes bust and asset prices fall. Dalio’s book on debt crises has a good discussion of the phases for those interested.
3. Low interest rates can create speculative orgies. Analysts value companies by discounting their future cash flows/dividends/earnings. Lowering interest rates lowers the discount rate, thereby raising valuations. This disproportionately benefits tech companies. Why? Because most tech companies are growth companies, that is, most of their profits are in the future—some far in the future. (It was said during the Dot-Com Boom, though I forget by whom, that some companies were discounting the future and the hereafter, so delayed were their profits!) The point is this: low-interest rates enable ridiculously irrational valuations. And there not infrequently develops a positive feedback dynamic, such that price rises cause more people to buy, which causes prices to rise, etc., etc., leading to speculative excess (Shiller, 2015). The flip side is that tech stocks have the greatest interest rate risk, as rate hikes raise the discount rate, thereby lowering the PV of future cash flows. Hence, the Nasdaq fell further than the S&P this year.
3. Hyman Minsky has an insightful taxonomy of companies’ credit quality:
Hedged, i.e., cash flows from operations are sufficient to cover interest and principal payments.
Speculative, i.e., cash flows from operations are only sufficient to repay interest charges, that is, principal payments must be rolled over.
Ponzi, i.e., cash flows from operations are insufficient to repay interest or principal, that is, interest and principal must be rolled over.
Ponzi financing is only sustainable if interest rates fall or profits rise—and, crucially, if the creditor allows the debt to be rolled over. Also, consider that these financing positions aren’t static: Minsky notes that “speculative positions turn into Ponzi positions if cash flows fall or if interest rates rise” (Wray, 2016, p. 28). As I understand it, many of SBF’s crypto bets were premised on the proposition that the price of a given crypto token/currency would only go up. One wonders how many crypto business models were predicated on such as premise.
4. The Bitcoin white papers were published in 2008, I believe, in response to the housing crises (though I’m sure the intellectual/technical work began long before). A big theme in the papers is the notion of peer-to-peer transactions, disintermediation, and decentralization. This serves many functions: it protects privacy rights; it prevents the state from intervening in commerce; it prevents the state from debasing the currency; and many other libertarian ideals. However, the idea of a crypto exchange is centralized and entangled with the state. SBF was lobbying the SEC to create a regulatory moat, for instance. Further, I’ve read some people in this space that believe that the prominent failure of crypto firms, such as FTX, will be used to push CBDCs, which are antithetical to the crypto project, as they aggrandize state power. Rogoff (2016) is a good book on the topic, one which argues in favor of CBDCs. Essentially, CBDCs will give the state absolute control and surveillance over commerce, to the point of determining who can and cannot transact. This is not only anathema to the crypto project, it is tyrannical and nightmarish.
Touted as a must read for anyone with an interest in global macro investing, I probably had too higher expectations. It’s filled with quality financial history, which should provide useful references against which to compare current events. Kindleberger, like his teacher Minsky, were students of credit cycles and the flow of global capital. I enjoyed the way in which he sketched the linkages between the financial crises of the last 50 years. From the inflationary 70s and the oil price shock of the early 80s, the Japanese 80s boom and its subsequent crash in 1990, the 90s East Asia boom and 1997 crash that followed with capital flooding into the US market, stoking the DotCom bubble. The solutions of the past crisis often sow the seeds of the next… Kindlebergers analytical approach is a welcome addition to an Austrian Economist but its supplemental. He implicitly places the responsibility for these cycles at the hands of central banks, banks and policymakers without explicitly obligating them to act more responsibly, which I see as a necessity. I’ll keep it as a reference book, but I wasn’t enthralled. Perhaps I just didn’t click with his writing style, even though I could display subtle comical undertones from time to time.
Have never read a book that galvanizes its title to your soul as much as this has.
Neverending examples that seem to be repeating themselves over and over, transcending time, culture, political beliefs and geography.
More often than enough, the examples, well researched as they might be, seem to be portraying only parts of the problem. Conclusions are easy to be drawn when an event has passed and been thoroughly documented.
Was expecting more conclusions as to what awaits us or more scientific evidence on the psychology behind this never ending cycle.
I liked the book a lot, as the author seems to make a sincere effort to address the data on panics and crashes and test the various theories about them rather than being doctrinaire and bashing the circumstances to fit a predetermined theory. The result is illuminating but also a difficult read that advocates for no clear position. On the other hand that is in part the message of the book -- that circumstances alter cases, and that no rule will really work to stabilize matters; as any rule-based intervention changes the behavior of speculators ("moral hazard") who count on future intervention. Worth it if you're interested in the subject.
The conclusion is very sharply summarized in the introduction and for me was 80% of what i will take away. This book would have been easier to follow if i had more awareness of the economic history is goes over. Overall this book is very dry.
