Saturday, October 1, 2011

A Short History Of Financial Euphoria: Chapter 7

While there is no doubt that free enterprise gives rise to recurrent episodes of speculation, the features that are common to these episodes are rarely analyzed, according to the author of A Short History of Financial Euphoria, John Kenneth Galbraith. This book from 1990 offers perspectives on bubbles that are still useful today. By paying attention to the signs, "there is a chance - a slim chance, to be sure, given the sweeping power of financial euphoria - that otherwise vulnerable individuals will be warned."

Galbraith argues that financial amnesia seems to last about 20 years. This appears to be enough time for a new generation of finance leaders to emerge who discover "innovative" financial techniques that once again get everyone in trouble.

A couple of factors help this process pickup steam and permeate society. The first is that good fortune is attributed to skill or high acumen. The second is that the less fortunate believe that those with wealth possess high mental aptitude.

Galbraith takes the reader through a few euphorias that occurred from the 1950s to the 1980s, including the mutual fund pyramid schemes perpetrated by Bernard Cornfield, the bank lending (to an extreme extent) to developing countries culminating in crisis, and the high-yield and risky bond and LBO transactions of the type encouraged by Michael Milken.

In these cases, a number of scapegoats were "identified", including the visible leaders and enablers of the euphorias, and the lack or presence of regulation. That speculation and its inevitably unwanted aftermath are recurrent throughout history is mostly unmentioned.

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