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Financial Bubbles #12 | JANUARY 2021 ISEG LIS FINANCIAL CLUB NEWSLETTER BUBBLES THE DOT COM BUBBLE Article written by Armando Vera Pichardo and Edgar Avila Sotelo Page 1 THE ROARING 20's Article written by Alejandro Avila Ramírez and António Amado Estriga Page 1 THE TULIP MANIA Article written by Gabriel Gonçalves and Pedro Lázaro Mendes Page 1 THE UNITED STATES HOUSING BUBBLE Article written by Andrés Damian Cerda and Lourenço Barreiros Cardoso Page 1 THE DOT COM BUBBLE Article written by Armando Vera Pichardo and Edgar Avila Sotelo HOW IT STARTED Between 1995 and 2001, the Internet (specifically the release of Mosaic and later web browsers that gave computer users access to the World Wide Web) created a euphoric attitude toward business and that inspired hopes ARMANDO PICHARDO for the future of online commerce. For this reason, many Internet Universidad Nacional Autónoma de méxico companies (known as “dot-com” which motto was “get big fast” referring about the business model) were launched and led investors to assume that were going to be worth millions in the future. Nonetheless, many companies were overvalued and not that successful, causing investors to lose important amounts of money because of their eager dreams to become millionaires, ignoring the basics of fundamental analysis. EDGAR SOTELO AVILA ECONOMIC PROSPERITY AMONG THE PARTICIPANTS AND Universidad Nacional Autónoma de méxico THE CRASH The bubble was enhanced by investment banks, which profited significantly from initial public offerings (IPO), rising levels of speculation and they encouraged investment in technology. There were highly reported cases of people quitting their jobs to invest all their savings to dot-com enterprises being motivated by the agile publicity made by the media, such as articles on The Wall Street Journal and CNBC. As a result, the venture capital reached historic levels and the Nasdaq Composite stock market index rose from 751.49 to 5135.52 between 1995 and 2000, meaning an increase of 400% in only 5 years, establishing P/E ratio levels of 200, surpassing the results of the Japanese Asset bubble in 1991. Several companies likewise Qualcomm, rose their value about 2000%. The picture below presents the bubble inside Nasdaq index, putting special attention in the downfall of 77.9% from its maximum value on March 2000 to its lowest point in October 2002. This newsletter was produced by members of LIS | #11 01 Source: Global Entrepreneurship Institute In addition to the crash, the terrorist attack of September 11th, 2001, created an important macroeconomic shock that affected the market, as the New York Stock Exchange dropped 14% on the day after the attack. MONETARY POLICY AND FINANCIAL REGULATION Consequently, the FED´s president, Alan Greenspan, decided to burst the bubble due the fact that he realized an overheating in the economy. The way that he popped it was through the increasement of the interest rate to the point of being the same as 1995, named the “Tequila Effect”. After that, he adopted a contracyclical monetary policy (decreasing interest rate), making the interest rate almost 0%, encouraging people to take adjustable-rate mortgage loans rather than traditional fixed-rate mortgage rates, allowing the birth of another world known financial bubble. This newsletter was produced by members of LIS | #11 02 Interest Rate from the FED through years Source: Extracted from https://s.libertaddigital.com/fotos/noticias/berle3.png AFTERMATH OF THE CRASH Once the bubble burst, there was insolvency (bankruptcy) from a lot of dot-com companies and many of them were accused of fraud for misusing shareholders ‘money. Additionally, the U.S. Securities and Exchange Commission levied fines against investment firms for misleading investors. Nevertheless, there were some enterprises that got few troubles and continue running till nowadays like E-Bay and Amazon, consolidating their position in the technology sector (their OPI were in 1997 & 1998, years before shock). Finally, though the adverse consequences, there were positive aspects to take into consideration likewise the optical fibber infrastructure development which lasted less than 5 years (it was expected for (at least) 15 years), the later creation of new web firms like Google and YouTube, and the Silicon Valley existence, promoting technological business models. This newsletter was produced by members of LIS | #11 03 THE ROARING 20´S Article written by Alejandro Avilla Ramírez and António Amado Estriga The 1920s gave us jazz, movies, radio, making out in cars, illegal liquor, prosperity, and a consumer culture based on credit, which eventually led to the worst economic crisis the US has ever seen. There is a stereotypical view of the 1920s as "The Roaring 20s” a decade of exciting change and new lifestyle, as well as increased personal freedom. The 1920s was a period of rapid change and economic prosperity in the USA. ALEJANDRO AVILA