CARDINAL STEFAN WYSZYŃSKI UNIVERSITY IN WARSAW
CRASHES AND CRISES IN
THE FINANCIAL
MARKETS . THE
IMPORTANCE OF
SPECULATIVE BUBBLES.
Global Financial Markets
Magdalena Cupryjak, Patrycja Gniadzik, Mateusz Jarzębski
Warsaw 2016
The article presents the phenomenon of speculative bubbles, which is an integral part of modern
financial markets. Most often the term speculative bubble understands the movement of asset prices,
which can not be explained by fundamental premises or other rational factors having a significant
impact on the price of these assets.
CRASHES AND CRISES IN THE FINANCIAL MARKETS . THE
IMPORTANCE OF SPECULATIVE BUBBLES.
Patrycja Gniadzik, Magdalena Cupryjak, Mateusz Jarzębski
Strona 1
A SPECULATIVE BUBBLE
The stock market bubble (speculative) is a phenomenon known for centuries. The
history of the free market is a story about growing bubbles and more painful craches. The
sharp price increases in many markets - not only stocks - are known for many hundreds of
years. Often these sharp increases end in equally spectacular decline of trading. Sometimes
assets lose 90% of its value in a few months. In this case, it speaks of "inflating and then
bursting of the speculative bubble". Very important (if not the most important) in this process
is played by the psychological attitude of investors.
An economic bubble “is trade in an asset at a price or price range that strongly
deviates from the corresponding asset's intrinsic value”
1
. This phenomenon may also be
understood as “a social epidemic whose contagion is mediated by price movements. News of
price increase enriches the early investors, creating word-of-mouth stories about their
successes, which stir envy and interest. The excitement then lures more and more people into
the market, which causes prices to increase further, attracting yet more people and fueling
'new era' stories, and so on, in successive feedback loops as the bubble grows”
2
. It follows
that the price bubble is self-perpetuating mechanism, in which the price increase is not
justified by economic and financial factors, and psychological, for example, constantly rising
expectations. Bubble occurs when a sharp increase in prices above their value followed by
equally rapid decline - a price correction. The place of frequent formation of bubbles are
securities exchanges. Investors saw a sudden upward trend in prices to buy shares in order to
achieve a quick and large profit. This is the tense atmosphere and high noise created by the
media creating the image of the potential profits. Investors behave in a herd by buying
advantages of not paying attention to the lack of justification for the price in the current
financial results. Usually speculative bubbles do not last long. When starting to fall in share
prices, investors are selling previously purchased securities. Followed by the deep downturn
in the market and serious losses of many shareholders and a period of low prices
3
.
1
King R., Smith V., Williams A., van Boening M., "The Robustness of Bubbles and Crashes in Experimental
Stock Markets". In Day, R. H.; Chen, P.Nonlinear Dynamics and Evolutionary Economics. New York: Oxford
University Press, 1993.
2
Shiller R., "Bubbles without Markets". Project Syndicate. Retrieved 17 August 2012
3
Garber P., Famous First Bubbles: The Fundamentals of Early Manias. Cambridge, MA: MIT Press, 2001
CRASHES AND CRISES IN THE FINANCIAL MARKETS . THE
IMPORTANCE OF SPECULATIVE BUBBLES.
Patrycja Gniadzik, Magdalena Cupryjak, Mateusz Jarzębski
Strona 2
Can be identified 5 steps of creating a bubble in the market - displacement, boom,
euphoria, profit and panic. Although there are different interpretations of these cycle, the
overall activity pattern bubble remains relatively consistent.
1. Displacement. Displacement occurs when investors are delighted with the new
paradigm, such as the new advanced technology or interest rates that are
historically low.
2. Boom. Prices are rising slowly, after moving, but then gain momentum as more
participants enter the market, setting the stage for the boom phase. During this
second phase of the bubble, the asset attracted widespread media attention. Fear of
missing out on what could be an opportunity once-in-a-lifetime spurs more
speculation, drawing more and more members into the fold.
3. Euphoria. During this phase, caution is abandoned by investors and asset prices
soar very high. "Great fool" theory played out wherever possible on the market.
During the phase of euphoria, new means of measurement and metrics are
promoted to justify the unstoppable rise in asset prices.
