Financial Crisis:A Hardy Perennial 17 in Southeast Asia in the mid-1990s,and for the bubble in U.S.stocks, especially those traded on the NASDAQ,at the end of the 1990s. The mania phase of the economic expansion is the subject of Chapter 3.The central issue is whether speculation can be destabilizing as well as stabilizing-in other words,whether markets are always ratic nal.The nature of the outside.exogenous shock that triggers the mania is examined in different historical settings including the onset and the end of a war,a series of good harvests and a series of bad harvests,the open ing of new markets and of new sources of supply and the development of different innovations-the railroad,electricity,and e-mail.A particular recent form of displacement that shocks the system has been finan cial liberalization or deregulation in Japan,the Scandinavian countries some of the Asian countries,Mexico,and Russia.Deregulation has led to monetary expansion,foreign borrowing,and speculative investment. Investors have speculated in commodity exports,commodity imports agricultural land at home and abroad,urban building sites,railroads,new banks,discount houses,stocks,bonds(both foreign and domestic),glam- the economy although individual investors encounter large losses.One question is whether the euphoria of the economic upswing endangers financial stability only if it involves at least two or more objects of specu- lation,a bad harvest,say,along with a railroad mania or an orgy of land speculation,or a bubble in real estate and in stocks at the same time. The monetary dimensions of both manias and panics are analyzed in Chapter 4.The occasions when a boom or a panic has been triggered by a monetary event-a recoinage,a discovery of precious metals,a change in the ratio of the prices of gold and silver under bimetallism an unexpected success of some flotation of a stock or bond,a sharp reduction in interest rates as a result of a massive debt conversion,or a rapid expansion of the monetary base-are noted.A sharp increase in interest rates may also cause trouble through disintermediation,as depositors flee banks and thrift institutions;the long-term securities still owned by these institutions fall in price.Innovations in finance,as in productive processes,can shock the system and lead to overinvestment in some types of financial services.5 The difficulty of managing the monetary mechanism to avoid ma- nias and bubbles is stressed in this edition.Money is a public good but monetary arrangements can be exploited by private parties.Banking moreover,is difficult to regulate.The current generation of monetarists
c01 JWBK120/Kindleberger February 13, 2008 14:58 Char Count= Financial Crisis: A Hardy Perennial 17 in Southeast Asia in the mid-1990s, and for the bubble in U.S. stocks, especially those traded on the NASDAQ, at the end of the 1990s. The mania phase of the economic expansion is the subject of Chapter 3. The central issue is whether speculation can be destabilizing as well as stabilizing—in other words, whether markets are always rational. The nature of the outside, exogenous shock that triggers the mania is examined in different historical settings including the onset and the end of a war, a series of good harvests and a series of bad harvests, the opening of new markets and of new sources of supply and the development of different innovations—the railroad, electricity, and e-mail. A particular recent form of displacement that shocks the system has been financial liberalization or deregulation in Japan, the Scandinavian countries, some of the Asian countries, Mexico, and Russia. Deregulation has led to monetary expansion, foreign borrowing, and speculative investment.4 Investors have speculated in commodity exports, commodity imports, agricultural land at home and abroad, urban building sites, railroads, new banks, discount houses, stocks, bonds (both foreign and domestic), glamour stocks, conglomerates, condominiums, shopping centers and office buildings. Moderate excesses burn themselves out without damage to the economy although individual investors encounter large losses. One question is whether the euphoria of the economic upswing endangers financial stability only if it involves at least two or more objects of speculation, a bad harvest, say, along with a railroad mania or an orgy of land speculation, or a bubble in real estate and in stocks at the same time. The monetary dimensions of both manias and panics are analyzed in Chapter 4. The occasions when a boom or a panic has been triggered by a monetary event—a recoinage, a discovery of precious metals, a change in the ratio of the prices of gold and silver under bimetallism, an unexpected success of some flotation of a stock or