Manias Panics and Crashes (Hardcover)

Those who are interested in the psychology of financial markets are often drawn to Professor Kindleberger's book after reading Charles MacKay's classic, Memoirs of Extraordinary Delusions and the Madness of Crowds. In this new edition, Professor Kindleberger has added useful perspectives on the Mexican and Asian financial crises of the 1990s and adjusted his interpretation to allow for more differentiation among crises than he did before. I found this edition by far the most satisfying of the four he has written.

Professor Kindleberger is one of the few remaining literary economists, those who make their points in essays rather than through long equations that depend on questionable assumptions. This makes his work very accessible, even though it is as rigorous as it can possibly be while still remaining a popular work.

If you believe in efficient markets or the overriding importance of macroeconomics, you will be angered and annoyed by this book. Milton Friedman and John Maynard Keynes each take their shots here, although in polite ways.

As Peter L. Bernstein summarizes nicely in his introduction, Professor Kindleberger's argument boils down to four principles:

(1) Irrational behavior does occur from time to time in financial markets.

(2) There is a general, repeatable pattern in how this irrational behavior plays out (a positive economic displacement is followed by euphoria that takes the form of overtrading, then distress following revulsion, discredit by lenders in the overtraded assets, and then panic leading possibly to a crash brought on by those who bought high).

(3) The economic system needs a lender of last resort to step in at the right time and in the right way to restore confidence and liquidity.

(4) Trying to solve these problems by being doctrinaire is "wrong . . . and dangerous."

Chapter one looks at how financial crises often accompany peaks in the economic cycle. Chapter two looks at the patterns of typical crises, described by "lumping" them together. Chapter three considers how speculative mania are begun by knowledgable insiders who then unload on overoptimistic outsiders who buy high and sell low. This chapter looks at how the crises differ from one another. Chapter four shows how either excess credit or too fast monetary expansion adds fuel to the flames. Chapter five considers the frequent association of swindles with these manias. Chapter six looks at the psychological stages of the whole process in more detail. Of central importance is the discomfort that many feel as they see a neighbor or friend become wealthy. Chapter seven looks at how the economic impact spreads to other domestic markets. Chapter eight looks at the transference to other international markets. Chapter nine looks at the pros and cons of trying to let these cycles take care of themselves. Chapter ten looks at the role of domestic lenders of last resort (the Federal Reserve in the U.S.). "How much? To whom? On what terms? When?" are the questions that require different answers each time in terms of who should get credit. In Chapter eleven, you see the special problems of the IMF. Will someone take the lead in time, or will everyone dally? The conclusion in Chapter twelve nicely summarizes the book in arguing that monetary and fiscal policy can make a difference in a deflation.

One issue that is not addressed in this edition is how such crises may occur more rapidly and with greater amplitude than before due to improved information flows. As a result, it will be more difficult for lenders of last resort to take correct action in a timely way. Clearly, "jawboning" such as talking about "irrational exuberance" will do little good.

How will you respond to the next mania that builds?

Keep your sight on rational values, even in times of irrational exuberance. For a deflation along with a credit squeeze will usually follow.

To begin, Kindelberger takes the traditional thought that people are rational beings and introduces the fact that speculation leading to destabilization is very much present, and that many of history's crashes have come from this irrational behavior, ie manias and panics. To explain, one must first define what a mania is, what a panic is, and ultimately, what a crash is.

According to Kindleberger, a mania is basically just excessive speculation in the market. It follows, as Kindleberger suggests, that if one observes someone else, ie a friend, who is making money through speculative investments, one tends to follow. Mania is movement from cash or money into illiquid real assets. As more and more people begin to investment on speculation, people that would normally be indifferent to this type of behavior decide to invest, it is called a mania. Also used interchangeabley with the term maina is the term "bubble". The use of the word "bubble" to explain this speculation foreshadows bursting. In this book, bubble refers to "an upward price movement over an extended range that then implodes. Extended negative bubbles, or periods of disinvestment are what are called crashes.

Panics refer to the period after the mania has died down, and people are beginning to speculate in the opposite direction. As the maina was the upswing, the panic is the downswing. Panics are easily defined as the movement away from illiquid assets to money or cash.

Crashes are sometimes thought to be the result of an extended period of panic. More often, a crash involves the collapse of prices or the failure of important firms or banks. However, financial crisis can result from one or the other or both, in no particular order. Kindelberger sites the crash of 1929 as an example. " The 1929 crash and panic in the New York stock market spread liquidation to other asset markets, such as commodities, and seized up credit to strike a hard blow at output." In spite of this Kindelberger explains that there was no money market panic as evidenced by the increase in interest rates.

Informative and concise, Kindelberger is able to encompass more than three hundred years of financial crises in about 200 pages. In he majority of these cases, he asks the important question of whether or not there was a lender of last resort, and if not, would it have made a difference. A lender of last resort acts to halt a run out of illiquid assets into money by making more money available, through a discount window. The author goes into great detail of who has been the lender of last resort in past crises. For example in the various crises that affected France in the nineteenth century, The Bank of France has acted as lender of last resort. While in Prussia in 1763, the king acted as lender of last resort.

From all of this, Kindelberger attempts to explain some of the lessons that all of the crises in the past have given us. Besides of the advantages of having a lender of last resort, he warns us that it is not the whole solution. Having a lender of last resort can pose its own problems. Many institutions, because there is someone to bail them out, partake in more risky practices. By simply bailing out these mismanaged firms, we are not giving them incentive to improve their operation.

Manias, Panics, and Crashes is a well of information on the topic of financial crises. Kindelberger has made this book an easy read for the everyday person, not just economists. By avoiding the mathematics and jargon used in so many other economics books, he has produced a book that is necessary reading if one is contemplating in "playing the market." Manias, Panics and Crashes would be a wise investment for them as well as anyone curious in financial history . The old adage is true, those who do not know the past are condemmed to repeat it. By learning of others past mistakes we can more successfully navigate our own way.

Kindelberger's analysis is not, therefore, a classic "history" primer for the curious - there is no spoonfeeding of facts, for that is not what the book sets out to present. Instead, this is an elegant and informed look at what how financial markets have departed from the course theoretical "rational" behaviour suggests that they should have taken. For all that, it is still an accessible text to those who take a casual interest in financial markets.