Monday, September 19, 2011

The Time Charles ('Popular Delusions...') MacKay Thought 'This Time it's Different'

The British Railway Mania has so many lessons for investors that I'll have to devote a couple posts to the subject.
I did mention the Mania in last year's "UPDATED: Visualizing Bubbles":
...The 1845 British railway bubble is also problematic. I don't know of any index that the chartmeisters could use to derive the 100% figure from and individual issues exceeded that degree of movement, some increasing 500 or 600%.

Also, a lot of the railway issues were subscriptions which meant that the 'scrip' traded (not legally) prior to the issuance of the stock....
Here's the latest:

Charles Mackay’s own extraordinary popular delusions and the Railway Mania
Andrew Odlyzko
School of Mathematics
University of Minnesota
Minneapolis, MN 55455, USA»odlyzko
Preliminary version, September 14, 2011

Abstract. Charles Mackay’s book Extraordinary Popular Delusions and the Madness of Crowds enjoys extraordinarily high renown in the financial industry and among the press and the public. It also has an extraordinarily low reputation among historians.
This paper argues that Mackay’s sins of commission were dwarfed by his sins of omission. He lived through several giant investment manias in Britain, yet he did not discuss them in his books. An investigation of Mackay’s newspaper writings shows that he was one of the most ardent cheerleaders for the Railway
Mania, the greatest and most destructive of these episodes of extreme investor exuberance. Mackay’s story provides another example of a renowned expert on bubbles who decides that “this time is different.” His moves through a sequence of delusions help explain the length and damage of the Railway Mania. He was a free market and technology enthusiast, and faced many issues that are important today, such as government ownership or regulation, interconnection, standardization, structural separation, and analogs to net neutrality. A crushing national debt and high unemployment in an economy pulling out of a deep depression (and in perceived danger of falling into another one) were very important in shaping attitudes towards railway expansion. The analogies and contrasts between Mackay’s time and ours are instructive.

1 Introduction
Charles Mackay’s book, Extraordinary Popular Delusions and the Madness of Crowds [27], first published in 1841, is famous for its depictions of irrational mass behavior. The popular press cites it extensively whenever there is concern about a potential new financial bubble. It is on the recommended reading list of the prominent investment bank Goldman Sachs [16], and a recent book used it as the basis for a collection of investment principles [42]. Bernard Baruch praised it highly, and apparently credited it with helping him sense market peaks ([18], pp. 95n, 252–253). Michael Lewis, known best for his colorful descriptions of Wall Street, included the chapters on financial manias from Mackay’s book among his “Six Classics of Economics,” thereby ranking Mackay with Adam Smith, Thomas Malthus, David Ricardo, Thorstein Veblen, and John Maynard Keynes [24].

Scholars who are have investigated Mackay’s book have a different view. Peter Garber found that in the treatment of the Tulip Mania, Mackay “plagiarized most of his descriptions from Beckmann [a German scholar of the late 18th century] with a little literary embellishment.” Beckmann, in turn, relied on pamphlets written shortly after the collapse of that mania of the first half of the 17th century that “were motivated by a moralistic attack against speculation” ([11], pp. 29–30) but did not have solid, verifiable information.
The more recent very thorough study of the Tulip Mania by Anne Goldgar similarly concluded that as a result of the extensive reliance in the literature on Mackay’s account, “we are left with a picture of tulipmania based almost solely on propaganda, cited as if it were fact” ([15], p. 6). Still, Mackay’s colorful style is appealing, and Ross Emmett, another recent scholar, wrote that Mackay’s “tale reaches further than the facts, but that should not stop us from enjoying it” ([10], vol. 1, p. 2).

The history and status of Extraordinary Popular Delusions have been covered in some detail in [25], for example, and are reviewed briefly in Section 3. The role of this work in shaping popular perceptions and the reasons it became very popular have also been covered in the literature, for example in [20,25].

The goal of this paper is to consider two points that have been overlooked in previous studies. One is the striking deficiency of Extraordinary Popular Delusions in not covering the great investment manias of 19th century Britain. The other is the role that Mackay himself played in stimulating and sustaining the greatest of these episodes of financial exuberance, the Railway Mania. The exploration of these two issues helps explain the size and persistence of the Mania. It also provides some interesting perspectives on the public policy issues of the 1840s, most of which bear close resemblance to modern ones. Mackay (whose life and work are outlined briefly in Section 6), was born in 1814, and died in 1889. Thus he lived through the four great investment manias of 19th century Britain, that of the mid-1820s, followed by one in the mid-1830s, the Railway Mania of the mid- to late-1840s, and another railway mania in the mid-1860s. (They are sketched in Section 2.) Yet there is practically no trace of them in Extraordinary Popular Delusions, nor in Mackay’s reminiscences [31,32].
MORE (48 page PDF)
HT: Simoleon Sense