A Few More Bubbles

1. A Few More Bubbles Fin254f: Spring 2010 Lecture notes 2.3-2.4 Readings: Shiller 1-2, Kindleberger and Aliber, 8, "What Moves Stock Prices"

2. Outline • The U.S. stock market summary • The U.S. real estate market • Three recent events • Japan 1980's • East Asia 1990's • U.S: dot.com 90-2000's

3. Real U.S. Stock Prices

4. Shiller's P/D plots

5. and U.S. Price/Earnings Ratio1881-2009

6. Unusual Periods for U.S. • Twentieth century peak, June 1901, P/E = 25.2 • Real earnings double over previous 5 years • Real return 10 years after this = 4.4% per year, 20 years = -0.2% (includes dividends) • Sept 1929: P/E = 32.6, • Real index does not return to this price level until mid 1950’s • Real price drop into early 1930’s = -80.6% • Real return = -1.4% over 10 years, 0.4% over next 20 years (includes dividends)

7. Unusual Periods for U.S. • January 1966: P/E = 24.1, Kennedy/Johnson peak • Earnings up over previous 5 years 36% • Real stock prices do not return to this level until 1992 • Real return over next 10 years = -1.8%, 1.9% over the next 20 years

8. Market Crashes and News"What moves stock prices" • Largest moves and news • Oct 19, 1987 (-20) • Oct 21, 1987 (+9) • (4) Sept 3rd, 1946 (-6.7) no basic reason • (6) Sept 26, 1955 (-6.62) Eisenhower heart attack • Some other important days • Dec 8, 1941 (-4.4) Japanese bomb Pearl Harbor • Oct 23, 1962 (-2.7) Cuban missile crises • Nov 22, 1963 (-2.8) Kennedy assassinated

9. U.S. Interest Rates

10. U.S. Interest Rates

11. U.S. Interest Rates • Few obvious movements with stock prices

12. International Comovements • Figure 1.2

13. Outline • The U.S. stock market summary • The U.S. real estate market • Three recent events • Japan 1980's • East Asia 1990's • U.S: dot.com 90-2000's

14. U.S. House Prices (long)

15. U.S. Real Estate Prices • Shiller figure 2.1 • Predictability (R2 = 0.5) • Run ups are small than stocks • Past not informative (nonstationary??) • Statistics difficult • Fundamentals not well connected (fig. 2.1)

16. Other Data Features • Several major declines • Small run up in the 1920’s • Many regional bubbles • Geography is important • Figs 2.2, 2.3 • Not all cities move together, but more so now? • Large (and permanent) increase after WWII • GI Bill of rights • Home construction restricted during the war, then expands

17. Why Do People Think Home Prices Always Rise? • Two possibilities • Infrequent transactions • Inflation • Example • House bought in 1948 for $16,000, and sold for $190,000 in 2004 • Total real return = 48% • Real return per year = 1% • Also, property probably improved a lot over time (different goods) - also in index too

18. Special Things about Real Estate • Long term comparative data • Difficult • Hard to find • Curious features about • Care and owner/renter incentives • Special tax breaks • Leverage • Cross country differences

19. Outline • The U.S. stock market summary • The U.S. real estate market • Three recent events • Japan 1980's • East Asia 1990's • U.S: dot.com 90-2000's

20. Bubbles in Asia (80’s-90’s)Kindleberger/Aliber (8) • Japan 1980’s • Land values: Imperial palace = California • Market value of Japanese land = 2 x U.S. • (land area = 5 percent of US) • Stock market: Twice the market val of US • 7/10 largest banks are Japanese (assets) • Japanese firms acquiring “trophy” properties • Rockefeller center • Pebble Beach Golf course

21. Japanese Growth History • Late 1800’s begins to industrialize • Adopting foreign institutional models • Early industry built around feudal families • Large multi-industry holding companies • General MacArthur outlaws at end of WWII • Firms replace this with “cross-holdings” • Holding of other firm’s shares • 1950’s-1960’s, Japan starts to catch up • Growth rates near 10 percent per year

