What do urban real estate prices in Japan, dot-com stocks and Dutch tulips all have in common? They were all subject to massive financial bubbles that sent prices soaring, only to burst and whipsaw eager investors from massive fortunes to bankruptcy.
Though the initial frenzy around bitcoin has dissipated somewhat, many are still considering whether to bet it all on cryptocurrency. It may be tempting, but there are plenty of cases from years past that can serve as sobering reminders that when something seems too good to be true, it usually is.
No matter how many times rampant speculation has blown up in people’s faces, there always seems to be a new generation of fortune seekers ready to dive into the next frenzy. The mirage of easy money, the fear of missing out and the Greater Fool Theory, which dictates that no purchase is truly foolish as long as a “greater fool” comes along to pay even more, all conspire to keep the same pattern playing out again and again.
Last updated: Feb. 19, 2021
Yes, you did read that correctly. Holland is now famous for its tulips, but it was Turkey that first introduced them to the country in 1593. The upper classes took an interest and soon “Tulip-mania” took hold of the Netherlands. Rare bulbs started selling for more and more, and some people eventually paid the price of a house to get an especially prized bulb.
How It Ended
While the prices had steadily increased for years, people seemed to truly lose their minds in January 1637. In that one month, the price of tulip bulbs increased twentyfold, and the inevitable crash followed in February.
The Dutch government eventually stepped in to offer 10 cents on the dollar for the face value of bulb contracts, but the prices continued to fall.
What is often cited as the first recorded speculative bubble is also illustrative of the underlying concept: So powerful is the urge to follow the crowd to a quick payday that thousands of otherwise rational Dutch aristocrats and merchants wound up losing a fortune on, well, flowers.
The South Sea Bubble
More than one major bubble occurred in 1720 as public speculation in corporate stock created a series of investment bubbles. One of the biggest was the South Sea Bubble.
With the British crown waging two expensive wars simultaneously, Chancellor of the Exchequer Robert Harley came up with the scheme to create the South Seas Company, which would issue stock in exchange for government debt. In exchange, the crown would grant the company exclusive trading rights for Mexico and South America.
The excitement around the company built steadily and it continued acquiring debt and issuing new shares, pushing shares higher and higher as more of the public took interest in stocks.
How It Ended
You don’t need fraud to spur a bubble, but it sure can help.
Spain owned Mexico and South America, which made the South Seas Company’s trading rights there essentially worthless. However, the company’s investors talked up their potential anyway, leading to an astonishing run on shares.
Prices spiked from 128 British pounds apiece in January 1720 to a peak of more than 1,000 pounds each by the end of June.
However, as it became clear that the South Seas Company would never be able to capitalize on the actual South Seas, shares began to plummet. By September 1720, prices had fallen to 175 pounds, wiping out hordes of eager investors in the process.
The Mississippi Bubble
The other major bubble of 1720 happened just across the English Channel in France with a stunningly similar storyline.
Having run up substantial debt under the reign of Louis XIV, France turned to John Law, a Scottish economist. Law devised a plan to exchange government debt for shares in a new company with exclusive trading rights in the New World — in this case, the French colony of Louisiana, centered around the Mississippi River.
How It Ended
Law dramatically oversold the potential of Louisiana for producing riches. As a result, shares in his company soared from 500 livres apiece in January of 1719 to 10,000 livres by the end of the year.
The French twist on this disaster: The government gave Law the right to issue paper money in exchange for shares, leading to the sudden doubling of the nation’s money supply. As it became clear that Louisiana was not as profitable as promised, shares crashed all the way back to 500 livres by September 1721, and Law was forced to flee the country.
The Panic of 1819
In the aftermath of the Napoleonic Wars, prices for agricultural goods soared in Europe.
At the same time, the end of the War of 1812 provided Americans with the opportunity for westward expansion when the output of the farms they would be building was at its highest value. Sale of Western land grew from 1 million acres in 1815 to 3.5 million acres by 1819 and, because of a government policy requiring that just a quarter of the money be paid upfront, most of it was purchased on credit.
How It Ended
The economies of Europe contracted considerably in the aftermath of the costly Napoleonic Wars, but the end to the conflicts also led to bumper crops across the continent as soldiers returned to their fields.
The result was that the prices for agricultural goods that were spurring the massive expansion in the west were cut in half. When the Second Bank of the United States tried to get a handle on the situation by tightening credit rules and requiring gold and silver to back paper notes, it caused real estate prices to collapse and investors and banks to go belly up.
The American economy remained stagnant throughout the 1820s as it recovered from the burst bubble.
The Original Ponzi Scheme
Charles Ponzi was an Italian immigrant living in Boston in 1919 when he discovered a loophole in the system of international postal reply coupons.
Because of postwar inflation in Europe, coupons could be purchased in Italy or Spain for a fraction of the value of the American stamps. It was easy money, and Ponzi quickly began calling for investors, promising to double their investment in 90 days. It proved immensely popular and, after early investors showed big returns, the scheme took off, with tens of thousands of Bostonians investing with Ponzi.
How It Ended
While Ponzi had found a loophole, he needed more of a loop-tunnel to handle the volume of investments he was bringing in. Not that it mattered — Ponzi never bothered trying to actually purchase postal coupons. He simply paid earlier investors with money from new investors.