bond, a sharp reduction in interest rates as a result of a massive debt conversion, or a rapid expansion of the monetary base—are noted. A sharp increase in interest rates may also cause trouble through disintermediation, as depositors flee banks and thrift institutions; the long-term securities still owned by these institutions fall in price. Innovations in finance, as in productive processes, can shock the system and lead to overinvestment in some types of financial services.5 The difficulty of managing the monetary mechanism to avoid manias and bubbles is stressed in this edition. Money is a public good but monetary arrangements can be exploited by private parties. Banking, moreover, is difficult to regulate. The current generation of monetarists
18 Manias,Panics,and Crashes insists that many,perhaps most,of the cyclical difficulties of the past have resulted from mismanagement of the monetary mechanism. Such mistakes were frequent and serious.The argument advanced in Chapter 4,however,is that even when the supply of money was nearly adjusted to the demands of an economy the monetary mechanism did not stay right for very long.When government produces one quantity of the public good,money,the public may proceed to produce many close substitutes for money,just as lawyers find new loopholes in tax laws about as fast as legislation closes up older loopholes.The evolution of money from coins to bank notes,bills of exchange,bank deposits and finance paper illustrates the point.The Currency School might be right about the need for a fixed supply of money,but it is wrong to believe that the money supply could be fixed forever The emphasis in Chapter 5 is on the domestic aspects of the crisis stage. One question is whether manias can be halted by official warning- moral suasion or jawboning.The evidence suggests that they cannot,or at least that many crises followed warnings that were intended to head them off.One widely noted remark was that of Alan Greenspan,chair- man of the Federal Reserve Board,who stated on December 6.1996.that he thought that the U.S.stock market was irrationally exuberant.The Dow Jones industrial average was 6,600;subsequently the Dow peaked at 11,700.The NASDAQ had been at 1,300 at the time of the Greenspan remark and peaked at more than 5,000 four years later.A similar warning had been issued in February 1929 by Paul M.Warburg,a private banker who was one of the fathers of the Federal Reserve system,without slow- ing for long the stock market's upward climb.The nature of the event that ultimately produces a turning point is discussed:some bankruptcy, defalcation or troubled area revealed or rumored,a sharp rise in the central bank discount rate to halt the hemorrhage of cash into domestic circulation or abroad.And then there is the interaction of falling prices-the crash-and its impact on the liquidity in the economy Domestic propagation of the mania and then the panic is the subject of Chapter 6.The inference from history is that a boom in one market spills over into other markets.'A housing boom in Houston is an oil boom in drag.'Thus a financial crisis may be more serious if two or more assets are the subject of speculation.When and if a crash comes,the banking system may seize and banks may ration credit to reduce the likelihood of large loan losses even if the money supply is unchanged; indeed the money supply may be increasing.The connections between price changes in the stock and commodities markets were especially strong in New York in 1921 and the late 1920s,and those linking stocks
c01 JWBK120/Kindleberger February 13, 2008 14:58 Char Count= 18 Manias, Panics, and Crashes insists that many, perhaps most, of the cyclical difficulties of the past have resulted from mismanagement of the monetary mechanism. Such mistakes were frequent and serious. The argument advanced in Chapter 4, however, is that even when the supply of money was nearly adjusted to the demands of an economy the monetary mechanism did not stay right for very long. When government produces one quantity of the public good, money, the public may proceed to produce many close substitutes for money, just as lawyers find new loopholes in tax laws about as fast as legislation closes up older loopholes. The evolution of money from coins to bank notes, bills of exchange, bank deposits and finance paper illustrates the point. The Currency School might be right about the need for a fixed supply of money, but it is wrong to believe that the money supply could be fixed forever. The emphasis in Chapter 5 is on the domestic aspects of the crisis stage. One question is whether manias can be halted by official warning— moral suasion or jawboning. The evidence suggests that they cannot, or at least that