4. Profit. At this time, the smart money - heeding the warning signs - overall sold
positions and implemented profits. But estimating the time when the bubble is the
result of the collapse is a difficult task and extremely dangerous to the health of the
financial, because, as John Maynard Keynes said, "Markets can remain irrational
longer than you can stay solvent."
5. Panic. During panic, asset prices are changing gear and fall as quickly as rose.
Investors and speculators, faced calls and plunging values of their farms, and now
they want to sell the share at any price to be rid of them. Because the supply
overwhelms demand, asset prices slide steeply
4
.
Market bubbles in some asset or another are inevitable in a free market economy. However,
refer to the steps of the formation of bubbles can help to see the next one and avoid becoming
involuntary participant in it.
There are a list of groups of criteria for early identification of a market bubble. Here
are some measurable criteria to help track down speculative bubbles before they burst.
1. The deviation from historical average valuation. Traditional indicators
(capitalization, price / profit, price / sales) start to uncontrollably change values. If
4
Five steps of a bubble, Forbes, published: 17.06.2010, web: http://www.forbes.com/2010/06/17/guide-
financial-bubbles-personal-finance-bubble.html, access 15.05.2016
CRASHES AND CRISES IN THE FINANCIAL MARKETS . THE
IMPORTANCE OF SPECULATIVE BUBBLES.
Patrycja Gniadzik, Magdalena Cupryjak, Mateusz Jarzębski
Strona 3
they grow above two standard deviations from the levels historically recognized as
the norm, we should verify that fundamentals have changed justifying such
behavior on the market.
2. Above-average returns. The ability to quickly get rich work for the investors like a
magnet in final phase of pumping the bubble. The first spectacular stock exchange
debuts and takeovers of innovative companies signal that if it has just created
another stock bubble, it is still at a very early stage. The expectation that similar
results will be repeated in the coming years, may negatively surprise the market
participants.
3. Excessive leverage. Cheap capital from various sources (subprime loans and
securitization, investors amateur and Internet bubble, central banks), but mostly
contributed to pumping the biggest bubbles.
4. New financial products. The Internet bubble boosted management and employee
options instead of cash. Their owners became millionaires when the company
entered the stock market. Currently, can also see an increased creativity of
financial engineers and bankers.
5. The increase in the number of transactions. Just before the spectacular bubble burst
trading volume is growing rapidly, investor greed and fear of missing the occasion
reaching the summit.
6. "Ripped off" rationalization, new indicators. Lovers of assets whose prices are
growing so fast, usually argue that "this time is different" and come up with
various arguments intended to suppress the voices of critics.
7. Conflicts of interest. There are conflicting interests of various stakeholder groups.
Similar mechanisms can watch in the business models of powerful Internet
startups.
8. Workplaces. New trends generate demand for workers in hot sectors, hence the
number of estate brokers and bankers grow unnaturally quickly in the United
States in the years 2004 -2007 before a mortgage crisis in 2008.
9. Lowering credit standards. "Easy" money goes on preferential terms to those not
prepared to repay loans, which almost always means big problems in the future.
10. Unnatural changes in the prices low. If the addition is accompanied by a price
movement almost exclusively in one direction, a sign that market participants there
is suspicious, unnatural unanimity. In such conditions often flowing information
CRASHES AND CRISES IN THE FINANCIAL MARKETS . THE
IMPORTANCE OF SPECULATIVE BUBBLES.
Patrycja Gniadzik, Magdalena Cupryjak, Mateusz Jarzębski
Strona 4
that "no one could to foresee" but viewed from the side, sooner or later something
has to restore balance to the market
5
6
.
Most bubbles are noticeable only in retrospect, when everyone involved in the pursuit of
profit, shaking his head in disbelief. Flexibility and willingness to change his mind as the
development of the market situation is one of the most important characteristics of successful
investors. We decided to take a look at the most - from tulip mania, who was one of the first
bubbles so large in size, and ending with one of the freshest, the US bubble in the property
market.
THE TULIPOMANIA
One of the first and most spectacular examples of speculative bubbles, which reported
the story, is the so-called tulip mania. The tulip was introduced from Constantinople to
western Europe, and particularly to Holland, in the middle of the 16th century. Such was its
influence that it became one of the strangest features of moral epidemic. Lust of fast buck
broke out in the Netherlands at the beginning of the seventeenth century. In a short time,
prices of tulip bulbs grew there almost for astronomical values. Soon after the Dutch tulips
were attacked by a virus mottling tulip (TBV), which caused the tulip petals took on
unprecedented shapes of the edges jagged and undulating. Since this is a symptom of a
disease, infected specimens often withered, which was another element of risk. This anomaly
gardening has become a cause of the development of the Dutch "tulip fever"
7
.
