There are always movements in the markets. On some occasions, the markets are more volatile than on the others. They are affected by news releases, political and economical events or natural disasters. But the price is in constant motion. There is, however, a huge difference between the conventional upwards and downwards movements and the extreme ones that are followed by the financial bubbles. And this will be the topic of today’s article.
4 famous bubbles in financial history
When a new product appears in the markets, the investors oftentimes make promises of spectacular returns. They are too excited to be cautious and they end up poorly. Financial bubbles and panics do not do any good. This is why it might be a good idea to learn about famous market bubbles that have happened throughout history.
The Tulip Fever from 1637
At the beginning of the 17th century, the tulips showed up in the Netherlands. The precious flowers arouse great interest and so the tulip mania had begun. The investors were sure they can sell the tulip bulbs for much more in the future.
What happened is that not only people in the trade were buying the bulbs. Also middle-class and even poor families wished to make profits and they began to take credits and mortgage their houses in order to buy tulip bulbs. The bulbs were being sold numerous times in a day and big money was put in.
Then, doubt had entered the scene. People stopped believing the price could hold up and so they started to sell what they had. The result was mass panic and the price obviously had crashed. Many novice investors fell to ruin.
The Dot-Com Bubble from 2000
Technology stocks had been on the focus of many investors at the turn of 1999 and 2000. The Internet gained popularity and there has been a growing demand for it in companies and online commerce.
Investors became passionate and put their money into Internet companies or dot-coms. They were sure they would turn into dot-com millionaires.
As speculation drove up the prices of companies that were generating good results, such as Amazon and eBay, their stocks became immensely overvalued. The investors were too excited to stick to some basic investing principles. They did not check companies’ business plans, incomes and price/earnings ratios. The money was invested in technology companies without achieving profits yet, and it was through IPOs that these companies were obtaining money. The warnings emerged that tech stocks had formed an unsustainable bubble. In 2000 interest rates started to rise and accountancy scandals at such companies as Enron came to light. People began to reconsider their investments in tech companies.
Businesses were failing and markets started to collapse. In the final count tech stocks were down $5 trillion in market capitalization since their high point.
Credit Crisis from 2008
The credit crisis in 2008 was caused by big banks in the USA when they lost enormous sums on mortgage-backed securities. There were all sorts of cheap debt backed by those securities being issued by banks before the crash. And these securities were backed by default swaps from insurance companies. There were mortgages being pooled and then sold in a market-driven by prices of real estate that were seemingly only going up. The conditions in the market changed and the owners of the homes could not pay their mortgages so banks seized the homes which also lost their value. That said, banks also overstretched themselves. The financial products that institutions were trading between themselves without much scrutiny tended to experience losses in value.
The principal investment firm to heavily suffer was Bear Sterns. It was March 2008. Six months later, Lehman Brothers declared bankruptcy. Plenty of others, such as Merril Lynch, Goldman Sachs and Freddie Mac, were also caught up in the scandal.
It was necessary for central banks to step in to save the financial system. They introduced programs like quantitative easing. It had to pass a decade to allow them to unwind a bit.
As a consequence of the credit crisis, some regulatory changes were made to guarantee that banks sustain a certain volume of available capital and the borrowers cannot take out greater loans than they actually are able to afford.
Bitcoin and Pot Stocks Manias from 2018
There was a time when both, bitcoin and pot stocks, were on investors’ focus. The excitement was huge but in fact, both were quite new for market participants, with companies that neither produced an income nor had any inherent worth except for investors’ willingness to purchase.
Bitcoin is a digital currency developed by solving cryptographic problems by users on a public decentralized ledger. A huge financial spike in the price was powered by hype and the pursuit of cashless payments. The market capitalization of the entire cryptocurrency world reached $700 billion. Bitcoin peak was noted in December 2017 at $19,511. And at the beginning of 2018, it had decreased by more than 65 per cent.
Recreational marijuana approached legalization in October 2018 and pot stocks immediately met “peak hype”. Retail investors did not really understand this next growth industry’s value nor they had reliable numbers to judge the stock’s value. Still, they put their money on it. Then, more growers appeared in the market. Companies encountered regulatory backlogs, the stores awaited licenses and certain questions about the company’s accounting practices emerged. A result was that pot appeared to become a commodity of less value. One year had passed after the eagerly awaited legalization and most cannabis stocks fell 50 per cent.
History shows the occurrence of multiple financial bubbles. It is quite probable that another one will happen. It can be even sooner than later as we live now in pandemic times. The economy is slowing down, but the US stock market is constantly growing. Be prepared. Those are symptoms of the upcoming bubble. Be ready to make Big Short.