many crises followed warnings that were intended to head them off. One widely noted remark was that of Alan Greenspan, chairman of the Federal Reserve Board, who stated on December 6, 1996, that he thought that the U.S. stock market was irrationally exuberant. The Dow Jones industrial average was 6,600; subsequently the Dow peaked at 11,700. The NASDAQ had been at 1,300 at the time of the Greenspan remark and peaked at more than 5,000 four years later. A similar warning had been issued in February 1929 by Paul M. Warburg, a private banker who was one of the fathers of the Federal Reserve system, without slowing for long the stock market’s upward climb. The nature of the event that ultimately produces a turning point is discussed: some bankruptcy, defalcation or troubled area revealed or rumored, a sharp rise in the central bank discount rate to halt the hemorrhage of cash into domestic circulation or abroad. And then there is the interaction of falling prices—the crash—and its impact on the liquidity in the economy. Domestic propagation of the mania and then the panic is the subject of Chapter 6. The inference from history is that a boom in one market spills over into other markets. ‘A housing boom in Houston is an oil boom in drag.’ Thus a financial crisis may be more serious if two or more assets are the subject of speculation. When and if a crash comes, the banking system may seize and banks may ration credit to reduce the likelihood of large loan losses even if the money supply is unchanged; indeed the money supply may be increasing. The connections between price changes in the stock and commodities markets were especially strong in New York in 1921 and the late 1920s, and those linking stocks
Financial Crisis:A Hardy Perennial 19 and real estate were strong in the late 1980s in Japan and in Norway, Sweden and Finland. The international contagion of manias and crises is highlighted in Chapter 7.There are many possible linkages among countries,includ- ing trade,capital markets,flows of hot money,changes in central bank reserves of gold or foreign exchange,fluctuations in prices of commodi- ties,securities or national currencies,changes in interest rates,and direct contagion of speculators in euphoria or gloom.Some crises are local others international.What constitutes the difference?Did,for exam- ple,the 1907 panic in New York precipitate the collapse of the Societa Bancaria Italiana via pressure on Paris communicated to Turin by with. drawals of bank deposits?There is fundamental ambiguity here.too Tight money in a given financial center can serve either to attract fund or to repel them,depending on the expectations that a rise in interest rates generates.With inelastic expectation-no fear of crisis or of cur- rency depreciation-an increase in the discount rate attracts funds from abroad and helps provide the cash needed to ensure liquidity;with elas- tic expectations of change-of falling prices,bankruptcies,or exchange depreciation-raising the discount rate may suggest to foreigners the need to take more funds out rather than bring new funds in.The trouble is familiar in economic life generally.A rise in the price of a commodity mav lead consumers to postpone purchases in anticipation of the de- cline,or to speed purchases before prices rise further.And even where expectations are inelastic,and the increased discount rate at the central bank sets in motion the right reactions,lags in responses may be so long that the crisis supervenes before the Marines arrive One complex but not unusual method of initiating financial crisis is a sudden halt to foreign lending because of a domestic boom;thus the boom in Germany and Austria in 1873 led to a decline in the capital outflows and contributed to the difficulties of lay Cooke in the United States.Similar developments occurred with the Baring crisis in 1890, when troubles in Argentina led the British to halt lending to South Africa, Australia,the United States and the remainder of Latin America.The stock market boom in New York in the late 1920s led Americans in 1928 to buy far fewer of the new bond issues of Germany and various Latin American countries,which in turn caused them to slide into depression. A halt to foreign trading is likely to precipitate depression abroad,which may in turn feed back to the country that launched the process.6 The discussion in Chapter 8a new chapter in this edition highlights the relationships among the three asset price bubbles in the last fifteen years of the twentieth century.The first of the three
