Manias, Panics and Crashes

Manias, Panics and Crashes: A History of Financial Crises is a classic analysis of the factors and causes of financial crises. In its sixth edition Kindleberger (and Aliber) added analysis of the 2008 housing bubble crash and worldwide consequences. Throughout the book they use an “anatomy of a typical crisis” as a framework and jumping off point to analyze different historical crises while recognizing that each crisis is different. Their model, based on that of Hyman Minsky, is that manias, panics and crises result from a pro-cyclical supply of credit. The cycle starts with a ‘displacement’ or shock that leads to a boom/mania, which they also call the transition from rational to irrational exuberance, involving an expansion of credit which creates a cycle of positive feedback and ever increasing expansion of credit. Then comes revulsion, when some signal event precipitates the crisis and prices decline and credit contracts. This contraction or ‘discredit’ triggers collapses and bankruptcies. The authors follow these premises through their relationship with the economic idea of the rationality of markets and trace in depth the ways these phases of the cycle have looked in historical cases, with chapters on the mania, distress, and euphoria phases. They also address the issue of fraud and cheating and their role in crashes and argue that fraud is also pro-cyclical, expanding as the market and its euphoria expands and sometimes precipitating the bubble burst when revealed. Kindleberger and Aliber address several other issues related to manias, panics, and crashes including an intriguing critique of the IMF’s role and seeming failure as an international lender of last resort. Additionally they analyze the potential of legislation to prevent future crises, and conclude that because legislation does do much to address of regulation expansion in the supply of credit and cannot prevent parallel systems that are developed to avoid regulations post-2008 regulation could not prevent another bubble and crash.

 One of Kindleberger and Aliber’s the most interesting points of analysis is their link between the four major financial panics that have occurred since 1980. Kindleberger and Aliber repeatedly mention that this concentration of four major international panics in thirty years is unprecedented. They provide and interesting and pervasive argument that the four crises were linked as a crisis in one area of the world facilitated and motivated the movement of credit and capital to another region causing a bubble and eventually a crash. Their argument is that increases in economic growth in primary producing countries allowed the expansion of credit to South America, when the bubble collapsed South American currencies depreciated rapidly. When this happened trade balances in developing countries morhphed into trade surpluses. This would then lead to appreciation of their currency and reduction in their trade surpluses. The Japanese did not want to accept decline in their trade surplus and therefore dampened the appreciation of the yen by increasing the money supply. This increases in money supple increased the supply of credit allowing the real estate boom in Japan. When the Japanese bubble collapsed the yen appreciated and Japanese firms increased their investment in Southeast Asian economies at the same time investment banks starting using “emerging market equities” as new asset class. This expansion of investment and credit in Asia created the Asian crisis. When that bubble popped creditors moved their money to the safer US creating the US stock price bubble, which imploded. After the implosion the dollar depreciated, which combined with debt repayment on the loans made after the Asian crisis created capital inflow into the United States and fueled the housing bubble. This argument provides a convincing link between these major financial events that I have never encountered before but seems to neat and fails to account for or discuss why exactly capital flowed to those particular regions over other possible directions.

 By the end of the book Kindleberger and Aliber’s argument that changes in the supply of credit are the source and mechanism of both manias and panics seemed so obvious and common sense that I wondered why it needed an entire book to explain. They wove the point into every chapter and most of his analysis and showed extensively how it worked in many different crises. This repetition combined with the fact that his point about credit expansion is now conventional wisdom combine to make Kindleberger’s point unsurprising. However it seems from the counter-arguments that he addresses in the book that it has not always been so and regardless, he managed to illustrate the point in multiple ways so that by the end the reader has a thorough understanding of exactly why “the cycle of manias and panics results from the pro-cyclical changes in the supply of credit.”

Kindleberger and Aliber weave historical examples of panics into every point. From the famous tulip bubble in Holland to the South Sea bubble and the Great Depression, they cover a wide range of historical crises from different eras, regions of the worlds, and types of asset bubbles. This thoroughness adds considerably to their analysis, both providing copious support and illustration to their theory and pulling out the aspects of financial behavior and economic principle that have remained consistent over time. The main problem with their use of historical crises is that in weaving them in throughout they neglect to ever thoroughly explain the history and mechanics of the crises and do not even give summaries until the eighth chapter. This makes the book and their points difficult to understand when the reader does not have a background in economic history. Overall they effectively illustrate both the theory and historical reality of their thesis that the “cycle of manias and panic results the pro-cyclical changes in the supply of credit” (13) despite excessive repetition and the confusion of copious unexplained historical references.

citation: Kindleberger, Charles Poor, and Robert Z. Aliber. Manias, Panics, and Crashes: A History of Financial Crises. 6th ed. New York: Palgrave Macmillan, 2011.