RAMÍREZ BSc in Economics It was a time of increased wealth for some people. During the 1920s, the government helped the business grow, by not regulating it much at all. This is known as “laissez-faire” Productivity rose dramatically largely because older industries adopted Henry Ford's assembly line techniques and newer industries grew up to provide Americans with new products and new jobs. The economy also grew because American corporations were extending their reach overseas, ANTÓNIO ESTRIGA and American foreign investment was greater than that of any other BSc in Economics country. The dollar replaced the pound as the most important currency for trade by the end of the decade. The widespread use of credit and layaway buying plans meant that it was acceptable to go into debt to support what came to be the American standard of living and this was a huge change in attitude. The fact that so many Americans were going into debt to pursue the American lifestyle meant that if the economy faltered, and it did, there was going to be lots of trouble. Prosperity in the 1920s was not equally distributed through the population. In the mid-1920s, around 3 million Americans owned stocks, and Wall Street captivated the imagination of the audience with stories of fortunes won the idea overnight of a big bull market in which it seemed that stocks could only climb, seized everyone. People had so much faith in the bull markets that started borrowing money in enormous amounts to speculate on rising prices of stocks. This newsletter was produced by members of LIS | #11 04 During the 1920s the number of manufacturing workers declined by 5%, the first time this class of workers had seen its numbers drop. New England was beginning to see unemployment in deindustrialization as textile companies moved their operations to the south where labour was cheaper. The 1920s also saw increased tension between science education in the United States and religious beliefs. Immigrants were necessary for the economic boom of the 1920s, but at the same time, their numbers were restricted, as they were a threat to traditional American values. The roaring 20s was a decade of excesses, and an obvious one was the stock market. By the fall of 1929, US stock prices had reached levels that could not be justified by reasonable anticipations of future earnings. A result of a variety of minor events led to gradual price declines in October 1929, leading to investors lose confidence and the stock market bubble burst. At that time, the President of the United States was a Republican, Herbert Hoover. He believed that if you were in trouble you should help yourself and not expect others to help you. This is called “rugged individualism”. Therefore, he did not do a great deal to help those affected by the crash. Hoover did not believe that the depression would last - “Prosperity is just around the corner” is what he said to a businessman in 1932 when things were at their worst. However, Hoover did do some good. Money was used to create jobs to build things such as the Hoover Dam. In 1932 he gave $300 million to the states to help the unemployed (Emergency Relief and Reconstruction Act) but it had minor impact as states run by the Republicans believed in “rugged individualism” more than Hoover did and they used only $30 million of the money offered to them. Many saw Hoover’s attempts as being “too little too late" During the 1920s, the U.S stock market underwent rapid expansion, reaching its peak in August 1929 after a period of wild speculation during the roaring twenties. By then, production had already declined, and unemployment had risen, leaving stocks in great excess of their value. This newsletter was produced by members of LIS | #11 05 Among the other causes of the stock market of 1929 were low wages, the proliferation of debt, a struggling agricultural sector, and an excess of large bank loans that could not be liquidated. Stock prices fell 33% between September and early October 1929, and on October 18 the fall began. Panic set in, and on October 24, Black Thursday, a record 12,894,650 shares were traded. Investment companies and leading bankers tried to stabilize the market by buying up great blocks of stocks, producing a moderate rally on Friday. On Monday, however, the market went into free fall. Black Monday was followed by Black Tuesday, in which stock prices collapsed completely and 16,410,030 shares were traded on the NYSE in a single day. Billions of dollars were lost, wiping out thousands of investors, and stock tickers ran hours behind because the machinery could not handle the tremendous volume of trading. After October 29, 1929, stock prices had nowhere to go up, so there was considerable recovery during succeeding weeks. Overall, however, prices continued to drop as the United States slumped into the Great Depression, and by 1932 stocks were worth only about 20 percent of their value in the summer of 1929.
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