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"This book's light-hearted, level-headed insights may be directed at the business world, but they ring equally true for government and public officials. Robert Menschel gives a valuable perspective
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"This book's light-hearted, level-headed insights may be directed at the business world, but they ring equally true for government and public officials. Robert Menschel gives a valuable perspective on the power of the crowd." --Senator Charles E. Schumer
"This wonderfully witty and wise book by one of the most successful investors I've ever known is a must-read. He reminds us that trees do not grow in the sky and that if it looks too good to be true, it is." --John C. Whitehead, former chairman, Goldman Sachs & Co. and Chairman, Lower Manhattan Development Corp.
"This timeless anthology on the madness of crowds is chock-full of worldly wisdom, relevant anecdotes, and wonderful quotations, interlaced with the light touch of our finest cartoonists. Coming as it does in the aftermath of the great stock market bubble, Bob Menschel's fine book is also a useful reminder of what we all knew, deep down, but were afraid to admit: When the perception of stock prices loses its linkage to the reality of corporate values, a day of reckoning always follows." --John C. Bogle, founder and former CEO, The Vanguard Group
"This highly entertaining book is must reading for everyone without exception, regardless of age, wealth, or political persuasion. Menschel's delectable presentations expose the very roots of human behavior in a variety of fascinating situations, familiar and unfamiliar. Don't skim; read every word." --Peter Bernstein, author of The Power of Gold: The History of an Obsession and Against the Gods: The Remarkable Story of Risk
Stock markets seesaw between greed and fear. They always have, and they always will because the people whose decisions drive the markets seesaw between greed and fear themselves.
At the upper end of a market run, greed becomes what Federal Reserve Chairman Alan Greenspan once called "irrational exuberance"--a belief akin to faith that the curve is going to climb and climb and that whoever doesn't get aboard now is going to be forever left behind. Money comes pouring into the markets. The bubble grows and grows as old rules of valuation are tossed out the window along with almost all practical sense. Then comes the day of reckoning when the last fool is finally found. Fear reasserts itself. Irrational exuberance turns to flight, flight to panic, and panic maybe to outright disaster. The more air that has gone into the bubble, the faster it comes rushing out, and the deeper and steeper the fall.
All bubble markets share common trajectories, but as we'll explore in this section, each is unique in its own right. The tulipmania that swept Holland in the first part of the seventeenth century--the first of the modern bubble markets and even almost 400 years later still one of the most fascinating--wouldn't have been possible if the Dutch hadn't already invented the stock market. The stock market wouldn't have prospered if the Netherlands hadn't found itself suddenly awash with florins as the continent's leading trading nation. And the price of tulip bulbs might never have been driven to such outlandish heights--as much as $110,000 in contemporary dollars for a single bulb--if newspapers hadn't been recently established to tout thevirtues of the tulip and to remind readers that everyone was getting rich but them.
The two great runaway markets of the early eighteenth century--the South Sea Bubble in England and the Mississippi Bubble across the channel in France--both involved stock companies set up, in theory, with patriotic ends in mind. Both would bait the trap with seemingly exclusive access to the untapped resources of distant climes. Both at least initially produced staggering returns. Between January and August 1720, stock in the South Sea Company rose eightfold, to £1,000 a share. In France, shares in the Mississippi Company were sometimes doubling in value every 5 to 10 hours the market was open. And as happens with bubble markets, both collapsed as rapidly as they had risen, carrying under not just the wealthy but the poor and very nearly the national economy as well.
Like the South Sea and Mississippi Bubbles, the Florida land boom of the 1920s had an untapped resource to offer: acres and acres of newly platted land in a state only recently made accessible by railroad and by the new proliferation of cars and highways. The land boom had an untapped reservoir to work as well: the paper wealth created by the soaring stock market of the Roaring Twenties. Like all bubbles, too, the Florida one had no absence of scam artists and other con men ready to sell a parade of suckers building lots that proved to be swampland infested with alligators, snakes, and all the other creepy-crawly charms of Florida.
