Bubbles Bursting Bubbles.*
Today I thought I would touch on a little history.
We all have very short memories, and I am sure many of you have forgotten the story behind the 2008 financial crisis—our most recent recession, if we ignore the effects of the COVID pandemic.
What we saw was something akin to a modern version of the South Sea Bubble of the early 18th century in Great Britain. The South Sea Company was granted a monopoly to trade in South America (mostly with Spanish colonies, where access was questionable at best).
In return, it would assume a large portion of Britain’s national debt, converting it into shares that investors could buy.
The company promised massive profits from South American trade—despite no real access to those markets.
Politicians and royalty were granted shares or encouraged to promote the scheme.
Public confidence soared. People believed the government would never let it fail.
The company’s stock rose from £100 to nearly £1,000 in one year (1720).
A flood of other “bubble companies” sprang up with absurd promises (e.g., “to extract silver from lead” or “a company for carrying on an undertaking of great advantage, but nobody to know what it is”).
The company’s value collapsed as people realized there were no actual profits.
Panic selling ensued. Fortunes were lost overnight.
Thousands were ruined—including nobles, merchants, and even members of Parliament.
Focusing again on 2008, the lead-up to this particular crisis can be tracked more from the sudden change in the Fed’s policies, where interest rates were suddenly brought down to their lowest in modern history—1.0% in 2003, from a high of 6.5% in 2001. The result of a Dot.Com bursting bubble and a little-known calamity called 9/11.
What followed was the housing boom, where sub-prime mortgages gave lower-income families the chance to realise their own American dream by owning the properties they lived in. At a steady 1.0% interest, what could go wrong?
But the Fed did as the Fed does. Under the leadership of Alan Greenspan—so successful in steering the economy to date—the interest rate began creeping up, easily shattering the dreams of the common man (and woman).
Fogy remembers reading an article at the time describing the impact on credit-card charges if interest rates were to rise even 0.25%. Imagine the impact on sub-prime mortgage holders.
Alan Greenspan was heavily criticised for keeping interest rates too low for too long, by greedy investors fully prepared to ignore the risks to lower-income borrowers.
Financial instruments were created to camouflage what had become toxic debt—and this, dear reader, is where the similarities to the South Sea Bubble become more apparent.
The Lehman Brothers collapse was not really the trigger to the crisis, as so many deemed it to be, but was symptomatic of the brewing storm.
Credit was tighter, lending was scarcer, and too many instruments for such a small financial orchestra ignited the boom that was soon to collapse.
2008 was just another bubble—and more recently, since the crypto bubble, we seem to be heading toward an AI bubble.
This, coupled with the unpredictability of an outrageous leadership, means that we really have to do a lot more penny watching and penny pinching.
Good luck with that.
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