**2. Speculative asset bubbles in modern financial history**

Although examples of speculative bubbles are recorded in ancient times, in more recent times the most commonly cited early example of a speculative asset bubble is the Tulip Bubble in the 1600s. Tulips imported from East to Holland in the 1600s became a collector's item, and tulip bulbs were sold as very high prices. An influx of speculative funds was accompanied by a surge in financial innovation until the bubble burst in 1673, and many who had purchased bulbs on credit went bankrupt, precipitating an economic depression all over the country [8, 9].

A second commonly cited speculative bubble in early modern financial history was the collapse of the South Sea Company, reported in England in 1720. The South Sea Company was a joint stock company, which was awarded a Royal Charter (monopoly rights) to trade in North and South America, and became the subject of massive speculation throughout Europe. The company's share price, recorded at £128 in January 1720, increased almost tenfold to £1000 over the next 6 months to July 1720. By the end of 1720 following a bursting of the bubble, however, it had reverted to £124 per share [10].

It was in early 1920s that the Florida real estate bubble burst. However the ability to purchase real estate with a down payment of 10% provided the leverage to the asset bubble. Accordingly house prices went up grabbing more peculators in to the business. The bubble burst in advance with a typhoon hitting Florida causing massive property damage. The sudden drop in prices paved the way for bankruptcies and default. The Great depression, the most longest, widespread, and deepest depression of the 20th century took place after the stock market crash of October 29, 1929. The speculative asset bubble started to grow in late 1920s' with the boom in many industries<sup>3</sup> resulting stock market speculation and paving way for thousands of investors to invest in the stock market, were as most of the investors have borrowed the money for investments. The asset bubble rose to such a high extent that the lenders have given loans up to three times of the face value of the stocks investors have purchased. Expecting stock prices to raise more, more and more funds were invested in the stock market creating a massive asset bubble by 1929. At the end with the dropping commodity prices the stock prices began to fall. By October 29, panic selling started and the stock market collapsed, leading to the longest depression in the world history [11–14].

The 'Tronics' burst took place in 1961 with emergence of electronics in the market. A number of investors were keen on investing shares belonging to

<sup>3</sup> Steel production, building, automobiles etc.

companies dealing with electronics. With the bubble burst in 1962, the share prices went down significantly. A speculative asset bubble, similar to the bubble in 1920s, took place in US by 1984. The speculative asset bubble was believed to be built on leverage and loose government economic policy. Similar to the event took place in 1920s. Junk bonds were the financial innovation of the day. The debts of less creditworthy companies were used as a tool to purchasing companies. Program trading and stock index futures were the other financial innovations. The Bubble peaked in October of 1987 followed by a stock market crash in a in a single day. Even though the public expectation was an economic depression, with the federal guarantee that they would guarantee the credit of market makers the recession never took place [15, 16].

As investors became increasingly reluctant to invest in securities based on sub-prime housing mortgages, this financial distress spread to securitizers of a sub-prime mortgage loans, and was further exacerbated when credit rating agencies such as Standard & Poor's, Moody's, and Fitch downgraded many mortgage-backed securities. In the words of Allen and Carletti, the mortgage-backed sub-prime home loan securitization market 'simply broke down' and a general loss of confidence became more widespread, affecting commercial asset-backed securitization markets in the latter half of 2007. Banks sponsoring many residential and commercial securitizers were required, under the terms of cross-guarantee arrangements, to pay debts that otherwise would have remained off-balance-sheet as contingent

*Political and Institutional Dynamics of the Global Financial Crisis*

*DOI: http://dx.doi.org/10.5772/intechopen.90728*

Institutional and corporate investors internationally had also purchased securitization products, adding to the linkages between large financial institutions in different jurisdictions. At about the same time, other banks in the United States, Britain and elsewhere in Europe—themselves uncertain about the extent to which they might be called to make unexpectedly large payments from their reserves under their own cross-guarantee arrangements with related securitizers and other companies—became reluctant to provide any more than very short term liquidity (of more than a few days' tenor) to each other. Institutional investors engaged in a 'flight to quality', investing in highly liquid, secure assets such as Treasury bills and other government securities. In approximately March 2008, company reports of further bad debts and asset write-downs because of mark-to-market accounting increased uncertainty about counterparty risk levels, with the result that global investment bank Bear Stearns Companies Inc. was unable to secure wholesale funding to continue its operations past mid-March, when it was sold to JP Morgan

Chase & Co. for approximately 7% of its pre-crisis equity value [2, 19].

Internationally, central banks in consultation with their governments intervened in their respective economies by markedly reducing official or cash rates; injecting liquidity into the system by effectively lending to primary dealers (e.g. by allowing them to swap less liquid asset-backed securities for Treasury securities, often at a substantial discount); and so-called government 'bailouts' of securitizing institutions perceived to be economically significant or 'too big to fail' (such as Northern Rock in Britain; and Bear Stearns, Fannie Mae and Freddie Mac in the U.S.).<sup>5</sup> In subsequent months, real economies in the United States, Britain and elsewhere in Europe have exhibited historically poor performance, with relatively high unemployment and low economic growth, despite relatively low interest rates and

Abstracting somewhat from this background, the GFC's chief characteristics as identified in the literature can be clustered around excessive system liquidity; high levels of executive compensation by community standards; high levels of financial innovation; banks and other financial intermediaries undertaking activities beyond their traditional roles; speculative asset bubbles; and the U.S. sub-prime crisis and

<sup>5</sup> A number of high-profile investment bank securitizers requested government support, including Bear Stearns, Merrill Lynch, Wachovia, Goldman Sachs, and Morgan Stanley. Of these, Bear Stearns, Merrill Lynch and Wachovia were ultimately sold at well below their year high equity prices, while Goldman Sachs and Morgan Stanley ultimately became commercial bank holding companies, subject to prudential regulation but able to access Federal Reserve swaps into liquid assets at substantially discounted prices.

Another high-profile securitizer, Lehman Brothers, went into involuntary liquidation [21].

liabilities [6, 17].

inflation [20].

**61**

the fallout resulting from it.

In 2007 the housing prices in US believed to have grown more than 100%, within a decade's time. These bubble in house prices paved the way for house owners to refinance their houses at a lower rate and further to gain a second mortgage with backed by the price appreciation. Backed by large investment banks, small banks funded brokers by buying loans for the mortgage broker. Lending to the subprime market was significant by the time, enhancing the housing bubble. Compared to 2006 the housing prices declined 20% by September 2008. Leading borrowers to default. Douglas et al. (2012) identifies the 2007-8 Global financial crisis had resulted in significant negative impact all over the world, while making policy makes re-consider the fact that they can or should manage such asset bubbles [5–7].

Humans never seems to learn from their mistakes as greed becomes the prominent decision making factor for the human-financial decision making.<sup>4</sup> The main factor that distinguish GFC from the rest of the crises is the fact that DFC 2007 is based on a housing bubble. Yet, ironically all financial crises are based on some sort of an asset. In 1600s it was the Tulip Bubble. In South Sea bubble it was company stocks. Again in dot.com bubble it was company stocks. In each occasion a financial asset accumulates its price creating a bubble, which breakouts suddenly with changes in surrounding economic factors. Hence at a glance the GCF is quite unique, since it developed on real estate prices. Yet, a deep analysis revels that underling mechanism of the GFC is no difference to the rest.
