Wednesday, 22 February 2012

Bubble: development of the Bubble

With dramatically rising demand, tulips became a stock of mass production and bulblets were sold while still in the ground, half a year prior to its lifting. This developed a futures market. The deception increased even further in the market, speculators bought tulip bulbs hoping that after lifting the value would have increased allowing them to re-sell it to other buyers, thus generating a profit. The market became very opaque: sellers did not know what they were selling, buyers-what they were buying.

In 1636, November – December, the trade in tulip bulb futures reached the peak of absurd - prices tripled (very popular breed prices went up 10 times), even previously despised plain tulips were sold, bulbs no longer were sold by its weight, but could be purchased in a dozen, pounds or baskets. Greedy Dutch deposited everything they had to pay off the purchase: from clothes and cows, to land and houses. The market became entirely speculative: it no longer involved exchange of goods, instead paper contracts and promises – buyers held no cash to finance their purchase, sellers held no actual bulbs. The uncertain ownership of tulips shifted amongst speculators while bulbs were still in the land.

This situation is similar to a real estate bubble of 2005, when at its peak people stopped thinking and took out levels of debt that they could not afford to pay back, and all only to project their “wealth”. Borrowers started taking out loans, promising to pay it off with expected future earnings, in order to purchase something they cannot afford. Banks gave out loans to high risk borrowers, despite the fact the reserves they held were not large enough to finance it, and so banks needed to borrow from other banks. It later led to a ‘credit crunch’, a number of banks failing in 2007-2008.

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