11/17/2010 5:00 PM ET|
Worst investing disasters of all time
As bad as the last few years have been, the markets have recovered from worse. Here's a look at some of the biggest investing mistakes of all time.
A man waits in a Depression-era bread line in San Francisco in 1933.
American investors have been through a lot in the 2000s. In the space of just 10 years, we've had the two recessions, a stock market bubble, a real-estate bubble, a commodities bubble and more. Depending on whom you listen to, there could be another bubble or two building now.
It's been all too easy to get tripped up and find yourself on the wrong end of an overvalued investment or the victim of an "infallible" investment strategy.
But this is nothing new. History is rife with examples of speculative exuberance followed by gut-wrenching losses. So, in the spirit of buyer-beware, here's a look at a few of the most memorable investing disasters of all time.
1637: Tulip mania
Perhaps the most famous example of an investment craze that ended in ruin was the frenzy over tulip bulbs in the Netherlands in the 17th century. The flowers were introduced to the country from Turkey and quickly captured the imagination of traditionally conservative Dutch financiers. Bulb markets opened in Amsterdam and Rotterdam in 1630. Eventually, the entire country caught tulip mania.
The prices investors paid for desirable species at the height of the bubble seem silly now. Viceroy, a purple-and-white variety, cost 2,500 florins on the Amsterdam exchange at its peak, the equivalent of 10 yoke of oxen or more than 30 suits of clothes. For a single bulb.
The craze came to a dramatic end in 1637 with tulips becoming essentially worthless, after a sailor mistook a bulb for an onion and proceeded to eat it with breakfast. Many began to wonder whether the bulbs were worth the hype. They weren't.
1792: The first Wall Street bailout
America's first stock market bubble came just two years into George Washington's first term as president. The genesis can be traced to Treasury Secretary Alexander Hamilton's financial programs, including the creation of the Bank of the United States, which boosted U.S. securities.
Hamilton contributed to the rise by repurchasing government bonds -- not unlike what the Federal Reserve is currently doing.
Speculator William Duer formed the "Six Per Cent Club" to corner the stock of the Bank of New York and the Bank of the United States. The combine found initial success, with stock prices toward the end of 1791 rising rapidly in New York, Philadelphia and Boston. Small investors were pulled into the fray.
The New York Journal wrote: "The cry is -- what can be the reason for this strange and astonishing rise of the American stocks! O that I had but cash -- how soon would I have a finger in this pie!"
It wouldn't last. Duer overextended himself and was forced to liquidate shares in March of 1792. Whispers of his failure spread up and down Wall Street, resulting in a wave of panic selling. Hamilton intervened.
It was America's first Wall Street bailout.
1837: The first real-estate bubble
President Andrew Jackson's campaign against the Second Bank of the United States ended in success -- and runaway inflation -- as a proliferation of state and local banks replaced a central bank as arbiter of the nation's money supply. Their lending fed much speculation, and rising security prices gave "the economy an aura of boom which was undeserved" in the words of the late historian Robert Sobel. The greatest bull market America had seen began in 1834.
The popular interest focused on land -- specifically, sales of government land in the untamed West. Public sales in 1834 totaled 4.7 million acres, reached 12.6 million the following year and hit 20 million acres in 1836. The land was paid for in "paper money" rather than the gold-backed dollars that Jackson favored. Real-estate prices soared nationwide.
Jackson responded by requiring that government lands be paid for with gold or silver. He hoped the move would force banks to call in bad loans and end speculation. It worked, but it pushed the economy into the Panic of 1837. Banks failed. Credit dried up. Stocks plunged. Foreclosures, bankruptcies and riots followed.
1884: An early Ponzi scheme
The Ponzi scheme -- a scam in which investors are paid with money from newer investors rather than from investment gains -- is named after Charles Ponzi and a 1920s crime. But the idea goes back much further.
In my mind, the most colorful example happened back in 1884 and resulted in the public shaming and bankruptcy of President Ulysses S. Grant.
The country was in the midst of a stock market boom when Grant left the White House in 1877. His excitable young son, Ulysses Jr., fell in with the slick but crooked Ferdinand Ward, and they eventually persuaded Grant to join them in a brokerage firm, Grant & Ward.
Ward persuaded many to hand over their wealth in the promise of large dividends and safety. As ventures failed, Ward started paying generous dividends illegally using bank loans rather than earnings. As railroad stocks plunged in the Panic of 1884 and lending dried up, the con collapsed.
Ward was jailed, and Grant spent the last days of his life writing his memoirs -- out of the need to restore his family's finances.
1929: The Great Crash
No discussion on the worst episodes on Wall Street is complete without a look at the 1929 stock market crash that led to the Great Depression. Too typically, the run-up was fueled by intense speculation, easy money and overconfidence. American stocks nearly quadrupled between 1921 and 1929.
The creation of the Federal Reserve led many to believe that the economy was done with booms and busts. The president of the NYSE announced that "we are apparently finished and done with economic cycles as we have known them." Voices of caution were ignored.
The beginning of the end came on Aug. 8, 1929, when the Fed increased its lending rate from 5% to 6%. This relatively minor act set off a chain reaction of tighter credit, forced selling and panic that culminated in the "Black Thursday" and "Black Tuesday" declines of Oct. 24 and Oct. 29, 1929. At their nadir in 1932, stock prices had fallen more than 80% from their pre-crash peak.
1987: Portfolio 'insurance'
The rise of modern finance in the 1970s and the 1980s resulted in a dramatic increase in derivatives trading -- swapping options and futures instead of actual stocks. At the same time, modern portfolio theory fueled the rise of "passive" investing -- investing in broad-based indices like the Standard & Poor's 500 Index ($INX) instead of picking stocks. Meanwhile, the availability of futures contracts for broad indexes made it easy for portfolio managers to hedge against price drops. They called this portfolio "insurance."
At the same time, Wall Street institutions turned to computerized trading to maintain these hedges and capture fast-moving profits.
This system worked well until the market entered a period of high volatility in October 1987 that culminated in the worst one-day loss in the U.S. stock market since the New York Stock Exchange was reopened after the outbreak of World War I. On Oct. 19, the Dow Jones Industrial Average lost nearly 23%.
Inquiries into the crash concluded that the increased demand for portfolio 'insurance' had actually increased volatility. And so-called "passive" investing actually created a high-risk environment that rewarded quick moves and raised risks. The same forces were at work in the May 6, 2010, "flash crash" that briefly sent the Dow down as much as 999 points.
The takeaway from all this: While there's money to be made in the market despite its turmoils, there's no such thing as risk-free investing.
Be sure to check out Anthony's new money management service, Mirhaydari Capital Management, and his investment newsletter, the Edge. A free, two-week trial subscription to the newsletter has been extended to MSN Money readers. Click here to sign up. Mirhaydari can be contacted at firstname.lastname@example.org and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.
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