The granddaddy of all bubble market collapses, the one in October 1929 that ushered in the Great Depression, was itself inseparable from the rampant prosperity that had turned the 1920s into a charmed decade. Optimism was everywhere. So were easy money and margin accounts. Along the market roared--higher and higher until it reached the cliff that all bubble markets get to, and plunged straight down.
For its part, the recently deceased Internet market had just what bubble markets need: a new technology that seemed to be ushering in a new paradigm. Gone were the old bricks-and-mortar companies. From now on, businesses would be dematerialized, able to change directions on a dime and travel quick and light. Naturally, everyone bought into it. Even the financial houses that are supposed to be the stock markets' gatekeepers of common sense were bringing out new initial public offerings by the hour, it sometimes seemed, creating public stakes in companies that by the old standards barely existed. No wonder the crash came with such fury: There was almost no infrastructure to hold the bubble up, other than the hot air inside.
As distinct as each bubble market is, the psychology that drives investors is always essentially the same. Think back to the last high-tech stock you bought before the bottom fell out on Nasdaq. What information or impulse were you acting on? Maybe it was a tip from a good friend who is usually well informed. But where did he get his information? A newsletter? If so, what was the circulation? His broker? If so, how many other clients was his broker passing the same information on to? Inside dope is only inside for a second. Once it hits the street, the "inside" goes outside in an instant.
The other day I found myself wandering through the financial message boards on America Online to see where the crowds were gathering these days. Level 3 Communications had 235 postings on its board so I decided to drop in and have a look. A one-time favorite of the Street, Level 3 had been touted as maybe the leading builder of a nationwide fiber-optic network. Even after the April 2000 shakeout in tech stocks, its share price had held over $50, but by the midfall of 2001, Level 3 had hit a 52-week low of $1.89 and was sitting at $3.57. Losses for the third quarter of 2001 had been set at $437 million, up from a loss of $351 million for the third quarter of 2000. What would the messages say about this falling comet, I wondered? So I picked out a posting at random and had a look. Here's how it began:
"I have a friend who is a doctor who has invested a fair amount in Level 3 and who has invested more since listening to the third-quarter earnings conference call. He has studied this company and this stock for years and is convinced that this company will not only survive but will become a telecom leader after this shakeout."
Well, maybe it will, I thought. But when you look at secondhand information being passed on in an anonymous venue (screen names only are used, not real ones) and pegged to such a slim reed, you've got to think this guy is either a patsy, a shill, or just maybe a wise man. Problem is, there's no way to tell which.
We live, it is said, in the Information Age, but what is this information we live with? When it comes to the financial markets, so many people are in search of the hot tip, the one secret that will transform their luck forever that they are prey to every bill of goods that comes down the street. Play the numbers based on what some astrologer divines or what the tea leaves suggest? Never. But it's amazing to me still how many of us will play the stock market on not much more, driven by peer pressure, envy, and panic to find a shortcut that is, by its very nature, irrational in the extreme.
It's also amazing to me how, when these bubble markets fall apart as they always do, the media inevitably goes looking for the one precipitating event: the pinprick that began to let the air out. It's like children building a tower with blocks. Up goes one cockeyed story, then another and another, each more unstable than the last, until one tiny block seems to topple the whole thing. But it's not the block, it's not the event, it's not the collapse of a single stock that brings everything down. It's the instability built in at every step along the way. That's where you need to look: not at the top of the tower, but at the infrastructure that supports it, or fails to.
Here's what 40-plus years of investing my own money and my clients' money has taught me: There are plenty of wise men in this business, but there are no shortcuts to success, no end runs around due diligence, and no free lunches.
