Stock Market Trouble: Five Books for Executives

I have just re – read four of the great books on stock-market debacles: Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds (1841); John Kenneth Galbraith’s The Great Crash (1954); Charles P. Kindleberger’s Manias, Panics, and Crashes (1978); and Edward Chancellor’s Devil Take the Hindmost: A History of Financial Speculation (1999). I strongly recommend them not only to investors, but executives as well. For further perspective, and especially because it was written in the lead-up to 1929, I also recommend Edwin Lefevre’s Reminiscences of a Stock Operator (1923).

In this, the first Ivey Business Journal issue of the new millennium, it may seem odd to be advocating literature that goes back to the time of Charles Dickens. Executives will find these books not only deliciously entertaining trips through epochal events, but also wonderful descriptions of the shenanigans and characters on the seamier side of financial history. They will also discover a treasure chest of anecdotes, advice, perspectives and wisdom on recognizing, projecting, mitigating and managing improvidence, excess, irrationality and the herd instinct as they apply to financial markets. More generally, these books are a case study in ego, greed, arrogance and stupidity and where they can lead. For executives, the trick is to read these books and come away wiser and better armed to run an enterprise in the 21st century, not frustrated, fearful or immobilized by the events of the day.

  • Extraordinary Popular Delusions is the story of the herd instinct and how, from time to time, it can lead the masses astray with disastrous consequences. It is a colourful and thoughtful account of some of the great manias, madnesses and delusions of history, including three spectacular financial fiascos: the Mississippi Bubble in Paris in 1719, the South-Sea Bubble in London in 1720, and Tulipomania in Amsterdam in 1637. For insight into how and why human irrationality can turn even the smallest event or issue into a life-of-its-own uncontrollable madhouse, you will find Extraodinary Popular Delusions tough to beat. To quote Mackay, “Every age has its peculiar folly; some scheme, project or phantasy into which it plunges, spurred on by the love of gain, the necessity of excitement, or the mere force of imitation.” In the forward to the 1979 edition, the writer Andrew Tobias says, “My God, I was impressed. What esoterica!… I subsequently learned that any business professor worth his salt would have had this book at tongue’s tip.” The legendary financier Bern a rd Baruch credits Extraordinary Popular Delusions with saving him millions.
  • The Great Crash is a compelling account of the stock market crash of 1929. It is folksy and personal. Galbraith says, “I never enjoyed writing a book more; indeed, it is the only one I remember in no sense as a labour but as a joy.” It shows! I cannot imagine an executive not being captivated. Galbraith’s goal is straightforward: “These speculative episodes have occurred at intervals throughout history, and the length of the interval is perhaps roughly related to the time it takes for men to forget what happened before. The useful task of the historian is to keep the memory green…. A good knowledge of what happened in 1929 remains our best safeguard against the recurrence of the more unhappy events of those days.” Executives will find The Great Crash helpful in distinguishing between a bubble-based market and a substance-based market.
  • Manias, Panics, and Crashes is a scholarly but highly readable trip through the history of financial crises from the Mississippi and South-Sea bubbles to the June, 1974, failures of the Herstatt Bank of Cologne and the Franklin Bank of New York. Kindleberger’s goal is to illustrate the causes and consequences of mania (a bubble in asset prices driven by an irrational excitement about business possibilities), panic (a sudden, equally irrational fright) and crash (a collapse in asset prices brought on by the mindless excesses of the mania and then the panic). Kindleberger is not as entertaining as Galbraith, but executives will find insight in his study of 250 years of financial crisis. Executives who read Manias will make reference to its anecdotes and arguments often in their careers.
  • Devil Take the Hindmost is the most comprehensive and up-to-date book, covering Tulipomania to the speculative blowout in Japan in the late 1980s, the Asian Crisis in 1997 and the Long-Term Capital Management fiasco in 1998. Chancellor’s credentials for writing a history of financial debacle are impeccable: history studies at Cambridge and Oxford, investment banking at Lazard Brothers and freelance writing for the Financial Times and The Economist. Chancellor knows markets and he has a gift for storytelling and detail. Devil may not endure like the others, but it is still worth an executive’s time. Chancellor correctly believes “that speculation can only be understood within a social context, and that a history of speculation cannot simply be a description of economic affairs but must also be something of a social history.” The Devil Take the Hindmost title refers to the South-Sea Bubble expression for no-holds-barred, do-whatever-you-have-to-do-to-win competition.
  • Reminiscences of a Stock Operator is a treasure. In the introduction to the 1964 edition, Benton W. Davis of “Ben Davis Says” fame describes Reminiscences . “There have been hundreds, probably thousands of books written about Wall Street, some interesting but most dry as dust….Reminiscences is, of all things, a book of fiction. It is the story of one Larry Livingston and his operations in Wall Street during about the first 50 years of his life. Yes, it is a book of fiction. But, over the years, I have regarded it, and recommended it, as just about the best single all-around textbook on the subject (of the market).” I include Reminiscences partly because today’s generation of executives may not be aware of it and what they are missing, and also because it is so thoughtful on one issue of absolutely huge importance — knowing whether you are in a bull or a bear market, and whether the major trend is up or down. In the resolution of that lies insight into whether a bubble has legs or the needle is near. Reminiscences was written in 1923, in a market very different from today’s. But read it and I am sure you will find Larry Livingston and his lessons timeless.

