I happened upon Scott Nations book and the title was so provocative I had to read it. Unfortunately we are more likely to remember things which are bad in our lives, so I am happy Mr. Nations a master of the financial engineering craft went back into history to extract gems of knowledge for us to reflect on and apply to our modern strategies. A prevailing theme is the opposite mantra of Gordon Gecko’s “greed, for a lack of a better word, is good” and more a synopsis “the crashes are similar despite spanning more than a century[.] … At their heart, it’s not about money or number or individual stocks but about fear and greed.” As the title says the book is divided up into 5 crashes sorted both chronologically but also in the order of the speed they recovered a nod to the shortening cycle of bear markets and the easier discovery of value in the information economy. The chapters are as follows:
- Panic | 1907 (The Panic of 1907)
- Crash | 1929 (Black Tuesday)
- Black Monday | 1987
- Meltdown | 2008 (The Great Recession)
- Flash Crash | 2010 (The Flash Crash)
The Panic of 1907
This chapter was funny in how wildly irresponsible it was and how regulations were skirted with equally dubious inventions. Trusts and daisy chaining banks paired with a dead president and rampant fraud led to a situation only JP Morgan had the resources to solve that would make It’s a Wonderful Life‘s Mr. Potter seem like a hit piece. A good character piece on greed and a new financial instrument colliding.
This chapter talked about the story stocks (Standard Oil, Radio Corporation of America, White Sewing Machine Company) of the roaring twenties. RCA was the original GME as you would see by the antics of Michael Meehan pushing the stock 2000% which led to the Securities Exchange Act of 1934. The character’s greed and subsequent losses lands him in asylum. Andrew Mellon, who was spitefully referred to in his starting of Carnegie-Mellon in the last book I reviewed, said of the crash it would “purge the rottenness out of the system.” Ironic coming from him, but nevertheless a fun chapter.
Insurance is a business chiefly based in mathematics, so naturally investors in the stock market should be able to buy portfolio insurance at least that is what Leland and Rubinstein worked to achieve. It was a noble goal but as with all hubris accompanied by initial success it preceded a fall. When the insurance became a leviathan on its own liquidity was nowhere to be found for the trades needing to be executed which tested the very institutions foundational to the markets (CME, NYSE).
The Great Recession
The adjustable rate mortgage (ARM) was illegal prior to 1981. Savings and Loan companies prior to 1980 were making 30 year bets the rates they had to pay to their depositors were going to be lower than the interest rate of a mortgage. They assumed as much risk (or more) as the homebuyer in this calculation dependent on the prime rate. The Fed had interest around 11% in 1979 and Savings and Loans were struggling with this. In late 1980 interest rates were put up to 20% to stop runaway inflation which caused a minor recession. Out of the ashes came the optional ARM where payers could decide how much to pay to earn an additional 1-2% spread on interest. This greed snowballed into the mortgage backed securities calamity that took down several hedge funds, a nearly century old insurer, and threatened a number of banks. Nations was really good at finding all the little nooks and crannies of policy decisions by Congress, inaction by the Federal Reserve, and the bad actors in both the rating and originator businesses who led to the 2008 disaster.
This chapter was a great statement on Greek culture and how it butts heads with the fiscal responsibility the Eurozone wants and how algorithmic high frequency trading may be the AI apocalypse no one is suspecting but maybe the one investors should be aware. I love how this chapter summarized easy investing addages for new investors when they are looking for opportunity:
- [The market] generates an attractive return but with the risk of loss.
- It is most vulnerable when it is overextended.
- Liquidity dries up when it’s most desired.
- New financial products might seem to solve an immediate problem, while creating a much larger one in the future when stressed.
That last one gave me pause when reflecting on products which have mainstreamed since this book was published like cryptocurrency utility coins and defi products. Thanks to Scott Nations for writing this book and I highly recommend you pick up a copy for yourself.
Price: $15 (on sale at Harper Collins)