An interesting read that is well-paced and exposes the reader to various financial crises throughout history. Please find below the notes that I made from the book.
Manias, Panics, and Crashes: A History of Financial Crises Chapter 1: Financial crises are neverending Markets drive incentives towards profits. Given high uncertainty investors seek secure assets for revenue streams. In the instance of uncertainty, the historic & predicted behaviour of monetary institutions play a large role in wider behaviour. Credit inflows drive the creation of tall buildings. Markets do not see systemic risk. Ostentatious behaviour is a sign of a problem. Asset bubbles are a monetary phenomenon driven by large growth in credit. Real estate is highly susceptible to credit-driven bubbles. Money is a public good but monetary arrangements can be carried out by private parties. Incentives to circumvent regulation are very high. Regulators should act to prevent deflation but create enough uncertainty to instil caution in market participants.
Chapter 2: Anatomy to typical crisis The Minsky model predicts that credit growth is pro-cyclical. Optimism & pessimism both have a self-fulfilling impact on market participants in terms of credit creation. In boom periods speculative highly leveraged borrowers increase who during downturns become distressed sellers. Minsky's taxonomy on finance • Hedge finance- anticipated operating income greater than interest payments & scheduled principal payments. • Speculative finance- anticipated operating income greater than interest on indebtedness but requires new loans to pay down principal payments. • Ponzi group- anticipated operating income lover than interest payments. Following the leader, phenomena are very common in the growth sector of the economy. Global credit flows can drive speculate booms & busts. Through systems of arbitrage, investors ensure that international prices for similar goods globally remain in tandem. Currency speculation is highly profitable but has a tendency for creating big winners and equally big losers. It is easy for real estate booms to drive net rental income below the interest payments required to maintain the property.
Chapter 3: Speculative manias A 'mania' is a loss of connection with reality. The capital markets behave on the assumption that markets are rational. Investor demand for a particular asset class can have a self-inducing impact on the short term return of that asset class. 4 understandings of rational • Most investors behave rationally mat of the time. • All investors behave rationally most of the time. • Market participants operate on the same intelligence. • All investors behave rationally all the time. Fixed-rate exchange systems were historically touted as bringing rationality to international capital flows. New theory pushes a rational market perspective. Rationality in most economic models is an 'a priori' assumption; based on deduction from given principles. Themes Dusenberry effect: increase consumption with a rise in income but do not decrease consumption with a fall in income. Bandwagon effects: excessive support for the most probable winner. Greater fool theory: pass on the inflated asset to another party before the bubble implodes. Banks do not have a new of real interest rates while borrowers do. Bucket shops: undertake to buy & sell orders with no capacity to fulfil them in the hope that outsiders bets will be proved wrong. Boiler shops: hustle naive investors by inflating stock and then slowly dumping it off on them. On inflated stock values: 'all fictitious value must be a loss to some person... the only way to prevent it is to sell out and so let the Devil take the hindmost.'
Chapter 4: Credit expansion Increases in credit supply do not necessarily equate to manias but every mania would be driven by a targeted growth in credit. Systems of delayed payment are highly conducive to expansions in credit. Meaningful monetary expansion is part of a systemic growth within a system rather than due to random and external events. What exactly is money? The definitions of money have significant implications on the quality of economic analysis. • M1: Currency + Demond deposits • M2: M1 + Time deposits • M3: M2 + Highly liquid securities In developed economies, there are highly liquid assets substitutable for money that are only inferior when it comes to collective payment. It is easier to accumulate debt than it is to accumulate wealth. Regulatory requirements on the quality of debt have huge implications on yield. Junk bonds may offer high yield, and only really be viable during periods of large savings requirements. The availability of credit drives business decisions. The quality of debt is inversely related to the quantity of debt. In a system of endorsed cheques even people of disrepute are treated as creditworthy. Regulations are quickly circumvented.
Chapter 5. Bubble about to bust The change of mindset from optimism to pessimism is what drives bubbles to bust. There are early signs that a bubble is about to burst; in the US the mortgage originating fins in 2006 were already showing high rates of bankruptcy. Bailouts are incredibly good mechanisms for wiping out equity. Regulators are wary of the long term consequences of bailouts. Government can quell fears by being transport on their own forecasts. The Bubble Act of 1749 was actually formulated to protect the bubble that was the South Sea company. Preventing other firms from raising capital helps existing firms find investment. Central Bank credibility has a huge impact on the functioning of markets. Premonitions of market failure can be self-fulfilling. Japan was able to stave off bank runs despite the negative mark-to-market values of their banking system due to strong assurances that depositors would be made whole by government bailouts. Theoretically safe price arbitration strategies like taking advantage of price differentials on varying tenures of risk-free debt only work if one can remain solvent. The Federal Reserve can force banks to take equity positions in their borrowers. The sudden cutting of credit, for instance from a change in credit policy, can cause a chain reaction of events that cause a bubble to burst. Fiddling with discount rates only works when there is confidence. The IMF worsened the crisis in Indonesia in 1997 by causing uncertainty in the health of institutions the government weren't forced to assist. Monetary easing can cause bubbles elsewhere in the economy.