There are a number of reasons why I encourage executives to have a look at these books. First, ongoing business success depends crucially on being able to effectively read changing business conditions. Enterprises that are continually surprised by the vagaries of economic growth, consumption, investment, inflation, interest rates and the dollar prosper over time only by accident. Strategy and execution are the keys to enduring profitability, competitiveness and industry leadership. A flawed view of emerging business conditions inevitably assures flawed strategy and execution. For an enterprise, it is usually a short step from flawed strategy and execution to trouble.

These books deal with the stock market — one of the most important business conditions in its own right and a major factor in most other business conditions. When the stock market is potentially hugely overvalued, it is arguably the most important business condition of all. To quote Galbraith “[Until the market crash], there were no reasons for expecting disaster [lengthy depression]…. Only after the market crash were there plausible grounds to suppose that things might now for a long while get a lot worse.” These books offer executives help in incorporating the likely course of the stock market into a picture of emerging business conditions, especially when the stock market is overheated.

One word links a crashing stock market with crashing business conditions: confidence. Nothing is more important to a properly functioning economy than consumer and investor confidence; nothing will knock the stuffing out of consumer and investor confidence faster than a stock market crash. Stock market crashes do not always produce economic catastrophe (for example, October, 1987), but the wise do not bet against it. That popular schoolyard ditty of the 1930s is instructive:

Mellon (the Treasury Secretary) blew the whistle,
Hoover (the President) rang the bell,
Wall Street gave the signal,
The country went to hell.

The second reason executives will find these books interesting is that they provide insight into today’s breathtaking stock market. Is today’s stock market a bubble with a needle lurking? Or is it justified by fundamentals like growth, productivity and earnings? No question is more important to future business conditions. The only thing we know for sure is that the stock market has been on an incredible tear. On paper, at least, many are richer than they ever remotely believed possible.

Every financial debacle has its own cause-effect story. That said, these books identify some common threads. Kindleberger sees speculation, extended credit and excessively easy money as the underlying culprits in stock market crashes. The spark, he believes, is “…some incident which snaps the confidence of the system.” Galbraith says, Watch out when the stock market becomes part of the culture. “By the summer of 1929 the market not only dominated the news. It also dominated the culture.” He focuses on mood: “Far more important than rate of interest and the supply of credit is the mood. Speculation on a large scale requires a pervasive sense of confidence and optimism and conviction that ordinary people were meant to be rich…. An inordinate desire to get rich quickly with a minimum of physical effort.” To Galbraith, a speculative market also needs plentiful savings. Chancellor agrees with the great Austrian economist Joseph Schumpeter, “Speculative manias generally appear during periods of profound economic upheaval.” To Mackay “(People) go mad in herds, while they only recover their senses slowly, and one by one.”

