The Coming Financial Crash: Learning from History

Panic: The Story of Modern Financial Insanity

Edited by Michael Lewis

WW Norton (2009)

Book Review

This book is a collection of essays about the four major Wall Street crashes of the last 30 years. The first was Black Monday, on October 19, 1987; the second the 1997 Asian financial crisis; the third the Dotcom crash of 2000-2002; and the fourth the global economic crash of 2007-2008.

Black Monday

At the time, Black Monday was the worst Wall Street crash in history – with a percentage decline in stock prices twice that of the 1929 crash. The various essays blame Black Monday on two main causes: an overvalued stock market (with too many shares bought with borrowed money) and new computerized trading programs that automatically sold larges volumes of institutional stocks (from pension plans, mutual funds, etc) once their price dropped below a designated price.

Asian Financial Crisis

The collapse of South East Asian currencies (South Korea, Philippines, Indonesia, Thailand, Hong Kong, Malaysia) in 1997 is blamed on a variety of factors. Malaysian Prime Minister Mahathir Mohamad blamed Soros, but Lewis claims the latter had temporarily stopped currency trading in 1997. The Asian crisis was contagious, causing investors to also pull their funds out of Russia and Brazil, as well as the six Asian countries. Both the ruble and the Brazilian real collapsed in 1998.

China, India and Vietnam were virtually unaffected, as they defied the US and IMF by imposing capitol and currency controls (preventing foreign investors from withdrawing funds or exchanging large amounts of currency without government authorization).

All three countries continued to experience 9-11% growth during the next decade.

Dot Com Crash

The Dot Com boom was largely fueled by the advent of computerized day trading, allowing investors to purchase large volumes of stock directly without going through established brokers. It was also the first time in history that investors scurried to buy shares in companies that operated at a loss. The immediate cause of the Dot Com crash was a decision by the Federal Reserve to raise interest rates, bankrupting hundreds of Internet startups that could no longer afford to borrow money. Amazon, which also operated at a lost, was spared by the continued support of Silicon Valley venture capitalist John Doerr.

The 2008 Global Economic Collapse

The most interesting essays in this section are by analysts who predicted the collapse. Hedge fund manager John Paulson made $3-4 billion in 2007-2008 by correctly predicting the timing of the crash and purchasing cheap credit default swaps.* As mortgage bonds started failing, demand for CDS’s skyrocketed as investors rushed to limit their losses.


*A credit default swap is a financial swap agreement that the bank that issues the CDS will compensate the buyer in the event of a debt default or other credit event.

 

 

 

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