5
Light J., How to spot a market bubble?, published; 18.04.2014, Web:
http://www.wsj.com/articles/SB10001424052702304626304579507413517999956, access;
13.05.2016
6
Davies G., How to detect a market buble?, published: 17.01.2014, Web:
http://blogs.ft.com/gavyndavies/2014/01/17/how-to-detect-a-market-bubble/, access; 16.05.2016
7
THE CONTEMPORARY WOMEN, Tulipomania: The Story about How the Tulip became a Distinctive Symbol
of the Netherlands, published: 26.05.2015, web:
http://thecontemporarywomen.com/2015/05/26/tulipomania-the-story-about-how-the-tulip-became-a-
distinctive-symbol-of-the-netherlands/, access: 28.05,2016
CRASHES AND CRISES IN THE FINANCIAL MARKETS . THE
IMPORTANCE OF SPECULATIVE BUBBLES.
Patrycja Gniadzik, Magdalena Cupryjak, Mateusz Jarzębski
Strona 5
Chart 1. The value of tulips in the Netherlands during the bubble in the seventeenth century.
Source: THE CONTEMPORARY WOMEN, Tulipomania: The Story about How the Tulip became a Distinctive
Symbol
of
the
Netherlands,
published:
26.05.2015,
web:
http://thecontemporarywomen.com/2015/05/26/tulipomania-the-story-about-how-the-tulip-became-a-distinctive-
symbol-of-the-netherlands/, access: 20.05.2016
Flowers became soon a symbol of luxury and social status. In 1623 the single most
sought after varieties of onions reached a price of up to 1 thousand guilders (average annual
income in the Netherlands was then about 150 guilders)
8
. It happened that sometimes was
turned tulips for real estate, land or cattle. Top traders earned frequently about 6 thousand
guilders a month to trade tulips. In 1635 the reported sale of 40 bulbs for 100 thousand
guilders. For comparison, a ton of butter cost 100 guilders then, and 8 fat pigs 240 guilders
(chart number 1). In the 30s the seventeenth century, tulips were traded on the stock
exchanges of Dutch cities. The unprecedented demand for these flowers meant that many
people began to speculate on the market (in the manner in which this is done today with
securities), hoping to duplicate the inserted capital. Some sold everything they had to buy the
first seedlings
9
. Many people earned fortunes, others have lost wealth. In 1637 there was a
collapse of the market, which was caused by too excessive prices, for which there were no
takers. Another important factor that contributed to the crash, there was non-compliance with
counterparty obligations under contracts guaranteeing the purchase of bulbs at a fixed price in
the future. There was panic as a result of which thousands of people have become bankrupt
(in their possession were only tulips that were worth only a fraction of what they paid in
8
Goldgar A., Tulipmania: Money, Honor, and Knowledge in the Dutch Golden Age. London: University of
Chicago Press, 2008
9
Frankel A., When the Tulip Bubble Burst, ,Business Week, April 4, 2000
CRASHES AND CRISES IN THE FINANCIAL MARKETS . THE
IMPORTANCE OF SPECULATIVE BUBBLES.
Patrycja Gniadzik, Magdalena Cupryjak, Mateusz Jarzębski
Strona 6
advance). In the worst situation were those who took loans to purchase tulips, and as a result
of the crash become insolvent
1011
.
THE GREAT DEPRESSION
At the end of the 30s of the twentieth century John Maynard Keynes said: humanity
lives in the shadow of one of the greatest economic catastrophes of modern history
12
. This
statement referred to the then-greatest threat to the world economic system, which was the
Great Depression. Lionel Robbins of the London School of Economics wrote the book titled
“The Great Depression” (London 1934) in which he put the idea supposedly the world crisis
not erupted suddenly in 1929, but lasted since 1914
13
. World War was a terrible disaster for
humanity, especially for Europe, it brought huge economic and human destruction;
international division of labor has ceased to function, have broken world markets. State to
finance war expenses, took out large loans in other countries or in their own nationals. After
the war, winning the state had to pay off war debts and Germany – reparations. We come to
this debt on the need to rebuild the economy, mainly through loans taken out of the United
States
14
.
