There is never an easy time to make an investment. Forces beyond one’s control can take the hard-earned paycheck and turn it into worthless dust. Being successful means that one is willing to stand firm in the face of financial storms, which are hopefully never as bad as some of the worst investment calamities in history.
In 17th century Netherlands, the investment craze that crashed in ruins was the mania over tulips. Introduced from Turkey, the flowers quickly caught the attention of the otherwise conservative Dutch bankers. With tulip bulb markets opening everyday in Amsterdam and Rotterdam, the country was awash with tulips and financiers were throwing more money into the fad.
The amounts of florins which investors were willing to toss in at the height of the bubble soared. One Viceroy — a purple and white variety of tulip — went for the equivalent of 10 yoke of oxen. Each yoke consists of two animals, so for twenty oxen an investor could buy one bulb.
When a hungry sailor grabbed a tulip bulb for breakfast one morning, people began to wonder if the bulbs were worth all of the attention they had been getting. It turns out they were not and the tulip craze came to an end in 1637.
Wall Street Bailout of 1792
George Washington had been president for just two years. Alexander Hamilton, the country’s first Treasury Secretary, started the Bank of the United States just a few months before. As Wall Street rose, Hamilton helped keep it inflated by repurchasing government bonds, similar to what the Federal Reserve has recently been doing.
About that time, speculator William Duer formed something called the “Six Percent Club.” Its goal was to corner the stock of the Banks of New York and the United States. With some early victories, stock prices in the fall of 1791 rose quickly in New York, Philadelphia and Boston. Small investors were pulled into the excitement.
The New York Journal breathlessly reported, “The cry is — what can be the reason for this … astonishing rise of the American stocks?” People fought each other for the opportunity to stick a finger into the pie of investment, but it would not last.
Duer spent more money than he had and was finally forced to liquidate his shares in March 1792. As people along Wall Street whispered about his failure, a tidal wave of panic ensued and people started selling. Hamilton stepped in and America’s first Wall Street bailout was performed.
The First Bubble in Real Estate
The year 1834 saw the beginning of the greatest bull market young America had seen. President Andrew Jackson’s tussle with the Second Bank of the United States ended in success for Jackson and runaway inflation for the country.
Most investors were mainly focused on land, specifically, the sale of government land in the unexplored wilderness of the West. In 1834, 4.7 million acres of government land were sold and the pace hit 20 million acres in 1836. With land being bought with “paper money” instead of the gold-backed dollars that Jackson preferred, real estate prices hit the stratosphere.
Jackson reacted by requiring government lands to be purchased with gold or silver. While his new requirement did force banks to end speculation, it also pushed the country into the financial panic of 1837. Banks failed, credit disappeared and stocks plunged.
A Pre-Ponzi Ponzi Scheme
The Ponzi scheme, named after Charles Ponzi and his famous 1920s crime, first appeared before there even was a Ponzi. One of American history’s most colorful examples happened in 1884, and none less than President Ulysses Grant was shamed and bankrupted.
When Grant departed Washington in 1877, the country was experiencing a stock boom. Grant’s son, Ulysses Jr., got connected with the slick — but crooked — Ferdinand Ward. Eventually the pair formed a brokerage firm.
Ward persuaded people to turn over their investments in exchange for the promise of large payouts down the road. When Grant and Ward Brokerage ventures started to fail, Ward starting paying large dividends using bank loans instead of earnings. The ruse and con were finally exposed when railroad stocks ran off the cliff during the Panic of 1884.
Ward was jailed and Grant lived out his last days writing his memoirs so that he could restore the family’s wealth.
The Great Crash
The stock market crash which led to the Great Depression was fueled by speculation, easy money and overconfidence. The value of American stocks almost quadrupled during the eight years which ended in 1929.
Prior to the crash, the American economy was full of boom-and-bust cycles. The creation of the Federal Reserve caused most investors to believe that the economy was done with the roller-coaster dips and climbs. Even the president of the New York Stock Exchange proclaimed that “we are finished and done with economic cycles…” Other people advised caution but were ignored.
On August 8, 1929, the beginning of the end happened. The Federal Reserve raised its lending rate a percentage point. The minor adjustment triggered a chain of events resulting in tighter credit, forced selling and panic, and stock market declines on October 24 and October 29. By 1932, stock prices had dropped over 80 percent from their pre-crash heights.
As modern finance theories took root in the 1970s and 80s, an increase in derivatives trading happened. With the swapping of options and futures instead of actual stocks, the modern portfolio theory generated an increase in “passive” investing. The availability of futures contracts for broad-based indexes, such as Standard and Poor’s 500 Index, made it profitable and easy for portfolio managers to hedge against declines in prices. This was called portfolio “insurance.”
While portfolio managers were hedging their bets, Wall Street was turning to computerized training to capture fast-moving dollars and profits. The system worked until the market got super-charged in October 1987. The result was the worst one-day loss in the U.S. stock market since World War I.
Investigators looking into the crash determined that the high demand for portfolio “insurance” had had the opposite effect. Instead of steadying the market, it had increased the market’s volatility. “Passive” investing created an environment filled with high risk that rewarded quick moves and elevated risk further. Wall Street did not learn. The same dynamics were at play in May 2010 when the “flash crash” dropped the Dow 999 points.
There is a lesson to be learned from the investment calamities of yesteryear. Although there is money to be made in the stock market despite all of its dips, soaring heights and tumultuous turns, there is no such animal as “risk-free” investing.
By Jerry Nelson