Looked at from the outside, Charles Ponzi had a wonderful idea. Beginning about 1920, his Boston-based Securities and Exchange Company (it predated the federal SEC) proposed to provide investors with incredible returns by exploiting the different exchange rates for International Postal Reply Coupons. Ponzi began by promising a 40 percent return in 90 days. Soon, his company was issuing 90-day notes at a 100-percent return and 45-day notes at 50 percent. To investors, the lure was irresistible. Ponzi's clerks were stacking banknotes in closets; wastebaskets were filled with dollar bills. The last fool, though, was finally found, as it always is, and the law caught on as well. Ponzi fled to Florida, where he tried his hand at real-estate fraud, and on to Rio de Janiero, where he died in a charity ward, but not before lending his name to the annals of crime.
Today, of course, Ponzi seems quaint. He was exploiting the Boston immigrant community; his scheme is transparent. And yet was Charles Ponzi's Securities and Exchange Company all that different from Reed Slatkin, the California investment adviser to whom some 800 wealthy people, including many Hollywood celebrities, entrusted nearly $600 million? Like Ponzi's company, Slatkin seemed to be manufacturing huge returns when, in fact, by Slatkin's own admission he was mostly manufacturing false earnings statements. Sometimes, the smarter or better known someone is, the more he seems willing to take nonsense on faith. Sometimes, too, the newer a con game appears the older it is.
Back in the early 1930s, Samuel Insull and his Middle West Utilities seemed like one of the few companies in a depression-ravaged economy that investors could still count on. Middle West had weathered the worst of the market collapse and come out well enough off for Insull to loan the city of Chicago $50 million to meet its payroll for teachers and police. A visionary as well as a good corporate citizen, Insull had advanced the then novel idea that central power plants should operate around the clock to help offset their high costs. To create demand for the increased supply, he pushed the idea of the "all-electric" home and even gave the language a new phrase for what he was proposing: "massing production," soon shortened to "mass production." It all worked great until 1934 when Middle West Utilities suddenly went bankrupt, exposing a long trail of crooked accounting practices, a huge pyramid of affiliates for hiding debt, and an avalanche of stock fraud that finally wiped out thousands of investors.
Substitute "Enron" for "Middle West Utilities," and you have pretty much the same story all over again: a groundbreaking approach to energy technology, a chief executive known for his large political donations and antipathy to federal regulation, a complex web of subsidiaries unknown to all but the most inside investors, and a trail of broken dreams for company employees and stockholders.
The collapse of Middle West Utilities shocked the political establishment: Within two years of its failure, Congress had passed the Securities and Exchange Act, the Public Utility Holding Company Act, and the Federal Power Act. So, too, the collapse of Enron shocked Washington. At hastily called hearings, members of Congress who only months earlier had been courting contributions from the company and heralding its innovative approach worked themselves into righteous indignation as they pilloried Enron chairman Kenneth Lay and other executives. Nor did the failure of Enron's accounting firm, Arthur Andersen, to run up a red flag go unnoticed. And yet, as always is the case with these blowups, the model was sitting out there all along. As columnist Paul Krugman wrote in the New York Times, "the most admired company in America turned out to have been a giant Ponzi scheme."
I have some specific investment strategies to suggest at the close of this chapter. Suffice it now to list three general principles that should help you avoid the Enrons of the future:
The faster a stock has climbed, the quicker it will fall. In investing as in hare-and-tortoise races, slow and steady gets the prize.
The easier information arrives, the less valuable it is. Good investment decisions are hard work, undertaken and arrived at one at a time.
The more certain the crowd is, the surer it is to be wrong. If everyone were right, there would be no reward.
And a last truth as well: As it is with societies, so it is with investing--the price of freedom is eternal vigilance.
What can you count on then? Not the reports everyone else is reading, "everyone else" being the operative phrase. Not the newspaper and magazine articles touting 10 sure winners. (A magazine with a circulation of a million or more readers that seeks to provide "inside info" is absurd on the face of it.) Not the pundits or analysts either, unless you want to turn your brain over to someone whose agenda you can't possibly know. Inform yourself, of course. Read all you can. Listen to the latest geniuses. Field test your instincts constantly, but in the end, it comes down only to yourself, to the crowd of one. The babble will always be there; the crowd will always be roaring in one direction or another. Fear and greed will always be battling for the upper hand. But remember this above all else: When everybody else is doing it, don't.
