Origins of the Crash: The Great Bubble and Its Undoing
by Roger Lowenstein

Jan 2005

Chicken or egg?

Well researched and well told, this book is both informative and misleading.

Informative in that it shines a clear light on the dangerous attitudes and corrupt culture that led to the bubble and its burst; misleading in that it presents a limited picture, a partial explanation implicitly represented as complete.

If a burned investor wished to understand the great bull's violent death, and had this book as a sole reference, he would likely assume that bubbles are largely the result of lax standards and creeping corruption, and thus likely infer an off-base conclusion: that future bubbles can somehow be prevented with a combination of better rules and tighter governance. The stories of Worldcom and Enron are informative and well told, but do they really count as 'origins' of the mania, rather than indirect creations of it?

A student of market history might suggest that most, if not all, big bull runs end in delusion and creeping corruption. As enthusiasm turns to mania, mania causes normally rational individuals to ‘take leave of their senses,' and desperate measures are implemented at the last in vain hope of keeping the dream alive.

Does endemic corruption lead to mania, or does the onset of mania lead to corruption as an inexorable byproduct of the times? The question, as it applies to this book, is whether situational specifics matter as much as understanding the age old cycle of boom and bust itself.

Consider Adam Smith's excellent book, The Money Game, which details dramatic boom and bust in the 1960s (and the all too familiar culture behind it all). Similar stories, similar players, similar reasons for excitement—even the 1960s version of dotcoms and the foreshadowing of Enron—and, of course, a violent and painful ending when it all comes crashing down.

Going back further, to 1929, or still further to tulipmania and the South Sea bubble, it could be argued that bubbles remain constant in caricature, with only details changing. Perhaps we are travelling along an expanding sine / cosine wave of boom and bust, as the cycles speed up and leverage allows for ever more spectacular highs and lows.

Origins of the Crash brings forth a number of useful insights. For instance, the wonderfully cynical notion that the efficient market hypothesis may does harm than good. To wit, the assumption of rationality actually makes the markets less rational by functioning as a rubber stamp; if stock prices are assumed always and everywhere reasonable, then incredible price movements are deemed reasonable by default, and the boosters are given perfect cover. Lowenstein also gives the phrase "shareholder value" a thoroughly sound thrashing, shedding light on insular corporate culture generally and gross CEO excess specifically. Exposing that culture down to the roots is the main aim of this book.

I was quite suprised, though, to see that a book called Origins of the Crash said nothing about so many major factors that came into play. For example, the fact that we were at the tail end of a record period of peacetime expansion that had been going on since 1982, with only one or two brief and limited interruptions. The fact that we were enjoying a "goldilocks economy" in the late 90's as the result of a long-fought battle with inflation that was finally paying dividends. And what about the major role played by the federal reserve vis a vis multiple events that spurred massive liquidity injections: Asian currency crisis, Russian default, LTCM meltdown, preY2K fears, etcetera. Nothing said of monetary policy, the boom / bust cycle of credit or the hidden inflationary consequences of easy money (namely, the tendency for fed induced liquidity to go directly into stocks and, as of this writing, real estate).

Nor did Lowenstein really address the compelling nature of the dot com story, except in brief passing. He noted that a seachange technology often leaves a vast litany of losers behind (railroads / automobiles etc), and that mass consumer benefits do not equal mass profits for companies riding the risky edge of innovation. He also noted the impossible driver of the mania… the notion that internet traffic was doubling four times a year to infinity.

But so much more could be said! Hyperbole aside, the information age really does change things dramatically; just not overnight. That line of thinking could have been, and should have been in my view, more deeply explored. Speaking of which, here are two of my favorite quotes from the book that practically beg for more discussion:

...Finance has its own Peter Principle, by which a successful model will be adapted to progressively riskier causes until it fails.

...There is always a germ of truth, a half-fact or momentary fact that, taken to hyperbole, can justify the most fantastic projections.

For any student of the markets, this is well worth the read (and at 227 compact pages it's a fast read); Lowenstein's book is practically a modern day addendum to Mackay's seminal Popular Delusions & The Madness of Crowds. But rather than title it Origins of the Crash, it might be more representative to see it as "A Slice of the Crash" or "Culture of the Crash." In focusing on creeping corruption and chicanery born of desperation, this book is more a cross section of details for a particular late great mania, rather than a deep chronicle of its origins.