What exactly was the Great Depression? The Great Depression – worldwide economic
downturn that began in 1929 and lasted until about 1939. It was the longest and most severe
depression ever experienced by the industrialized Western world – Christina D. Romer
15
wrote in her text. Great Depression originated in the United States, officially it lasted in the
years 1929-1932
16
. It resulted in drastic declines in output, severe unemployment, and acute
deflation in almost every country of the globe. In the United States the Great Depression right
after Civil War is considered to the gravest crisis in American history
17
.
10
Garber P.,. Tulipmania. „The Journal of Political Economy”. 3 (97), The University of Chicago Press, July
1989, p. 535-560.
11
Gross D., Bulb Bubble Trouble; That Dutch tulip bubble wasn't so crazy after all, Slate, July 16, 2004.
Retrieved on November 4, 2011.
12
Gabiś T., Wielki kryzys – wielka zagadka? , published: 29.02.2012, web:
http://nowadebata.pl/2012/02/29/wielki-kryzys-wielka-zagadka, access: 27.05.2016
13
Ibidem.
14
Ibidem.
15
Romer C.D., Great Depression, Forthcoming in the Encyclopedia Britannica, 2003, p. 223
16
Murray N. Rothbard, Wielki Kryzys w Ameryce / America’s Great Depression, The Ludwig von Mises
Institute, 2000, p. 151.
17
Romer C.D., Great Depression, Forthcoming in the Encyclopedia Britannica, 2003, p. 223
CRASHES AND CRISES IN THE FINANCIAL MARKETS . THE
IMPORTANCE OF SPECULATIVE BUBBLES.
Patrycja Gniadzik, Magdalena Cupryjak, Mateusz Jarzębski
Strona 7
The then US President Herbert Hoover in 1932, presented a summary of his campaign:
(…) we could do nothing. This would lead to the final catastrophe. Reacting to the situation,
we presented to entrepreneurs and the Congress of the largest in the history of the republic
program of defense and counterattack. We introduced it in life. (…) So far, no government in
Washington does not want to take so much responsibility for leadership in times of crisis
18
.
Well, his actions were completely different than all previously used in America in times of
crisis. So far, always guided by the principle of laissez-faire, just do not interfere to the
economy, so that the government does not exacerbated the crisis, and softened its course. The
president however has applied aggressive action and tossed aside laissez-faire
19
.
The situation was really serious, since Hebert Clark Hoover decided to introduce new
rules, discarding the previous one. The Great Depression brought about fundamental changes
in economic institutions, macroeconomic policy, and economic theory.
On October 24, 1929, the stock market bubble burst, as investors began dumping shares end
masse. A record 12.9 million shares were traded that day, known as “Black Thursday.” Five
days later, on “Black Tuesday” some 16 million shares were traded after another wave of
panic swept Wall Street. Millions of shares ended up worthless, and those investors who had
bought stocks “on margin” (with borrowed money) were wiped out completely
20
.
Chart 2. Real GNP in the U.S. during the Great Depression.
Source: Richman H., Growing Trade Deficit continues U.S. Depression, published: 31.10.2010, web:
http://www.idealtaxes.com/post3242.shtml, access: 04.06.2016
18
Starr Myers W., Newton W.H., The Hoover Administration, New York 1936, part 1; William Starr Myers
(red.), The State Papers of Herbert Hoover, New York 1934,
19
Murray N. Rothbard, Wielki Kryzys w Ameryce / America’s Great Depression, The Ludwig von Mises
Institute, 2000, p. 151-153.
20
The Great Depression, web: http://www.history.com/topics/great-depression, access: 27.05.2016,
CRASHES AND CRISES IN THE FINANCIAL MARKETS . THE
IMPORTANCE OF SPECULATIVE BUBBLES.
Patrycja Gniadzik, Magdalena Cupryjak, Mateusz Jarzębski
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From the Wall Street crash , the world economy entered a period called the Great Depression
in the United States and in other countries of the Great Depression Economic. Production in
the major industrial countries has fallen from 30 to 50 %, the value of world trade in 1932 was
about one-third lower than three years earlier (chart number 2). In 1933, 30 million people
were out of work, everywhere decreased gross national income (chart number 3). Between
1929 and 1932 the average American family income fell by 40% - from 2,300 to 1,500 dollars
a year. Between 1929 and 1933 fell from 10 000 to 25 000 commercial banks USA
21
.
