TIP784: History's Biggest Market Bubbles w/ Clay Finck

Aligned-Incentive Bubble Structure

How three-party incentive alignment creates self-reinforcing price inflation

A bubble structure where the scheme operator, government, and investors all have financial incentives to inflate the asset price regardless of fundamentals. The operator issues fewer shares at higher prices, keeping extra cash; the government reduces liabilities or gains politically; investors see paper gains. All parties benefit from continued inflation until the mechanism breaks, leaving late entrants with catastrophic losses.

Insider Scarcity Pump

How artificial scarcity and insider control drive speculative price inflation

A four-step playbook used by bubble-era promoters: retain majority shares with insiders to control supply, promote a small public float to create scarcity, allow prices to rise as demand outstrips supply, then offload insider shares to the public at inflated prices. Banks provide leverage against shares, amplifying the cycle. Used extensively in Railway Mania and modern IPO fraud schemes.

When all parties in a system benefit from the same outcome, they will collectively act to produce that outcome regardless of external rationality.

In Practice: South Sea Company three-party incentive alignment structure

Demonstrated by Leg-cf-001

A feedback loop where each iteration amplifies the effect of the previous iterat

In Practice: South Sea leverage cycle and Japanese Zytex financial engineering feedback loop

Demonstrated by Leg-cf-001

Deliberately withholding information or creating confusion to prevent accurate assessment of value.

In Practice: John Blunt's deliberate opacity strategy in South Sea Company

Demonstrated by Leg-cf-001

Success breeds overconfidence, which leads to overreach, which triggers collapse.

In Practice: Comparison of bubble orchestrators across centuries

Demonstrated by Leg-cf-001

When regulators or government officials are financially incentivized to protect the entities they are supposed to regulate.

In Practice: South Sea directors bribing government officials with shares

Demonstrated by Leg-cf-001

Choosing not to seek information that would contradict a desired belief.

In Practice: Investors ignoring public valuation information in South Sea Bubble

Demonstrated by Leg-cf-001

The belief that even if an asset is overvalued, someone else will pay a higher price.

In Practice: Adam Anderson's observation that South Sea buyers knew prospects were hopeless

Demonstrated by Leg-cf-001

When financial records are kept private, fraud can persist far longer than with transparency.

In Practice: George Hudson's secretive accounting and false dividend payments

Demonstrated by Leg-cf-001

When supply is deliberately restricted to drive up prices.

In Practice: Railway promoters' playbook of insider-majority and public scarcity

Demonstrated by Leg-cf-001

Leverage multiplies both gains and losses. In bubbles, leverage amplifies demand

In Practice: Banks providing loans against railway shares, amplifying the bubble

Demonstrated by Leg-cf-001

When capital flows into unproductive uses at scale, it drains resources from productive parts of the economy.

In Practice: Massive railway overbuilding and worker diversion into speculation

Demonstrated by Leg-cf-001

Revolutionary technologies often produce tremendous societal benefit but poor returns for early investors.

In Practice: Comparison of Railway Mania to 1990s internet bubble

Demonstrated by Leg-cf-001

Rising asset prices enable more financial engineering (borrowing against assets,

In Practice: Japanese Zytex self-reinforcing financial engineering cycle

Demonstrated by Leg-cf-001

When companies derive majority profits from financial engineering rather than operational performance, it signals unsustainable business models.

In Practice: Japanese companies deriving majority profits from financial engineering

Demonstrated by Leg-cf-001

When banks lend based on collateral value rather than borrower cash flows, it creates a fragile system.

In Practice: Japanese banks lending on land collateral instead of cash flows

Demonstrated by Leg-cf-001

When actors believe they will be bailed out, they take excessive risks.

In Practice: Japanese banks assuming government would prevent collapse

Demonstrated by Leg-cf-001

When the government backs an investment, it creates a false sense of security driving irrational behavior.

In Practice: NTT IPO oversubscription based on belief government would support share price

Demonstrated by Leg-cf-001

When large market participants coordinate to manipulate prices, they can sustain artificial prices far longer than market forces alone.

In Practice: Japanese government ordering brokers to support the Nikkei

Demonstrated by Leg-cf-001

Lowering interest rates cannot stimulate demand when asset prices are collapsing and confidence is destroyed.

In Practice: Japanese interest rate cuts failing to revive markets after 1989 collapse

Demonstrated by Leg-cf-001

When a bubble is large enough relative to the economy, recovery can take decades

In Practice: Japanese market taking 35 years to return to 1989 peak

Demonstrated by Leg-cf-001

Railway Mania of 1845 as precedent for 1990s internet bubble

The Railway Mania of 1845 is one of history's first examples demonstrating that revolutionary new technology does not necessarily produce good returns for investors at large. Despite railways transforming society with faster, cheaper transportation, most railway investors lost tremendous wealth as over 8,000 miles of track were built in just a few years, consuming the nation's capital resources. The parallel to the 1990s internet bubble is precise: both involved transformative technologies, massive capital inflows, widespread speculation, and catastrophic losses for most investors despite the technology's genuine societal benefit. One key difference: internet companies required far less capital to launch, as a few programmers could spin up a website versus building thousands of miles of physical track. This suggests a general principle: avoid investing in hyped new technologies when capital is pouring in, as the competition for returns and capital misallocation typically destroy investor value even when the technology succeeds.

Chancellor comparing Railway Mania to 1990s tech bubble, noting both involved revolutionary tech that failed to reward early investors

Keynes on deflation: monetary policy like pushing on a string

John Maynard Keynes observed during the Great Depression that in deflationary conditions, monetary policy is no more effective than pushing on a string. This insight, applied to the Japanese bubble collapse, explains why interest rate cuts to 0.5% in 1995 and 0.25% in 1998 failed to revive the market or economy. When asset prices are collapsing, consumer confidence is destroyed, and banks are insolvent, lowering interest rates does not create demand for credit. Borrowers won't borrow if they don't believe in future returns, and banks won't lend if collateral values are falling. The 'string' metaphor captures the asymmetry of monetary policy: you can pull on a string to tighten, but pushing on a string to stimulate is futile. This principle applies to all deflationary collapses following bubbles: once the psychology shifts from greed to fear and asset prices enter freefall, central banks lose their primary tool.

Explanation of why Japanese interest rate cuts after 1989 bubble collapse failed to revive markets for 35 years

Railway King, Chairman of York and North Midland Railway

Director of the South Sea Company

Former Cashier of the South Sea Company

annuities

Fixed income streams paid annually, typically from government bonds

“In 1719, the South Sea Company took over £1.7 million of government debt in the form of annuities, which it then converted into South Sea stock.”

stags

Speculators who buy shares with no intention of holding, hoping to flip quickly for profit

“Speculators known as railway stags had no intention of meeting subsequent calls on shares.”

Zytex

Japanese term for financial engineering using corporate cash for speculation

“Japanese companies started to supplement regular income from operations with interest earned on token accounts.”

Director of South Sea Company, orchestrated the 1720 bubble

Former South Sea Company cashier

Railway King of 1840s Britain

British economist

Debt privatization

Converting government debt into private company shares, transferring obligations to equity holders

Regulatory capture

When regulators act in the interest of entities they regulate rather than public interest

Greater fool theory

Buying overvalued assets expecting someone else will pay even more in the future

Moral hazard

Taking excessive risks because you believe someone else will bear the consequences