Chapter 6: Conspicuous consumption Tall buildings and other projects showcasing excessive spending are symptomatic of asset bubbles. Things that would otherwise seem wasteful, in periods of excess are commonplace. Excessively tall buildings very quickly get into diseconomies of scale. Tall buildings in regions of large land availability are significantly concerning. Changes in stock prices are predictive with a high degree of false positives of a pending economic recession. Changes in the prices of speculative assets are closely tied to the cash availability of speculating communities. Real estate defaults can exceed the defaults of other highly speculative fields during downturns. Real estate booms can draw capital flow from other productive sectors of the economy, e. g- in Japan when industrial firms ventured into real estate. Real estate is fertile ground for creative accounting.
Chapter 7- Frauds & The credit cycle People are likely to retain funds with institutions offering high yields. Bernie Madoff was successful due to feeder firms he incentivized to route funds into his scheme. It is commonplace for firms to misrepresent the value of their inventories, investments, & profit rates. When profit rates are rising investors are likely to retain funds with the business and may even borrow to meet personal expenses as opposed to drawing down on their investment funds. Corruption is hard to measure. Audit firms are easily captured as their financial incentives are to the provision of services to the company. Borrowers can be made to lie when credit is readily available. People involved in the compilation of financial information are cognizant of the fact that the information is not true. Market strategists are not incentivized to publicly predict a drop in share values. White-collar crime has a low conviction rate. Traders can easily circumvent rules and are dangerous if they have a tendency to double down on losses. Feeder firms and advisory agents can knowingly sell bad or already failed financial products. There is more theft in terms of loan applications from a bank than there is in terms of bank heists. Highly inflated appraisal values especially in retail for collateral purposes assist in the fraud. Favouritism towards certain borrowers is not noticed in times of euphoria. Market participants in certain instances seem to want to be deceived. Savings expectations of regular returns drive reporting the behaviour to 'smoothen' out financial earnings. Mutual funds do not treat all customers equally and can have insider dealings with larger clients to boost returns/channel funds. Boiler shops are common when investors want to hold growth stocks. Journalism is easily bought and does not play enough of an adversarial role.
Chapter 8: International contagion International collapses in confidence precipitate through trading & investment partners and can be caused without any external shock to the economy. The law of one price brings about the equalisation of prices globally to the costs (freight, customs, transport). Global contagion is asymmetric with the crisis in counties with hard currencies impacting more so than crises in less important locales. Countries compete globally for investment flows and as such a reduction of investment flows in one country can be driven by better prospects in another country. Currency debasement & selling to ignorant common people is more profitable than actual entrepreneurial endeavour. Historically markets with an information edge tend to do better. In times of bust activity on the exchanges crashes. Systems to increase credit with weak regulatory oversight can drive booms & thus more severe busts. Repayment over extended periods can cause losses to the creditor. Large institutional investors and their actions can have a huge impact on the confidence of markets. 'Get rich quick' schemes are always a cause for concern. Trading partners tend to develop complex investment flow mechanisms. Positive growth prospects as for instance brought about by the discovery of gold drive expansion in credit bases which can precipitate regionally. Suspensions of convertibility, historically into gold, drive collapses. Competing demand for credit can hurt businesses in the weaker sector/locality. There is global contagion in a loss of confidence. Banks drive up the value of the things that they have a stake in.
Chapter 9: Bubbles from other bubbles Countries are increasingly facing concurrent bubbles in financial markets with similar characteristics. The 3 components helping international contagion of bubbles • A large pool of funds to be lent. • A shock driving behaviour towards higher anticipated returns. • A welcoming regulatory environment. Payments imbalances driven by trade imbalances, investment inflows, or lending inflows cause large increases in the money supply. Barks like high yielding assets in hard currencies & therefore are willing to expand dollar-denominated debts to so-called 'emerging markets' The need to recycle' petro- dollars' allowed counties to finance a much larger trade deficit as oil-exporting nations invest in international reserve assets. Under the current system of trade industrial countries have much larger current account surpluses. Trade surpluses have to be met with trade deficits elsewhere. Policies helping create trade surpluses are protected by the profits of the export-oriented firms. Export surplus countries are more likely to have policies facilitating money outflows to dampen upward pressure on the currency. Industrial policy can erode savings returns for households. Bank lending to the property sector can have self-fulfilling properties in terms of capital appreciation. It is even possible for individuals to have cash outflows from the property investment as rental proceeds exceed interest expenditure. Securing ridiculous appraisals of property values is commonplace and a means to rob from the banking system. International cities are tied to open flows of international capital. Coastal Chinese towns do better than other regions within China in the recent multi-decade growth phase. Trade agreements facilitating low-cost sourcing bring about international investment flows. Privatization brings about international investment flows. Venture capital firm's make money by selling growth prospects. There is a lot of capital seeking high returns. IPOs can be structured, even at cost to existing shareholders or against the goal of raising as much money as possible, to create price pops, an increase in traded value over the subscription price. Bank liquidity can seep into capital markets. Capital flow cause issues for maintaining pegged exchange rates. Credit bubbles can be self-perpetuating growth schemes in the short run.
