Crash course in market mania

Crash course in market mania

Bollywood is abuzz with howRGV Ki Aag—a remake of the classic Sholay—has failed to excite the masses. Different characters, different period, same plot.

Financial markets have been making and remaking the same movie every few years… characters change, periods, props and locations can be different but the plot is almost always the same. The movie’s title could interchangeably be Mania, Panic, Crash, Greed (and Fear), or Leverage. The modern versions might add Bailout, Moral Hazard, and Backstop to that list.

Manias, Panics, and Crashes—A History of Financial Crisis by Charles P. Kindleberger—this is the seminal work on the subject that makes up its title and has had to be updated and printed several times (now in its fifth edition) since it was first published in 1978.

Kindleberger’s lucid and enjoyable writing combined with his clarity of thought makes this book a “must read" for all those interested in financial markets. He dissects the anatomy of a typical crisis and how it builds from mania to panic to crash. He recognizes the role of monetary expansion in fuelling the flames. Later editions add an “international propagation" to the excellent chapter on domestic propagation. Kindleberger elucidates the role of a lender of last resort and rather presciently asks if there is one such for the whole world. An appendix table has a chronological list of all the financial crises from the very first one (AD 1618-23) related to debasement of the currency in the Holy Roman Empire.

My dog-eared, author signed, third edition of the book has a foreword by Peter L. Bernstein, who by no coincidence has written a classic that is worthy of a being reread at times like these.

Against the Gods: The Remarkable Story of Risk by Peter L. Bernstein—like Kindleberger, Bernstein is a master at telling the tale. Even though this book is the story of risk, it intersects with the story of greed at many points. The central characters are such giants as Galileo, Pascal, Leibniz, Newton, Gauss, Poincare, von Neumann and Keynes. While the main plot here is about how the study and understanding of risk separates modern from medieval man, Bernstein’s nuanced views suggest a more delicate interplay between reasonableness and irrationality, between certainty and uncertainty, between tools to manage risks and the very same tools to add to risk.

Bernstein and Kindleberger write with practised ease and with a sweep that covers economics, sociology and indeed all of humanity. In contrast, Nobel Laureate Milton Friedman and colleague Anna J. Schwartz write with academic erudition.

A Monetary History of the United States—1867-1960 by Milton Friedman and Anna Jacobson Schwartz—this is the most scholarly and exhaustively researched book in the collection. This magnum opus is a canon from the Chicago temple of monetary economics. It describes the role of monetary policy as the central villain in the depression that followed the stock market crash in 1929. It is written with laser-sharp arguments made in the dispassionate voice of an academic economist.

The staggering amount of detail and data covered in the book do not make for lazy afternoon reading. But it has one great virtue—it is the most comprehensive and theoretically well-argued reason for the depression that followed the crash of 1929. It raises important questions about the role of the central bank before, during and after a crash and lays out a monetary prescription for economic stability.

The Great Crash 1929 by John Kenneth Galbraith—serious students of economics will take issue with Galbraith’s assertions on the causes and lessons of the great crash of 1929. In my view, the real lessons from Galbraith’s analysis is in the realm of people and politics intersecting with the economics of a crash. Read from this perspective, Galbraith’s book is a masterpiece at describing the frailties, egos and short-sightedness of politicians and regulators in any crisis.

Typical of this were words such as those of President Calvin Coolidge’s in the State of the Union address in 1928: “No Congress of the United States, has met with a more pleasing prospect than that which appears at the present time. ...There is tranquillity and contentment and the highest record of years of prosperity."

Can “It" Happen Again? Essays on Instability and Finance by Hyman Minsky—I must confess that this and other books by Minsky are not on my shelf. Other than a passing reference in Kindleberger’s book I have not heard or read about Minsky’s ideas prior to this year. In the last year or so, George Magnus of UBS and Paul McCulley of Pimco have rediscovered Minsky for the rest of us.

During the Russian debt crisis in 1998, McCulley coined the term a “Minsky moment" to describe a tipping point where investors who have borrowed too much have to sell even good assets to make good on the bad. Minsky has become something of a cult figure on Wall Street.

Almost as if to build on President’s Coolidge’s comments Minsky proposed a framework for understanding bubbles. Minsky contends that it’s precisely when a society is prosperous and content that the seeds are sown for speculation.

Minsky’s bubble progresses through seven stylized stages as the preference for risky assets increases, prices rise, cheap credit fuels the rise further, overtrading begins, and it leads to euphoria. The inevitable begins to happen with insiders taking profit, and then the herd begins to panic.

Investors in India have largely been spared the pain of this episode. Equity markets around the world are not the ones in a bubble this time and our fixed income markets are too nascent and de-linked from the world to have been affected by this. But money market investors in New York and London, carry-trade retail investors in Japan and hedge funds of different types have sharply felt the pain. And it is not clear that it is over.

You can wade through these five classics on financial crises or spend a pleasant afternoon watching a re-run of Sholay. If neither attracts you, a remake is always around the corner.

Narayan Ramachandran is managing director of Morgan Stanley Investment Management. Comments are welcome at