c01 JWBK120/Kindleberger February 13, 2008 14:58 Char Count= Financial Crisis: A Hardy Perennial 19 and real estate were strong in the late 1980s in Japan and in Norway, Sweden and Finland. The international contagion of manias and crises is highlighted in Chapter 7. There are many possible linkages among countries, including trade, capital markets, flows of hot money, changes in central bank reserves of gold or foreign exchange, fluctuations in prices of commodities, securities or national currencies, changes in interest rates, and direct contagion of speculators in euphoria or gloom. Some crises are local, others international. What constitutes the difference? Did, for example, the 1907 panic in New York precipitate the collapse of the Societa` Bancaria ltaliana via pressure on Paris communicated to Turin by withdrawals of bank deposits? There is fundamental ambiguity here, too. Tight money in a given financial center can serve either to attract funds or to repel them, depending on the expectations that a rise in interest rates generates. With inelastic expectation—no fear of crisis or of currency depreciation—an increase in the discount rate attracts funds from abroad and helps provide the cash needed to ensure liquidity; with elastic expectations of change—of falling prices, bankruptcies, or exchange depreciation—raising the discount rate may suggest to foreigners the need to take more funds out rather than bring new funds in. The trouble is familiar in economic life generally. A rise in the price of a commodity may lead consumers to postpone purchases in anticipation of the decline, or to speed purchases before prices rise further. And even where expectations are inelastic, and the increased discount rate at the central bank sets in motion the right reactions, lags in responses may be so long that the crisis supervenes before the Marines arrive. One complex but not unusual method of initiating financial crisis is a sudden halt to foreign lending because of a domestic boom; thus the boom in Germany and Austria in 1873 led to a decline in the capital outflows and contributed to the difficulties of Jay Cooke in the United States. Similar developments occurred with the Baring crisis in 1890, when troubles in Argentina led the British to halt lending to South Africa, Australia, the United States and the remainder of Latin America. The stock market boom in New York in the late 1920s led Americans in 1928 to buy far fewer of the new bond issues of Germany and various Latin American countries, which in turn caused them to slide into depression. A halt to foreign trading is likely to precipitate depression abroad, which may in turn feed back to the country that launched the process.6 The discussion in Chapter 8—a new chapter in this edition— highlights the relationships among the three asset price bubbles in the last fifteen years of the twentieth century. The first of the three
20 Manias,Panics,and Crashes bubbles was in Tokvo in the second half of the 1980s the second was in Bangkok,Kuala Lumpur,and Jakarta and the other capitals in the region in the mid-1990s and the third was in New York in the second half of the 1990s.The likelihood that these three asset price bubbles were in- dependent events is low;the theme of this chapter is that there was a systematic relationship among them.The bubble in Japan was sui generis; when that bubble imploded at the beginning of the 1990s,there was a surge in the flow of funds both to China and the various Asian countries and to the United States.The currency values and the asset prices in the countries that were receiving the money from Japan adjusted to an in- crease in the inflow of foreign savings.When the bubble in stock prices and real estate prices in Bangkok and the other Asian capitals imploded in 1997 and 1998,there was a surge in the flow of funds to New York as the borrowers in these asian countries sought to reduce their indebted- ness.The foreign exchange value of the U.S.dollar and U.S.asset prices increased in response to the increase in the inflow of foreign saving.The money had to go someplace,and the result was that the prices of U.S. stocks reached stratospheric leves Swindles that occur in the mania phase and then in the panic phase are reviewed in chapter 9.The combination of failed thrift institutions and the rapid growth of junk bonds in the 1980s cost the American taxpayers $150 billion.Enron,MCIWorldCom,Tyco,Dynegy,Adelphia Cable are like a rogue's gallery of the 1990s.And then many of the large U.S.mutual fund families were exposed as providing favored treatment to hedge funds.Crashes and panics are often precipitated by the revela- tion of some misfeasance,malfeasance or malversation(the corruption of officials)that occurred during the mania.The inference from the his- torical record is that swindles are a response to the greedy appetite for wealth stimulated by the boom;the Smiths want to keep up with the Joneses and some Smiths engage in fraudulent behavior.As the mon- etary system gets stretched,institutions lose liquidity and unsuccessful swindles are about to be revealed,the temptation to take the money and run becomes virtually irresistible Jail time,fines and financial penalties:financial behavior in the 1990s U.S.economic boom Enron was the poster-child of the 1990s boom;the company had trans. formed itself from the owner of regulated natural gas pipelines into a financial firm that traded natural gas,petroleum,electricity,and broad- band width as well as owning water systems and an electrical power