Chart 3. Unemployment in the United States in the years 1929-1942.
Source: PHOTOS OF-1930 -THE GREAT STOCK MARKET CRASH & DEPRESSION unemployment,poverty –
AMERICA, web: http://pazhayathu.blogspot.com/2010/10/photos-of-1930-great-stock-market-crash.html, access:
03.06.2016
British historian Paul Johnson wrote: The collapse of Wall Street in September and
October 1929 and the subsequent Great Depression them among the most important events of
the twentieth century. They made the Second World War, though not inevitable, it became
possible
22
.
21
T. Gabiś, Wielki kryzys – wielka zagadka?, published: 29.02.2012, web:
http://nowadebata.pl/2012/02/29/wielki-kryzys-wielka-zagadka, access: 27.05.2016
22
Ibidem.
CRASHES AND CRISES IN THE FINANCIAL MARKETS . THE
IMPORTANCE OF SPECULATIVE BUBBLES.
Patrycja Gniadzik, Magdalena Cupryjak, Mateusz Jarzębski
Strona 9
Chart 4. The US stock market (benchmark: Dow Jones Industrial Average (DJIA)© Index) in years
1920-1932.
Source: Stock market crash - Black Thursday / Black Tuesday - October 1929, web: http://www.sniper.at/stock-
market-crash-1929.htm, access: 04.06.2016
The unity of the world financial system collapsed ultimately prevailed monetary chaos. The
breakdown of global markets and the collapse of the international financial system and trade,
prepared the ground for World War II. It is not an exaggeration to say that the whole edifice
of world trade and global finance has implosion. Intensified social unrest, political crises and
conflicts between political elites of various countries
23
.
The Great Depression affected not only America. The USA was the place where it was born,
and later spread to the whole world. The Depression played a vital role in the development of
macroeconomic policies intended to temper economic downturns and upturns
24
. We can see
dates of the Great Depression in Various Countries: United States (1929-1933), Great Britain
(1930-1932), Germany (1928-1932), France (1930-1932), Canada (1929-1933), Switzerland
(1929-1933), Czechoslovakia (1929-1933), Italy (1929-1933), Belgium (1929-1933),
Netherlands (1929-1933), Sweden (1930-1932), Denmark (1930-1933), Poland (1929-1933),
Argentina (1929-1932), Brazil (1928-1931), Japan (1930-1932), India (1929-1931), South
Africa (1930-1933)
25
.
23
Ibidem.
24
Romer D. C., Great Depression, Forthcoming in the Encyclopedia Britannica, 2003, p. 223
25
Ibidem.
CRASHES AND CRISES IN THE FINANCIAL MARKETS . THE
IMPORTANCE OF SPECULATIVE BUBBLES.
Patrycja Gniadzik, Magdalena Cupryjak, Mateusz Jarzębski
Strona 10
The Great Depression surprised the United States – the only one industrialized country in the
world without some form of unemployment insurance or social security. In 1935, Congress
passed the Social Security Act, which for the first time provided Americans with
unemployment, disability and pensions for old age
26
.
A new deal taken an unequal fight against unemployment through the launch of public
works for the construction of roads and even bridges in the United States. Prosperity tried to
shoot the procurement and development of the defense industry. But in fact all the plans
reduce unemployment to only 10% ended in a fiasco
27
.
What was the real problem? Economic theory shows that the business cycle can be
invoked only by inflation stimulated by the government, and the inflationist and
interventionist methods can only prolong and deepen the crisis. the cause of the crisis was not
the principle of laissez – faire, because just government interventions have led to an unhealthy
boom of the twenties , and new methods of Hoover , involving advanced interventionism,
tightened the course of the Great Depression. A blame is not on the side of a free market
economy – it's time to clean the free market and laissez-faire. To be honest, someone else
should be blamed, it means: politicians, bureaucrats and a lot of “enlightened” economists.
DOT-COM BUBBLE
The dot-com bubble was a historic speculative bubble covering roughly 1997–2000
during which stock markets in industrialized nations saw their equity value rise rapidly from
growth in the Internet sector and related fields. While the latter part was a boom and bust
cycle, the Internet boom is sometimes meant to refer to the steady commercial growth of the
Internet with the advent of the World Wide Web, as exemplified by the first release of the
Mosaic web browser in 1993, and continuing through the 1990s.