Markets as well as mobs respond to human emotions; markets as well as mobs can be inflamed to their own destruction.
--Owen D. Young
Preface: An Epidemic of Fear xv
The Bulb That Ate Holland: Tulipmania 10
Booms & Bubbles 16
New Lands, New Schemes: The South Sea and Mississippi Companies 18
Panics & Runs 25
Crash: The Great Depression 27
He Said/She Said 34
Bernard Baruch on Basic Math & Eternal Truths 37
Making the Play: The Internet and the "New" Economy 40
A Bubble Is a Bubble Is a Bubble 47
Keeping Your Head When All About You Are Losing Theirs 49
2 Rumors & Suggestions
Chicken Licken’s Apocalypse Now 61
Something from Nothing: The Alchemy of Suggestion 66
Tom Wolfe on the Beatles 76
Waiting for Godot 81
Roswell, New Mexico: Things That Go Bump in the Night 84
James Thurber on the Day the Dam Broke 88
Keeping Your Head When All About You Are Losing Theirs 94
3 Fear & Panic
Worst-Case Scenario: The Martians Are Coming! 104
Life Imitates Art, Art Imitates Life 110
The Iroquois Theater Fire: "They Had Gone Mad" 116
The Mechanics of Disintegration 120
The Fall of Saigon: "If You Have Time, Pray for Us" 123
Russell Baker: Roar of the Crowd, Inc. 126
Harry Truman on the "Harvest of Shame": What Hysteria Does to Us 130
Keeping Your Head When All About You Are Losing Theirs 135
4 Violence & Vigilantes
Los Angeles, April 29 to May 1, 1992: Dance of Destruction 144
Riffraff or Resister? 149
The Beast Within 151
Lynching: Thinking About the Unthinkable 155
An Outcome "Altogether Predictable" 158
Mark Twain: "The Pitifulest Thing Out Is a Mob" 162
"The Men Snarled and Shouted
As They Flung Their Stones" 167
Rwanda: When the Mob Is the State, Horror Becomes Ordinary 171
Keeping Your Head When All About You Are Losing Theirs 176
5 Leaders & Followers
Der Führer: The Voice of the Mob 187
Lemming See, Lemming Do 192
Following the Leader: The Violence of Nonviolence 194
Leading the Followers: Fire Within Fire 196
Off with Their Heads 200
A Little Knowledge Is a Dangerous Thing 204
Hans Christian Andersen's Tale of Leaders & Yes-Men 205
The Mind of the Mob: Stupidity Accumulates, but Also Heroism 210
Rudyard Kipling on Leading and Following 215
Keeping Your Head When All About You Are Losing Theirs 217
Text Credits 221
Illustration and Photo Credits 225
This book began more than 30 years ago with my determination to update and broaden MacKay's and Le Bon's works so that their wisdom might be made accessible to new generations still caught up in the same old groupthink. Life interfered with that goal as it often does. I had a family to raise. Launching and overseeing Institutional Investing at Goldman Sachs & Co., where I've spent almost my entire professional life, seemed to consume whole decades of time. As the years went on, I also found myself more and more involved with outside projects such as the New York Public Library and the Museum of Modern Art, where I now serve as president. But all that time I was saving string for this book: cartoons and pieces of art that caught the spirit of crowd mania, magazine articles and newspaper columns, passages from books, relevant quotations from across the centuries. Boxes filled with clippings. Then the boxes spilled over into drawers, as my wife, Joyce, will readily attest.
Now, finally, I've had a chance to sort through the files, to pick out the best examples, and to reflect in tranquility on what it all means. Inevitably, I suspect, this book will appeal most immediately to investors. That's the world I've lived in, and it's the subject I start this book with. But my hope is that the book will find a broader audience. Stock markets provide a bottom line for the madness of crowds, but the madness extends far beyond Wall Street into every corner of our political and civic life. Maybe the greatest advantage of having waited so long to finish this book is that I've had so much opportunity to see and think about this madness in action. Robert Menschel