c01 JWBK120/Kindleberger February 13, 2008 14:58 Char Count= 20 Manias, Panics, and Crashes bubbles was in Tokyo in the second half of the 1980s, the second was in Bangkok, Kuala Lumpur, and Jakarta and the other capitals in the region in the mid-1990s and the third was in New York in the second half of the 1990s. The likelihood that these three asset price bubbles were independent events is low; the theme of this chapter is that there was a systematic relationship among them. The bubble in Japan was sui generis; when that bubble imploded at the beginning of the 1990s, there was a surge in the flow of funds both to China and the various Asian countries and to the United States. The currency values and the asset prices in the countries that were receiving the money from Japan adjusted to an increase in the inflow of foreign savings. When the bubble in stock prices and real estate prices in Bangkok and the other Asian capitals imploded in 1997 and 1998, there was a surge in the flow of funds to New York as the borrowers in these Asian countries sought to reduce their indebtedness. The foreign exchange value of the U.S. dollar and U.S. asset prices increased in response to the increase in the inflow of foreign saving. The money had to go someplace, and the result was that the prices of U.S. stocks reached stratospheric levels. Swindles that occur in the mania phase and then in the panic phase are reviewed in Chapter 9. The combination of failed thrift institutions and the rapid growth of junk bonds in the 1980s cost the American taxpayers $150 billion. Enron, MCIWorldCom, Tyco, Dynegy, Adelphia Cable are like a rogue’s gallery of the 1990s. And then many of the large U.S. mutual fund families were exposed as providing favored treatment to hedge funds. Crashes and panics are often precipitated by the revelation of some misfeasance, malfeasance or malversation (the corruption of officials) that occurred during the mania. The inference from the historical record is that swindles are a response to the greedy appetite for wealth stimulated by the boom; the Smiths want to keep up with the Joneses and some Smiths engage in fraudulent behavior. As the monetary system gets stretched, institutions lose liquidity and unsuccessful swindles are about to be revealed, the temptation to take the money and run becomes virtually irresistible. Jail time, fines and financial penalties: financial behavior in the 1990s U.S. economic boom Enron was the poster-child of the 1990s boom; the company had transformed itself from the owner of regulated natural gas pipelines into a financial firm that traded natural gas, petroleum, electricity, and broadband width as well as owning water systems and an electrical power
Financial Crisis:A Hardy Perennial 21 generating system.The top executives of Enron felt the need to show continued growth in profits to keep the stock price high,and in the late 1990s they began to use off-balance sheet financing vehicles to obtain the capital to grow the firm;they also put exceptionally high prices on some of their long trading positions so they could report that their trad- ing profits were increasing.The collapse of Enron led to the failure of Arthur Andersen,which previously had been the most highly regarded of the global accounting firms. MCIWorldCom was one of the most rapidly growing telecommunica. tions firms.Again the need to show continued increases in profits led the managers to claim that several billion dollars of expenses should be regarded as investments.Jack Grubman had been one of the sages in Salomon Smith Barney(a unit of the Citibank Group);he was continually promoting MCIWorldCom stock.Henry Blodgett was a security analyst for merrill lvnch who was privately writing scathing e-mails about the economic prospects of some of the firms that he was otherwise promoting to investors;Merrill Lynch paid $100 million to move the story off the front pages.Ten investment banking firms paid $1.4 billion to forestall trials.The chairman and chief executive officer of the New York Stock Exchange resigned soon after it became known that he had a compensa. tion package of more than $150 million;the exchange served both as a tent for trading stocks and as a regulator and it appeared that the man agers of some of the firms that were being regulated served as directors of the exchange and participated in determining the compensation package Then a number of large U.S.mutual funds were revealed to have allowed firms to trade on stale news. more individuals have already gone to prison than in the aftermath of any previous crisis,and a number are still awaiting trial.Six Enron senior managers already have been jailed.One Arthur Andersen partner who worked on the Enron account went to prison.Two of the senior financial officials of MCIWorldCom have gone to jail.Martha Stewart was found guilty of obstruction of justice and imprisoned for five months. The subject of Chapters 10 and 11 is crisis management at the domestic level.The first of these two chapters considers the range of domestic re sponses to a crisis;at one extreme the government may take a hands-off bosition.at the other there is a range of miscellaneous measures.Those who believe that the market is rational and can take care of itself pre fer the hands-off approach;according to one formulation,it is healthy for the economy to go through the purgative fires of deflation and bankruptcy to get rid of the mistakes and excesses of the boom.Among the miscellaneous devices are holidays,bank holidays,the issuance of scrip,guarantees of liabilities,issuance of government debt,deposit in surance and the formation of special institutions like the reconstruction Finance Corporation in the United States(in 1932)or the Istituto per la
c01 JWBK120/Kindleberger February 13, 2008 14:58 Char Count= Financial Crisis: A Hardy Perennial 21 generating system. The top executives of Enron felt the need to show continued growth in profits to keep the stock price high, and in the late 1990s they began to use off-balance sheet financing vehicles to obtain the capital to grow the firm; they also put exceptionally high prices on some of their long trading positions so they could report that their trading profits were increasing. The collapse of Enron led to the failure of Arthur Andersen, which previously had been the most highly regarded of the global accounting firms. MCIWorldCom was one of the most rapidly growing telecommunications firms. Again the need to show continued increases in profits led the managers to claim that several billion dollars of expenses should be regarded as investments. Jack Grubman had been one of the sages in Salomon Smith Barney (a unit of the Citibank Group); he was continually promoting MCIWorldCom stock. Henry Blodgett was a security analyst for Merrill Lynch who was privately writing scathing e-mails about the economic prospects of some of the firms that he was otherwise promoting to investors; Merrill Lynch paid $100 million to move the story off the front pages. Ten investment banking firms paid $1.4 billion to forestall trials. The chairman and chief executive officer of the New York Stock Exchange resigned soon after it became known that he had a compensation package of more than $150 million; the exchange served both as a tent for trading stocks and as a regulator and it appeared that the managers of some of the firms that were being regulated served as directors of the exchange and participated in determining the compensation package. Then a number of large U.S. mutual funds were revealed to have allowed firms to trade on stale news. More individuals have already gone to prison than in the aftermath of any previous crisis, and a number are still awaiting trial. Six Enron senior managers already have been jailed. One Arthur Andersen partner who worked on the Enron account went to prison. Two of the senior financial officials of MCIWorldCom have gone to jail. Martha Stewart was found guilty of obstruction of justice and imprisoned for five months. The subject of Chapters 10 and 11 is crisis management at the domestic level. The first of these two chapters considers the range of domestic responses to a crisis; at one extreme the government may take a hands-off position, at the other there is a range of miscellaneous measures. Those who believe that the market is rational and can take care of itself prefer the hands-off approach; according to one formulation, it is healthy for the economy to go through the purgative fires of deflation and bankruptcy to get rid of the mistakes and excesses of the boom. Among the miscellaneous devices are holidays, bank holidays, the issuance of scrip, guarantees of liabilities, issuance of government debt, deposit insurance and the formation of special institutions like the Reconstruction Finance Corporation in the United States (in 1932) or the Istituto per la