New on FinoLib · Volume II: Capital Markets
New on FinoLib, my finance education website: I have published an article called Stock Market Crashes Throughout History: 1929, 1987 and More, from Volume II: Capital Markets. Here is what the article explains, written as a short expert briefing; the full piece, with every worked example, is one click away.
10.7 The Repeating Pattern — What Every Bubble and Crisis Shares
The idea in plain words
Bubbles and crises tend to follow five stages. They start with a real foundation, then leverage amplifies the buying, a story detaches price from value, a small trigger arrives, and forced selling deepens the fall. Some crises in this Part were runs rather than bubbles, so a later section scores every case on five broader features.
Key points
■Leverage amplifies both the rise and the fall.
■The trigger is usually small and unforeseeable, so size borrowing to the fall you can survive.
■A 10% margin position, the 1920s norm, is wiped out by a 10% fall.
A closer look
Across nearly four centuries and radically different assets — tulip bulbs, a trading monopoly, Southeast Asian currencies, US bond spreads, Japanese real estate, internet stocks, and, as covered extensively in Volume I, US mortgage securities — the same structural skeleton recurs.
Decision rule
Reading rule: when an asset has risen fast, check stages 2 and 3 before anything else. If buyers are borrowing to buy (rising margin debt, installment payments, low down payments) and the main argument for buying is the recent price rise, treat the market as in the pattern and decide your exit before the trigger, because you will not see the trigger coming. If the rise is paid for in cash and backed by growing earnings, the pattern does not apply.
The costliest mistake
Waiting for the trigger to identify itself. In every case in this Part the trigger looked small or unrelated when it came: a missed auction, a peg breaking in another country, a Russian default, a budget statement. A position financed at 10% margin, the 1920s norm, is wiped out by a 10% fall; the Dow fell nearly 13% on October 28, 1929, alone. Decide in advance what fall you can survive, and size borrowing to it.
Recap
Bubbles share five stages, from a real foundation through leverage, narrative detachment and a small trigger to forced selling that deepens the fall. Not every crisis is a bubble, so Section 10.10: The Pattern Across Every Case compares all the cases on trigger, leverage, liquidity mismatch, regulatory gap and who was surprised.
10.8 Earlier and Later Crashes: 1929, 1987 and Portfolio Insurance, Harshad Mehta 1992
The idea in plain words
Three older crashes each left a lasting rule. In 1929, loans that funded buying with only 10% down were withdrawn, $2.4 billion of them in October. In 1987, portfolio insurance sold futures into a falling market as the Dow lost 22.6% in a single day. In 1992, Harshad Mehta moved bank money into shares through bank receipts with no securities behind them. The lasting results were Fed margin powers, circuit breakers, and India’s securities reforms.
Key points
■The Dow fell 89.2%, from 381 in September 1929 to 41.22 in July 1932; Regulation T now requires 50% margin.
■Portfolio insurance sold about 2% of the insured portfolio per 1% fall: $1.2 billion per 1% on $60 billion.
■Richard Roll found 19 of 23 national markets fell over 20% in October 1987, many without portfolio insurance.
A closer look
Three crashes, three amplifiers: borrowed money that could be called overnight in 1929, a hedging rule that sold as prices fell in 1987, and collateral that existed only on paper in Bombay in 1992.
On October 20 the Federal Reserve said it stood ready “to serve as a source of liquidity.” Exchanges adopted circuit breakers, trading halts triggered by large index falls; since April 8, 2013, US market-wide halts trigger at 7%, 13% and 20% falls in the S&P 500.
Decision rule
As a lender, count only collateral you control: if the security sits in your account at a depository, custodian or tri-party agent, treat the exposure as secured; if you hold only a promise, such as a bank receipt, limit and price it as unsecured credit. As a hedger, multiply the selling your rule needs per 1% fall by all the assets following similar rules; if that is a large share of a normal day’s trading, the hedge will not execute at the prices it assumes.
The costliest mistake
Accepting a receipt in place of the asset. In 1992 Indian banks paid out against bank receipts and checks routed through brokers, leaving ₹3,018.63 crore, about $1.04 billion, of exposures they might not recover. Insist on delivery into an account you control on the settlement date, reconcile it that day, and escalate any deal that settles by certificate or by a third party’s word.
What the full article covers
In the full article I take you through these sections:
■10.7 The Repeating Pattern — What Every Bubble and Crisis Shares
■10.8 Earlier and Later Crashes: 1929, 1987 and Portfolio Insurance, Harshad Mehta 1992
It includes a look under the hood at the mechanics, a clear decision rule, the one mistake that costs people the most, a recap, a reveal-on-click quiz and the official sources behind every figure.
Volume II: Capital Markets
Read the full article on FinoLib
The complete article, Stock Market Crashes Throughout History: 1929, 1987 and More, with every worked example, diagram, quiz and source, is free to read in Volume II, Capital Markets on finolib.com.
Explore the Finance Education Series: Vol. II — Capital Markets · Vol. I — Global Economy · Vol. III — Finance Encyclopedia · Vol. IV — Finance Careers · Vol. V — Personal Finance