During the late 20th century, the Internet created a euphoric attitude toward business
and inspired many hopes for the future of online commerce. For this reason, many Internet
26
The Great Depression, web: http://www.history.com/topics/great-depression
,
acces: 27.05.2016
27
Redakcja Investroom, Wielki Kryzys z 1933 r. – największy kryzys gospodarczy w historii, published:
16.03, web:
https://investroom.pl/blog/307-2/
, access: 30.05.2016
CRASHES AND CRISES IN THE FINANCIAL MARKETS . THE
IMPORTANCE OF SPECULATIVE BUBBLES.
Patrycja Gniadzik, Magdalena Cupryjak, Mateusz Jarzębski
Strona 11
companies (known as “dot-coms”) were launched, and investors assumed that a company that
operated online was going to be worth millions.
The dotcom bubble started growing in the late ’90s, as access to the internet expanded and
computing took on an increasingly important part in people’s daily lives. Online retailing was
one of the biggest drivers of this growth, with sites like Pets.com getting big investors and
gaining a place in American consumer culture
28
.
Chart 5. The Nasdaq (index of leading technology) in years 1995-2010).
Source: Madslien J., Dotcom bubble burst: 10 years on, published: 10.03.2010, web:
http://news.bbc.co.uk/2/hi/business/8558257.stm, access: 04.06.2016
With the investment and excitement, stock values grew. The value of the NASDAQ,
home to many of the biggest tech stocks, grew from around 1,000 points in 1995 to more than
5,000 in 2000. Companies were going to market with IPOs and fetching huge prices, with
stocks sometimes doubling on the first day. It was a seeming wonderland where anyone with
an idea could start making money.
Due to the rise in the commercial growth of the Internet, venture capitalists saw
record-setting growth as "dot-com" companies experienced meteoric rises in their stock prices
and therefore moved faster and with less caution than usual, choosing to mitigate the risk by
starting many contenders and letting the market decide which would succeed. The low interest
rates of 1998–99 helped increase the start-up capital amounts. A canonical “dot-com”
28
Smith K., History of the Dot-Com Bubble Burst and How to Avoid Another, web:
http://www.moneycrashers.com/dot-com-bubble-burst/, access: 02.06.2016
CRASHES AND CRISES IN THE FINANCIAL MARKETS . THE
IMPORTANCE OF SPECULATIVE BUBBLES.
Patrycja Gniadzik, Magdalena Cupryjak, Mateusz Jarzębski
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company’s business model relied on harnessing network effects by operating at a sustained
net loss and building market share. These companies offered their services or end product for
free with the expectation that they could build enough brand awareness to charge profitable
rates for their services later. The motto “get big fast” reflected this strategy
29
.
This occurred in industrialized nations due to the reducing “digital divide” in the late
1990s, and early 2000s. Previously, individuals were less capable of accessing the Internet,
many stopped by lack of local access/connectivity to the infrastructure, and/or the failure to
understand use for Internet technologies. The absence of infrastructure and a lack of
understanding were two major obstacles that previously obstructed mass connectivity. For
these reasons, individuals had limited capabilities in what they could do and what they could
achieve in accessing technology. Increased means of connectivity to the Internet than
previously available allowed the use of ICT (Information and Communications Technology)
to progress from a luxury good to a necessity good. As connectivity grew, so did the potential
for venture capitalists to take advantage of the growing field. The functionalism, or impacts of
technologies driven from the cost effectiveness of new Internet websites ultimately influenced
the demand growth during this time.
In financial markets, a stock market bubble is a self-perpetuating rise or boom in the share
prices of stocks of a particular industry; the term may be used with certainty only in retrospect
after share prices have crashed. A bubble occurs when speculators note the fast increase in
value and decide to buy in anticipation of further rises, rather than because the shares are
undervalued. Typically, during a bubble, many companies thus become grossly overvalued.
When the bubble “bursts”, the share prices fall dramatically. The prices of many non-
technology stocks increased in tandem and were also pushed up to valuations discorrelated
relative to fundamentals
30
.
In March of 2000, everything started to change. On March 10, the combined values of
stocks on the NASDAQ was at $6.71 trillion; the crash began March 11. By March 30, the
NASDAQ was valued at $6.02 trillion. On April 6, 2000, it was $5.78 trillion. In less than a
month, nearly a trillion dollars worth of stock value had completely evaporated.