Ponzi took in some $15 million in eight months, only to have it all unravel. The scheme collapsed, and his investors lost millions. He was charged with 86 counts of fraud and spent the next 14 years in prison. But the enduring legacy of his crimes lives on: Pyramid scams are called “Ponzi schemes” to this day, and Ponzi’s scheme remains one of the biggest money scams of all time.
The Whole American Stock Market
In the aftermath of World War I, the American economy was booming. Driven by the rapid growth in stocks, investors big and small poured into the market, dumping their savings into stocks and watching as prices rose year after year.
From January 1921 to early September 1929, the Dow Jones Industrial Average advanced from a value of 76.13 to a high point of 381.17, more than quintupling in value in less than a decade.
How It Ended
The Great Depression.
The stock market of the 1920s was rampant with fraud and price manipulation, and the rest of the public was prone to purchasing stock on margin — i.e., with debt.
Prices started to wobble in the fall of 1929, and panic selling ensued. The Dow eventually lost almost 90 percent of its pre-crash value, landing at 44.39 by July of 1932. The banking system failed, investors were wiped out and the country was thrown into a major financial depression.
Japanese Real Estate
In the mid-1980s, the Bank of Japan started an era of low interest rates meant to boost the economy. The result was a massive run on stocks and real estate, with both the Nikkei 225 and urban real estate prices tripling in just five years.
By the time the market peaked in 1991, Japan, which is about the size of California, saw total land values rise to $18 trillion, more than the entire United States.
How It Ended
When the central bank finally stepped in to try to slow growth, it resulted in a crash in both real estate values and the stock market, sending the Japanese economy into a tailspin.
The Nikkei lost more than 60 percent from its peak, land values were cut in half over the next decade and GDP growth collapsed, which prompted an extended period of economic stagnation dubbed the Lost Decade.
When bubbles are limited to a certain asset type, losses can be limited to speculators when they burst. However, when bubbles expand to include an essential piece of a nation’s economy, like housing, the end result can be disastrous for everyone.
Learn More: How To Invest In Real Estate Safely
The advent of the internet in the mid-1990s resulted in an explosion of people and companies looking to take advantage of this new commerce space.
Dot-com companies sprung up everywhere and went on to massive IPOs as investors scrambled to get a piece of the future. The tech-focused Nasdaq Composite Index increased by more than 500 percent over five years, growing from just under 750 at the start of 1995 to a peak of over 5,000 in March 2000.
How It Ended
Not long after the market’s peak, leading members of the tech sector like Dell and Cisco placed sell orders on their stock. This caused a stir that would send the Nasdaq into a downward spiral. The index eventually bottomed out at just over 1,000 in late 2002. The Nasdaq wouldn’t get back over 5,000 for another 15 years.
Perhaps the best-remembered casualty of the dot-com bubble was Pets.com, which was valued at $290 million after its February 2000 IPO. By November of 2001, that figure was effectively zero as the unprofitable company headed to bankruptcy.
While plenty of bubbles are rooted in folly and fraud, there are also examples where the underlying assets are actually quite strong. Bubble or not, the assumption that the internet would define commerce in the coming decades was spot on. Amazon grew from its dot-com to become a company that wants to touch everything you buy.
The US Housing Market
Mortgage-backed securities (MBSs), which are bundles of mortgages from individual homeowners packaged together to create an investable security, have been around since 1968.
However, following the stock market crash of 2000, the Federal Reserve lowered interest rates at the same time there was a spike in investable money worldwide. Hungry for better returns, investors eventually settled on MBSs to satisfy their demand.
Money flowed into the U.S. housing market, which saw home values skyrocket across the country. From 2000-2007, the total quantity of MBSs issued went from under $50 billion a year to over $225 billion.
Is Your State in Trouble Again? 8 States With the Biggest Real Estate Bubbles
How It Ended
Mortgage lenders, desperate to meet the demand investment banks had for home loans, began radically relaxing their standards, writing more and more loans for shaky homebuyers.
Investment banks, desperate to keep pace with the market demand for MBSs, were more than ready to overlook this fact, especially when rating agencies continued rubber-stamping their products as AAA, investment-grade securities based on the assumption that housing prices would continue rising.
That’s usually a safe assumption. But, in this case, the housing bubble gave way to the housing crisis and home prices started to decline. It soon became clear that most of the MBSs that sold like hot cakes only a few years earlier were, in fact, virtually worthless.
The collapse of the housing market precipitated a crash in stocks, a bailout of the banking industry and the Great Recession.
The idea of bitcoin was first advanced in a 2009 white paper by someone using the alias Satoshi Nakamoto. A completely digital currency, bitcoins can be transferred from one person to another without the need for any bank or third party to facilitate the transaction due to the currency’s decentralized, public ledger known as the blockchain.
Although bitcoin was largely associated with criminals in its earlier days, it quickly started to gain popularity in the mainstream. Today, you can buy all sorts of surprising things with bitcoin. In 2017, prices positively exploded, with the total value of bitcoins in circulation going from under $20 billion in March to over $325 billion by mid-December.
How Will It End?
Great question. At this point, it’s impossible to say with certainty. In the span of several years, bitcoin has continued to be volatile, bouncing up and down steeply and quickly. Today, the market is doing well — it may soar to new heights or drop off a cliff tomorrow.
Will bitcoin wind up being more like Dutch tulips or internet stocks in the end? Only time will tell.
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Photos are for illustrative purposes only. Some might not reflect the specific events described in this article.