22. Japan in 1980’s • Global economic power • World leader in • Cars • Electronics • Photo optics • Industrial planning: “Japan Inc.” • Financial structures: bank lending

23. Financial Regulation • Restrictions on interest rates • Negative real returns • Leaves only real estate and stocks with positive returns • Mid 80’s begins to deregulate • Begins to financially become more global • Real estate and stock markets continue rising • Bank assets increase, collateral increases, lending increases • Cross holdings magnify changes in asset values: Buy shares of other firms rather than investing

24. Three Factors in the Japanese Real Estate Bubble • Long term positive returns (lots of scarce land?? Phoenix versus Tokyo) • Financial liberalization: Opens up more real estate lending • Monetary growth • Bank of Japan intervenes to keep value of Yen low relative to the dollar • Money supply expands • Banks increase reserves : can lend more

25. Stock Market Bubble Continues • Cross holdings drive firm and investor wealth • As value of Japanese market rises, international funds allocate larger amounts to Japan • Drives prices higher • (Same in dot com bubble: Passive funds part of problem.)

26. Peaks in 1989 • Some real estate buyers in cash bind • Rentals smaller than interest payments • Think “Ponzi”! • Distressed selling starts • Land and stock prices begin falling • Downward spiral • Property sales, price drops • Bank capital falls • Lending falls - > more price drops

27. Japan

28. Japan in the late 90’s and early 2000’s • Japan has some periods of deflation • Near zero interest rates • Bankruptcies rise • Banks in trouble • Depositors do not withdraw • Belief government will step in • Too big to fail • Foreign lenders to Japanese banks believe government will not help them • Japanese lenders and firms move to foreign banks

29. Shift Away from Japan • Exports increase/Imports fall • Yen appreciates • Investors shift to China, Malaysia, Thailand where labor costs were lower

30. Early 1990's • East Asian "tigers" • Beginning in the 1960's and 70's • Key aspects • Transformations • Growth (often near 10%) • Stock markets in Thailand and Malaysia take off in the early 90's (300 - 500%)

31. Foreign Capital • Foreign direct investment • Setting up manufacturing • Real estate booms • Consumer lending takes off • 1996: Consumer finance companies experience losses, begin to fail • Foreign creditors nervous • Capital inflows suddenly stop • Thai Baht can no longer be managed on a dollar peg, currency collapses

32. Regional Contagion • Triggers crisis across region • Other currencies collapse • Indonesia loses 70 percent of value • Stock prices down 30-60 percent • Large number of banks fail

33. "Miracle" Comments Disappear • Crony capitalism • Destabilizing speculation

34. Ending in Asia, Starting in the U.S. (late 90's) • Current account deficits shift to surplus • (Central bank reserves increase) • Exports to U.S. rise • U.S. trade deficits rise • U.S. dot com bubble gets really heated

35. Dot Com World • VC's, Entrepreneurs, IPO's • First day "Price Pop" • December 1996: Greenspan "Irrational Exuberance" • Dow = 6300, NASDAQ = 1300 • End of 1999 • Dow = 11700, NASDAQ = 5400 • NASDAQ value = 80% NYSE value • Initially "new economy" stocks • Eventually all stocks

36. “Our proprietary portfolio of New Economy stocks was up over 80.2% in 1998!” “At this rate, $10,000 turns into $3.4 million in 10 years or less!”

37. When Did the Bubble Start? • 1995? • 1998?

38. S&P and NASDAQ

39. Bubble Persists • 1999: Fed obsessed with Y2K • Increases bank liquidity • After 2000 Fed reduces liquidity • Stock market falls 40%, NASDAQ 80%

40. International Aspects of Dot.com • Capital inflows to U.S. • Dollar appreciates • Import prices fall in U.S. • U.S. inflation low • U.S. savings rates fall

41. Summary: The Three Recent Bubbles • Japan: 1980's • East Asia: 1990's • US dot com: late 90's early 2000's • How do they fit into the Minsky taxonomy? • Ponzi??