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The Historic Link Between Tulips and The Sub-Prime Mortgage Debacle

by: Geoff Ficke

Almost every living individual is being effected adversely in some way by the international economic meltdown we are experiencing today. The genesis of this severe financial downturn is attributed to the United States government encouraging the expansion of homeownership to people who would have historically been deemed unworthy of obtaining credit. The banking systems participation and eagerness to leverage credit risks by extending loans to people with poor credit histories is the principal cause of the current sub-prime mortgage crisis.

Historically, the bursting of the credit bubble follows a long and dubious line of similar scandals. Greed, hubris and suspension of common sense and disbelief are always present before the hen comes home to roost after the gravy time has ended. The panic of 1908 in the United States, the worldwide Great Depression and the implosion of the technology stock bubble in the late 1990’s are memorable examples of euphoric periods followed by great loss and assignation of blame as to the causes of these financial busts.

These peaks and troughs in economic fortune are not unique to modern times. One of the earliest documented financial crazes was the Dutch Tulip Mania in the 17th century. The Dutch, being a tiny, mercantile nation, surrounded by larger, stronger empires were the earliest creators of trade policies and sophisticated financial products. One of their most creative vehicles was the introduction of the futures market.

Tulips were introduced into the Dutch economy and agronomy early in the 17th century. They quickly became prized for their beauty and the floral engineering that created many unique, exotic varieties of tulips. An exchange mechanism developed for speculation in the valuations of the various strains of bulbs. By 1637 a full-scale mania had erupted in evaluating future tulip bulb harvests.

Records from that period are sketchy, but it is known that a single Viceroy Tulip bulb was valued under contract for between 3000 and 4200 Dutch florins in 1637. Contrast this with the annual wage of a skilled Dutch craftsman of 150 florins per year. Isn’t this a definitive example of excessive senseless mania?

The Dutch referred to such trading contracts as “wind trade”. This was because no one ever actually took possession of the tulip bulbs. They simply owned a piece of paper, a contract that documented their claim on the tulip bulbs. Does this example of financial engineering ring any bells today in our current distressed situation?

The popularity of the tulip trade, and the amazing returns, mostly paper gains that were realized by the early speculators created a stampede of inexperienced, gullible speculators. Noblemen, farmers, sausage makers, chimney sweeps and day laborers began to speculate hoping to turn a few florins into exponentially huge investment returns. Of course, the last investors in, were the most harshly abused by the implosion of the tulip bulb speculative bubble. This is true in all bubble cycles.

The British economist Charles Mackey wrote a tome in the 18th century cataloguing the history of the Dutch Tulip Mania. His “Extraordinary Popular Delusions and the Madness of Crowds” remains in print to this day. Business schools and economists refer to Mackey’s study of the herd mentality of people during manias. Nevertheless, though Extraordinary Popular Delusions is still studied, its lessons have hardly been taken to heart.

The greed and hubris that are always present in manias too often define the human condition. People tend to see someone profit from an enterprise and try to emulate their perceived success. This engenders ever more people attempting to participate in the affair and the result is a panic, a mania, a bubble, then disaster.

The no money down payment, zero document loans, offered in the last decade created a completely different type of borrower and lender. The borrowers have no skin in the game. They get to possess a home in which they have no equity. As long as their condition is stable they can maintain possession. However, if their fiscal condition recedes, or the value of the property declines, they are in deep trouble. Foreclosure is a reasonable action for them to undertake to simply walk away from a gamble that did not work out for them.

The lenders have suspended proper underwriting standards in order to induce entry into these risky home sales transactions. They have little skin in the game, because they have conceived exotic packaged investment vehicles where mortgages are bundled and sold to investment speculators all over the world. The owner of the mortgage is actually unknown to the mortgagee, or even the originator of the loan. The loan originator collects their fees and offloads the loan obligation from their balance sheet. The risky transaction is now someone else’s responsibility.

As a result we have endured a period of fake prosperity built on credit swaps, personal irresponsibility, corporate irresponsibility and governmental corruption. The mania of our time is cheap credit. This bubble has burst, and every homeowner faces shrinkage in the valuation of their property because of the greed of speculators and the attempt of government to secure homeownership for people who should be renters. Community banks and credit unions that have maintained high lending standards are being hurt because of the recklessness of the giant money center banking institutions. Retirees and prudent investors have seen their savings and investments slaughtered because of the inane greed and corruption of others.

The 1990’s technology stock bust decimated a generation of people who came to believe that investing in the inter-net was the new “Holy Grail” for prosperity. Startup companies with no sales, no balance sheets and inexperienced management were given huge market valuations. Investors were advised that the tech boom was just in the first or second inning of this nine inning game. Brokerage firms provided guidance on equities that they actually made markets for. This bit of double dealing lead to constant buy calls on tech firms stock that insiders knew had no prospects for success.

The Dutch Tulip Mania, the Mississippi Company, the South Seas Company, the South African Milk Culture craze and the many modern crazes, Ponzi schemes and asset bubbles that we continue to experience are testament to man’s inability to control emotions. Greed, power and wealth are aphrodisiacs for many. We are imperfect beings, susceptible to herd mentality, even when we have knowledge of history’s lessons and could apply these to spare ourselves the pain of participating in activity that will assuredly lead to great pain and loss. Discipline, responsibility and thrift are essential to long term success.