I am very familiar with three prior speculative markets. Two I worked during and the other I studied extensively. I worked as a stock broker during the internet boom and then when the bubble burst, and I currently work in mortgages. I have also studied the stock market crash of 1929 extensively. These three markets, like most speculative markets, have some characteristics that are universal. First, they were all caused by not only excessive greed but by far too many people trying to cut corners on their way to success. Second, these speculative markets were obviously speculative to everyone and yet it didn't stop the masses from participating wholeheartedly. Third, and most importantly, all of them ended up in disaster, and that is the truth for all speculative markets. Finally, speculative markets prove that markets aren't perfect however markets themselves correct the excesses better than any regulation or well meaning politician.
Before the internet boom, companies needed to show years of solid earnings before any investment bank would ever take them public. That all ended with the internet boom. Companies with little revenue and serious red were going public on a regular basis. Furthermore, many of them began to gain market capitalization (the worth of the company as measured by its stock price) that far exceeded traditional brick and mortars. Even those with solid earnings were trading with Price to Earnings ratios that were well out of line from those of traditional companies. AOL and EBAY would trade at P/E ratios in the hundreds and thousands, while a traditional company like GE and Walmart would trade at P/E's of 20-30.
Warren Buffet once remarked that he didn't buy internet stocks because he couldn't value them, and this remark was met with calls that Buffet was a dinosaur and didn't understand the new investing paradigm. People watched internet stocks double, triple and quadruple overnight and they wanted in. Novice investors were suddenly day trading and buying options. They weren't keen on holding any stock longer than months if that long. All of this was clear while the internet boom was happening, and not only did conventional wisdom not warn against it, but many embraced it.
The real estate boom was characterized by folks buying up properties using little and no money down and using so called stated loans (where income was stated but never proven). Banks were all too willing to give these loans, and the conventional wisdom among much of the industry was that real estate value would go up forever and thus these loans were risked properly. Novice real estate investors were now suddenly buying multi units, rehab properties, and the art of flipping (buying and selling quickly) became all the rage. Just as in the internet boom, these risky endeavors were not only not frowned upon, but encouraged. Adjustable Rate Mortgages became all the rage. Many folks went from owning one property to swallowing up three, four and more nearly overnight.
The stock market crash happened because investors bought on heavily leveraged margins. They would buy stocks only putting down ten percent of what they owned. Most of these investors never actually had the total amount of the investment, and thus if there was a margin call (when a stock goes down enough and an investor is asked for more money) they would have no choice but to sell. This was also not only not frowned upon, but encouraged at the time.
The one thing I remember about both the internet boom and the real estate boom is during both they became chic. Both became the thing to do. It stopped being about getting a good investment or finding a good home, and merely became the thing to do. Again, at the time, this was not only not frowned upon, but encouraged.
All of these things I mentioned are characteristics of individuals that were swept up in their own sense of greed and cutting corners. Because folks were making obscene percentages on real estate and internet, everyone else wanted it. The warning signs of the speculative market were there for everyone. Folks who only a year ago didn't know what a stock was were suddenly quitting their jobs and day trading. Folks that didn't own their own property yet were trying to flip properties in hot markets they didn't even live in. In the twenties, every Joe on the street was starting a stock account and buying on margin. Like I said, this wasn't isolated, it was the thing to do.
All three of course came crashing down. Three trillion dollars in paper losses were caused in nine months in 2000 when the internet bubble burst. We are still assessing the damage of the real estate crash, and of crash 1929 lead to the Great Depression.
Finally, all speculative markets lead certain ideologues to question the wisdom of the free market. Speculative markets are the perversion of the free market system. They are results of the imperfections of the human psyche. Yet, while speculative markets are proof that free markets aren't perfect, the way in which free markets deal with the aftermath are proof that free markets are still best. In the aftermath of the 1929 crash, Congress passed a law that barred margin buys below 50%. This was overkill since no investment company in the world would have gone below fifty percent anyway. Most of the troubling loans like stated, no money down, and option arms, are all now nearly extinct eaten away by the free market. The novice day traders lost all their money and never dared to enter the market again. The market is always self correcting. Regulations and well meaning politicians look to correct previous errors. Those regulations aren't going to stop the next crisis.
Given that the humans that participate in free markets are themselves flawed, it is unfair to expect free markets to be perfect. Yet, that is the reaction of some when free markets fail. It is unclear what regulation could have done to avoid the real estate bubble for instance. Most of the stated loans that were in fact fraudulent were already going outside of laws. Fraud is not now nor was it then legal. The reason these incomes were accepted was because the banks were caught up in the excitement and believed these loans would be fine even with out of bounds income. The reason that borrowers accepted payments they couldn't afford is because they were caught up in the excitement of owning an investment property or beautiful home. Jesse Ventura once said that you can't regulate stupidity. That is true and excitement and in many ways greed is also difficult to regulate. Avoiding the next speculative market means that the players realize the signs and don't fool themselves into believing they aren't there or worse that this time they won't lead to the disaster they always do. I don't however believe there is a regulation against such behavior.
Please check out my new books, "Bullied to Death: Chris Mackney's Kafkaesque Divorce and Sandra Grazzini-Rucki and the World's Last Custody Trial"