Companies started folding. (Pets.com was one.) Magazines, including TIME, started running
stories advising investors on how to limit their exposure to the tech sector, sensing that people
29
Galbraith J.K., Hale T., Income Distribution and the Information Technology Bubble, University of Texas,
2004, p. 14
30
Lowenstein R., Origins of the Crash: The Great Bubble and Its Undoing, Penguin Books, 2004, pp. 114–
115.
CRASHES AND CRISES IN THE FINANCIAL MARKETS . THE
IMPORTANCE OF SPECULATIVE BUBBLES.
Patrycja Gniadzik, Magdalena Cupryjak, Mateusz Jarzębski
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were going to start taking a beating if their portfolios were too tied to e-tailers and other
companies that were dropping like flies.
Several communication companies could not weather the financial burden and were
forced to file for bankruptcy. One of the more significant players, WorldCom, was found
engaging in illegal accounting practices to exaggerate its profits on a yearly basis.
WorldCom’s stock price fell drastically when this information went public, and it eventually
filed the third-largest corporate bankruptcy in U.S. history. Other examples include
NorthPoint Communications, Global Crossing, JDS Uniphase, XO Communications, and
Covad Communications. Companies such as Nortel, Cisco, and Corning were at a
disadvantage because they relied on infrastructure that was never developed which caused the
stock of Corning to drop significantly. Many dot-coms ran out of capital and were acquired or
liquidated; the domain names were picked up by old-economy competitors, speculators or
cybersquatters. Several companies and their executives were accused or convicted of fraud for
misusing shareholders’ money, and the U.S. Securities and Exchange Commission fined top
investment firms like Citigroup and Merrill Lynch millions of dollars for misleading
investors. Various supporting industries, such as advertising and shipping, scaled back their
operations as demand for their services fell. A few large dot-com companies, such as
Amazon.com, eBay, and Google have become industry-dominating mega-firms. The stock
market crash of 2000–2002 caused the loss of $5 trillion in the market value of companies
from March 2000 to October 2002. The September 11, 2001, attacks accelerated the stock
market drop; the NYSE suspended trading for four sessions. When trading resumed, some of
it was transacted in temporary new locations
31
.
More in-depth analysis shows that 48% of the dot-com companies survived through
2004. With this, it is safe to assume that the assets lost from the stock market do not directly
link to the closing of firms. More importantly, however, it can be concluded that even
companies who were categorized as the “small players” were adequate enough to endure the
destruction of the financial market during 2000–2002. Additionally, retail investors who felt
burned by the burst transitioned their investment portfolios to more cautious positions.
Nevertheless, laid-off technology experts, such as computer programmers, found a glutted job
market. University degree programs for computer-related careers saw a noticeable drop in
31
Goldfarb, Brent; Kirsch, David; Miller, David A., Was there too little entry during the Dot Com Era?, Journal
of Financial Economics 86, 2007, (1): 100–44.
CRASHES AND CRISES IN THE FINANCIAL MARKETS . THE
IMPORTANCE OF SPECULATIVE BUBBLES.
Patrycja Gniadzik, Magdalena Cupryjak, Mateusz Jarzębski
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new students. Anecdotes of unemployed programmers going back to school to become
accountants or lawyers were common
32
.
As the technology boom receded, consolidation and growth by market leaders caused
the tech industry to come to more closely resemble other traditional U.S. sectors. As of 2014,
ten information technology firms are among the 100 largest U.S. corporations by revenues.
HOUSING BUBBLE
A real estate bubble or property bubble (or housing bubble for residential markets) is a
type of economic bubble that occurs periodically in local or global real estate markets,
typically following a land boom. A land boom is the rapid increase in the market price of real
property such as housing until they reach unsustainable levels and then decline in a bubble.
Bubbles in housing markets are more critical than stock market bubbles. Housing price
busts are less frequent, but last nearly twice as long and lead to output losses that are twice as
large. A recent laboratory experimental study also shows that, compared to financial markets,
real estate markets involve longer boom and bust periods
33
.
