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savings of many citizens and fueled an overall decline in the European economy with the Dutch economy suffering into the 1640s.

      Dot-Com Bubble of 2000: Another more recent example of the bursting of an asset bubble was the dramatic rise and fall of Internet stocks in the late 1990s. Per one index that tracked the performance of Internet stocks, prices of this sector rose 1,000 % from October 1998 to February 2000.17 Prices started to drop in February 2000 and ultimately lost 80 % of their peak value by the end of 2000, equating to approximately $8 trillion in lost market value. The Internet bubble exhibited similar characteristics of previous bubbles, including over-inflated prices driven by speculative buying, subsequent selling by insiders, short selling made easier by significant increases in asset float, and an eventual crash in prices.

      Speculative Manias: Many crises throughout history can be traced to the rampant speculation by investors in any number of assets or investment opportunities. Herbert Simpson in a 1933 paper discusses the urban boom and collapse in the period 1921–30:

      The economic history of this country is colorful with recurring speculative epochs and episodes, growing out of varying conditions and with varying effects upon our economic structure and welfare. We have had periods of gigantic speculation in western lands; periods of oil and mining speculation; periods of bank speculation; and of railroad speculation. 18

      The term mania implies that investors are behaving irrationally. This contrasts with the rational expectations assumption, which holds that investors behave rationally and react to changes to economic variables as if they are fully aware of the long-term implications of such changes. This is an example of the long-used axiom that all available information about a company is fully reflected in its security price, as investors theoretically react immediately to any new news about the company. Many theories exist as to why investment manias occur. One example is groupthink, when all investors in a market change their views simultaneously and act together.

      The South Sea Company of 1720: An example of an event that can be categorized as a speculative mania, which in turn led to an asset bubble, occurred in Britain in 1720. The South Sea Company had been given special rights by the British government to trade with Spain's American colonies, which resulted in an effective monopolistic position. The price of the company's stock rose 330 % in a five-month period to £550. Following its success, several other companies attempted to enter this market and trade in the same stock market. The South Sea Company successfully convinced Parliament to approve what was called the Bubble Act of 1720, which prevented such firms from becoming publicly traded, further boosting their stock price to over £1,000. Insiders of South Sea Company realized the company's business opportunities did not support a price so high and started to sell, fueling a dramatic decline in the share price to below £100 before end of the year. Consider the following comment by Adam Smith about the South Sea Company crisis:

      The evils of reckless trading are always apt to spread beyond the persons immediately concerned. When rumors attached to a bank's credit they make a wild stampede to exchange any of its notes which they may hold; their trust has been ignorant, their distrust was ignorance and fierce. Such a rush often caused a bank to fail which might have paid them gradually. The failure of one caused distrust to rage around others and to bring down banks that were really solid. 19

      The Great Depression: The 1921–30 period of investment speculation in the United States was fueled mainly by growth of urban populations and wealth. The rural sections of the country had been in a state of depression throughout most of this period, and the very cities in which active real estate speculation had been carried on had been surrounded by rural populations in severe distress. It was the agricultural depression that led to shifting population, income, and wealth to the cities, in addition to the numerous other factors contributing to the urban growth of this period. The urban population of the United States increased 14.5 million in the decade 1920–30. It was this growth of urban population and wealth that provided the basis for real estate speculation.

      As such, real estate, real estate securities, and real estate affiliations in some form were the largest single factor in the failure of the thousands of banks that closed their doors during the Great Depression. We discuss the Great Depression in detail in Chapter 14.

Banking Crises

      Systemic events often occur not because of a single idiosyncratic event, but rather the linkages or spillovers that occur among several different segments of the financial system or global economy. A good example of such a common linkage is the prior discussions about asset booms in real estate, often fueled by speculative behavior on the part of investors, which is financed by the banking sector.

      Banking crises may be defined as either the failure, takeover, or forced merger of one of the largest banks in a given nation or, absent such corporate events, a large-scale government bailout of a group of large banks in that nation. Using this definition, there have been a tremendous number of banking crises that have occurred globally throughout history. Dating back to the year 1800, 136 countries have experienced some form of banking crisis.20

      A high rate of banking failures occurred during the Great Depression of the 1930s in the United States. Following this period of extreme global banking stress, there was a prolonged hiatus of failures between 1940 and the 1970s, after which several events such as the breakup of Bretton Woods fixed exchange rate system and a spike in oil prices led to an extended global recession and a renewal of bank failures.

      The volume of bank failures during the past 30 or 40 years has been much larger in scope than in previous decades. For example, between 1970 and 2011 there have been 147 episodes of systemic banking crises around the globe and the costs to society have been substantial.21 While not every recent banking crisis was of equal magnitude, with some representing isolated events, many have had systemic implications for a nation or even the global economy.22

      During the 1980s, many Mexican banks failed as a result of the country's currency devaluation and credit losses to local banks. Also during the 1980s, U.S. taxpayers suffered losses of more than $100 billion due to the failure of approximately 3,000 U.S. savings & loan associations and thrift institutions. In Japan, the economy continues to recover from the collapse of its banking system in the 1990s, fueled by the bursting of asset bubbles in real estate and stocks. The Japanese banking crisis led to 25 % reduction to the gross domestic product (GDP).23 In March 2001, a bank run occurred in Argentina that led to partial withdrawal restrictions and the restructuring of fixed-term deposits to stem the outflow of funds. Lastly, the recent Credit Crisis resulted in hundreds of bank failures and set off a prolonged economic contraction in both the United States and Europe. During this crisis, the stock market in the United States fell by 42 %, and the U.K. market fell by 46 % (in dollar terms). Similarly, the global GDP fell by 0.8 %, representing the first decline experienced in many years, while international trade fell 12 %.

Sovereign Debt Crisis

      There have been numerous prior crises brought on by the default by governments on both their external debt (e.g., default on payment to creditors under another country's jurisdiction), as well as domestic debt. There were at least 250 sovereign external defaults during 1800–2009 and at least 68 instances of default on domestic public debt. Perhaps the most well-known example of the former was Argentina's 2001 default on $95 billion of external debt, while a notable example of the latter was Mexico's 1994–1995 near default on local debt.

During the 500-year period ended 1799, both France and Spain could be considered serial defaulters, with these nations defaulting on their external debt on eight and six occasions, respectively (see Table 2.2). The dominance of France and Spain as serial defaulters pre-1800 may be explained by the basic fact that these countries were the only ones that had the resources and stability to engage in international trade and borrowing on a large scale.

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