So is today’s stock market a speculative bubble? I hesitate to answer. Irving Fisher, one of the finest economists America has ever produced, may best be remembered for what Galbraith called his “immortal estimate,” which he made in the fall of 1929: “Stock prices have reached what looks like a permanently high plateau.” A few weeks later the stock market crashed and The Great Depression was on. The only really honest answer is “Who knows?” But let me suggest there are many reasons for optimism about today’s stock market: wise leadership at the Federal Reserve — arguably the world institution most able to preserve stability and prosperity; well-developed early warning systems that should enable preventive action ahead of serious trouble — that is what the soft-landing exercise currently under way is all about; steadily improving corporate governance practices that increasingly assure sound financial reporting and good management; stunning productivity growth; well-behaved unit labour costs; spectacular capital investment; an extraordinarily diversified world economy that accordingly lowers the risk of serious global setback; an absolute conviction among key policymakers that a 1930s will never happen again, and an absolute willingness to do whatever it takes to avoid it. To me, the case is compelling that today’s stock market is fundamentally based. But if you invest any money based on my view, you are on your own!

All that said, Galbraith gets the last word on where the current stock market is headed. He writes: “So someday, no one can tell when, there will be another speculative climax and crash. There is no chance that, as the market moves to the brink, those involved will see the nature of their illusion and so protect themselves and the system. The mad can communicate their madness; they cannot perceive it and resolve to be sane.” For perspective, the great technological company of 1929, the Nortel of its day assuredly leading all into the promised land, was Radio Company of America (RCA). In 1929, RCA stock sold for $114; three years later it was $2.50. Indeed, who knows!

Third, executives will find that these books offer insight into the proper practice of management when stock markets are precarious. Galbraith is particularly thoughtful on debt: “The word that a man had ‘got caught’ by the market was the signal for his creditors to descend on him like locusts.” Prudent finance is always in style; excessive debt is always an accident waiting to happen. If you want control of your enterprise, do not make yourself a hostage to bankers; the “locusts” are never far away when you have too much debt. The best protection against a major stock market reversal is a strong balance sheet and good investment community relations, along with committed staff, sound ethics, a strong customer focus, quality products, competitive costs and a willingness and ability to adapt and innovate.

Fourth, important executive responsibilities are financial structure, investment and acquisition. Each is dependent on the likely course of the stock market. The time, for example, to issue equity is when the stock market is strong. Otherwise dilution occurs. These books should be especially interesting to executives these days, what with equity markets such an important source of start-up and other investment capital, share exchanges such an important part of acquisitions, and stock options such an important part of executive pay packages.

Fifth, these books are about debacle and catastrophe. But any good executive knows that in everything, including debacle and catastrophe, there is opportunity as well as threat. Executives will find these books insightful on seeing and exploiting opportunities in serious stock market difficulty. As Edwin Lefevre writes: “When something happens which you did not count on when you made your plans, it behooves you to utilise the opportunity.”

Finally, remember that knowledge is credibility and nothing should be more important to an executive than credibility. These books will greatly enhance an executive’s knowledge of business history in general, and stock market history in particular.

On Dec. 5, 1996, Alan Greenspan uttered probably the two most famous words ever said by a Federal Reserve Board Chairman: “Irrational exuberance.” Irrational exuberance is the territory of these books. Given the stock market today, they are particularly timely executive reading. But they are timeless. Enjoy!

About the Author

John S. McCallum is Professor of Finance at the I. H. Asper School of Business, University of Manitoba, and former Chairman of Manitoba Hydro. Contact