As with all types of economic bubbles, disagreement exists over whether or not a real
estate bubble can be identified or predicted, then perhaps prevented. Speculative bubbles are
persistent, systematic and increasing deviations of actual prices from their fundamental
values. Bubbles can often be hard to identify, even after the fact, due to difficulty in
accurately estimating intrinsic values. In real estate, fundamentals can be estimated from
rental yields (where real estate is then considered in a similar vein to stocks and other
financial assets) or based on a regression of actual prices on a set of demand and/or supply
variables
34
.
Within mainstream economics it can be posed that real estate bubbles cannot be
identified as they occur and cannot or should not be prevented, with government and central
bank policy rather cleaning up after the bubble bursts. Economic bubbles, and in particular
real estate bubbles, are not considered major concerns. Within some schools of economics, by
32
Geier B., What Did We Learn From the Dotcom Stock Bubble of 2000?, published: 12.03.2015, web:
http://time.com/3741681/2000-dotcom-stock-bust/, access: 02.06.2016
33
Shiller R., Irrational Exuberance (2d ed.). Princeton University Press, 2005, p. 16
34
Laperriere A., Housing Bubble Trouble: Have we been living beyond our means?, published: 10.04.2006,
The Weekly Standard, 2006
CRASHES AND CRISES IN THE FINANCIAL MARKETS . THE
IMPORTANCE OF SPECULATIVE BUBBLES.
Patrycja Gniadzik, Magdalena Cupryjak, Mateusz Jarzębski
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contrast, real estate bubbles are considered of critical importance and a fundamental cause of
financial crises and ensuing economic crises. The United States housing bubble was a real
estate bubble affecting over half of U.S. states. Housing prices peaked in early 2006, started to
decline in 2006 and 2007, and reached new lows in 2012. On December 30, 2008, the Case-
Shiller home price index reported its largest price drop in its history. The credit crisis
resulting from the bursting of the housing bubble is—according to general consensus—the
primary cause of the 2007–2009 recession in the United States
35
.
Any collapse of the U.S. housing bubble has a direct impact not only on home
valuations, but mortgage markets, home builders, real estate, home supply retail outlets, Wall
Street hedge funds held by large institutional investors, and foreign banks, increasing the risk
of a nationwide recession. Concerns about the impact of the collapsing housing and credit
markets on the larger U.S. economy caused President George W. Bush and the Chairman of
the Federal Reserve Ben Bernanke to announce a limited bailout of the U.S. housing market
for homeowners who were unable to pay their mortgage debts
36
.
The 2008 bubble burst within the red line districts of the United States residential
market. In their late stages, they are typically characterized by rapid increases in the
valuations of real property until unsustainable levels are reached relative to incomes, price-to-
rent ratios, and other economic indicators of affordability. This may be followed by decreases
in home prices that result in many owners finding themselves in a position of negative
equity—a mortgage debt higher than the value of the property. The underlying causes of the
housing bubble are complex. Factors include tax policy (exemption of housing from capital
gains), historically low interest rates, lax lending standards, failure of regulators to intervene,
and speculative fever. This bubble may be related to the stock market or dot-com bubble of
the 1990s.
A SUMMATION
Speculative Bubbles are a phenomenon that is not really fully understood. For a more
complete understanding of any speculative mania each case should be looked at separately, so
35
Holt J., A Summary of the Primary Causes of the Housing Bubble and the Resulting Credit Crisis: A Non-
Technical Paper, 2009, 8, 1, The Journal of Business Inquiry, p. 120-129.
36
Nielsen B., Why Housing Market Bubbles Pop, web:
http://www.investopedia.com/articles/07/housing_bubble.asp, access: 01.06.2016
CRASHES AND CRISES IN THE FINANCIAL MARKETS . THE
IMPORTANCE OF SPECULATIVE BUBBLES.
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from a psychological, as well as the econometric point of view. Financial bubbles described
above are selected examples of crises of this kind in the history of mankind. They resulted in
huge financial losses and deprived of hope for a better tomorrow huge and powerful state and
its residents. Mechanisms of financial crashes are very similar, regardless of when and where
they occur. They point to the need for a rational assessment of the risks of investing. Global
capitalism is entering a new era. World trade continues to govern the logic of supply and
demand, just panic and euphoria, behind which follow the huge waves of financial resources.
CRASHES AND CRISES IN THE FINANCIAL MARKETS . THE
IMPORTANCE OF SPECULATIVE BUBBLES.
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IMPORTANCE OF SPECULATIVE BUBBLES.
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IMPORTANCE OF SPECULATIVE BUBBLES.
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