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

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 's

Real U.S. Stock Prices

Shiller's P/D plots

and U.S. Price/Earnings Ratio

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)

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

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

U.S. Interest Rates

 Few obvious movements with stock prices

International Comovements  Figure 1.2

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 's

U.S. House Prices (long)

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)

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

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

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

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 's

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

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

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

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

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

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.)

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

Japan

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

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

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 ( %)

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

Regional Contagion  Triggers crisis across region  Other currencies collapse Indonesia loses 70 percent of value  Stock prices down percent  Large number of banks fail

"Miracle" Comments Disappear  Crony capitalism  Destabilizing speculation

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

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

“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!”

When Did the Bubble Start?  1995?  1998?

S&P and NASDAQ

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

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

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??