Bubbles provide cover for fraudulent activities, as rising prices mask underlying problems. In cases like the South Sea Company and Railway Mania, it wasn't until after the collapse that the full extent of financial engineering, corruption, and deception came to light, by which point it was too late for most investors.
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The South Sea Bubble wasn't just a market mania; it was enabled by government corruption. Directors secretly gave shares to government officials who, in turn, had a direct financial incentive to keep the share price rising, regardless of the cost to the nation. This highlights how state actors can be complicit in creating systemic risk.
The 'bezel' is the inventory of hidden, fraudulent wealth that builds up during good economic times. Investor overconfidence, plentiful capital, and lax due diligence create the perfect environment for financial scams to flourish, with this phantom wealth only being discovered during a downturn.
The most imprudent lending decisions occur during economic booms. Widespread optimism, complacency, and fear of missing out cause investors to lower their standards and overlook risks, sowing the seeds for future failures that are only revealed in a downturn.
Bubbles are created when assets like startup equity are valued astronomically, creating immense perceived wealth. However, this "wealth" is not money until it's sold. A crash occurs when events force mass liquidation, revealing a scarcity of actual money to buy the assets.
The dot-com era was not fueled by pure naivete. Many investors and professionals were fully aware that valuations were disconnected from reality. The prevailing strategy was to participate in the mania with the belief that they could sell to a "greater fool" before the inevitable bubble popped.
During the 1980s bubble, Japanese firms engaged in "Zytec," using profits from financial speculation to boost reported earnings. This created a circular feedback loop: rising share prices increased their ability to raise cheap capital for more speculation, which in turn fueled share prices even higher, detaching them from operational reality.
The South Sea Company, the British government, and investors were all incentivized to push the stock price higher. The company could issue fewer shares, the government reduced interest payments, and investors saw immediate paper gains, creating a circular logic where a rising price justified itself.
Unlike the 2008 crisis, which was concentrated in housing and banking, today's risk is an 'everything bubble.' A decade of cheap money has simultaneously inflated stocks, real estate, crypto, and even collectibles, meaning a collapse would be far broader and more contagious.
The Railway Mania of the 1840s proves that a world-changing technology can still lead to a catastrophic investment bubble. Despite railways transforming society, massive over-investment and hype caused an 85% collapse in share prices, wiping out fortunes and illustrating the danger of investing in frenzied sectors.
Contrary to intuition, widespread fear and discussion of a market bubble often precede a final, insane surge upward. The real crash tends to happen later, when the consensus shifts to believing in a 'new economic model.' This highlights a key psychological dynamic of market cycles where peak anxiety doesn't signal an immediate top.