Chapter 10: Policy responses Countries have put in place systems to prevent a sudden shortage of liquidity that would otherwise trigger a solvency crisis in firms. The Austrian school of economics holds the view that the best solution to a crisis is to let it run its course. The school asserts that over time the economy would adjust to the decline in household wealth, de-capitalization of banks, and slowdown in business and household spending. Too big to fail works along the same lines of deposit insurance as it makes participants less wary of placing cash in institutions as they assume that a larger institution would guarantee the funds. Internationally there have been movements to strengthen bank capital structures with the imposition of a similar risk-based capital requirement for banks across countries. Regulators have been called on to forestall lending in euphoric periods that may cause a financial crisis. The argument that the repeal of the Glass-Steagall Act caused the International Financial crisis fails to explain why it is that banks outside the US jurisdiction and in other periods. Manias are macro phenomena driven by large growth in credit whereas regulation is a micro-phenomenon that only captures a small part of the broader economy. Liquidity shortfalls are supposed to be self-clearing by the ability of firms to raise rates to encourage others to lend to them. The banking sector can reduce speculation in commodities and securities by increasing deposit rates. Businesses can continue to operate despite having wiped out all shareholder capital as was the case with AIG. During liquidity crises, interest rates for private borrowers may seem excessively high as there is a loss of trust in the system which by its very nature is highly interconnected. The government can normalize rates in crises by issuing guarantees to the markets which have historically crashed borrowing costs. Institutions with positive net worth can be wiped out by not being able to borrow against their securities. Temporary rises in rates should under certain conditions allow for there to be large inflows of capital looking to profit from the high rates. The Austrian school notes that there is always an incentive for authorities to intervene during a crisis as authorities tend to be political and driven by short-term political objectives. Closing markets helps market participants return to a state of sanity during a panic. Bank runs can be stopped by slowly disbursing funds, bank holidays, and deposit guarantees. Systemic failure by bank lending can be extended by banks choosing not to recognize loan losses which are assisted by the forbearance of bank examiners. Excessive competition on bank rates can be exacerbated during a crisis and systems to ensure that banks accept each other's papers helps reduce competition on this front. Crises can also be stopped through the conversion of debt obligations to equity forms of capital. Deposit guarantees are abused by wealthy people to guarantee a high rate of return. The US Banking system is unique in that banks are more freely allowed to form and historically were even allowed to issue their own currency. Government bad loan agencies can reduce the eventual losses to the taxpayer by forcing a quicker and more managed resolution to the crisis. Speculation helps cause crisis and can extend to even the most minor of asset classes.
Chapter 11: Domestic lender of last resort The development of the lender of last resort has come about historically as the market gets used to systems of credit and then suddenly there is a loss of confidence in the system and this precipitates a crisis. Over time various institutions which in certain instances were not even empowered legally to do so have stepped in to issue a credit to the market. The role of the Central Bank in any country was historically viewed as being either to defend the value of the currency which in the current day can not be unentwined from the health of the financial system. Bagehot’s Lombard Street in 1873 popularized the concept of a lender of last resort. A lender of last resort brings about the problem of whether economic agents should focus their concerns on a current pandemic or the next boom made possible by a lender of last resort. Economic collapse can be brought about by small shortfalls in confidence. The lender of last resort must be wary of setting a precedent by bailing out industries with a sudden borrowing requirement. It is difficult to set out hard rules on the actions of a lender of last resort. The lender of last resort brings about the question of who should hold reserves and in what quantity? If an institution has been entrusted with the position as a lender of last resort, then the institutions that it insures might take the position that they do not have to maintain proper liquidity. Lenders of last resort by the interests brought about by the role want to have a monopoly on the issuance of currency. The decision to act as a lender of last resort is a political one that has implications on regional balances in the economy. Regional banks may be less likely to be bailed out than one located in close proximity to the lender of last resort. Requiring endorsements of bills of exchange do not tend to work as they are easily obtained with people of disrepute.