Read an Excerpt

Chapter One

"It's Never Different This Time"

Federal Reserve chairman Alan Greenspan has a favorite stockmarket joke that he tells which describes how to know if a stockmarket bubble is about to burst.

A friend of mine decided to get into the stock market and called his broker. "Buy me 100 shares of XYZ." And sure enough he bought 100 shares and the price went up. He says, "This is great. I'm making money." He picks up the phone three days later. "Buy me another 100 shares." The price goes up again. And this goes on for weeks and the price is mounting and he's building a huge block of stock in his portfolio. My friend says, "You know, I've gotten to the point where I don't want to be too greedy. I want to sell." He picks up the phone, once again to call his broker. He says, "Jim, I've had enough. I want you take all my stock and sell it." The broker responds, "To whom?"

The joke, as Mr. Greenspan recalls, was told by an old vaudevillian, George Jessel, the man known as "the Toastmaster General" to his contemporaries. Jessel, famous in his day for emceeing the Friar's Club roasts, was a Roaring Twenties raconteur and a showman whose name many still remember. He, along with other noted entertainers of the time, like Eddie Cantor and Groucho Marx, was badly burned by the stock-market crash in 1929.

In fact, in the Broadway version of the Marx Brothers comedy Animal Crackers, Groucho paused onstage to lament the plunge in stock prices the very day it happened. In an unscripted moment on the night of the crash, he moved upstage for a brief soliloquy, a tactic he frequently used, much to the surprise of theaudience and his fellow actors. While commenting on the possibility of marrying his usual foil, actress Margaret Dumont, Groucho threw in a gag about plunging stock prices, a line not easily lost on a New York crowd in October of 1929: "Living with your folks, the beginning of the end ... drab dead yesterdays shutting out beautiful tomorrows. Hideous, stumbling footsteps creaking along the misty corridors of time. And in those corridors I see figures, strange figures, weird figures, Steel 186, Anaconda 74, American Can 138 ..." In The Marx Brothers Scrapbook, Groucho recalls that everyone he knew "was affected by the crash. They were either wiped out or became very poor." As is the case today, the stock market in the 1920s was not just a Wall Street phenomenon, it was a part of pop culture. It is not surprising that the crash left animprint on those who witnessed it firsthand.

The Jessel joke, however, has a serious point ... when everyone who wanted to buy stock has bought it, there's no one left to sell to. That, by the way, is also the point at which financial market bubbles burst, when the buying power in a particular market has been exhausted. It was as true in the 1920s as it was in the 1990s. It is that moment in time when the great opportunities and riches created by a financial market bubble turn into great risks for Wall Street and Main Street alike. The downside of the bubble threatens to undermine the very prosperity on which it was purportedly based and hurt the greatest number of investors. Throughout global economic history, the bursting of a speculative bubble leads to great hardship. Whether it was the damage inflicted on the Dutch economy in 1636, when the famous "tulip-o-mania" was deflowered in Holland, or the ossification of the Japanese economy in the 12 years since the Nikkei-225 hit its historic highs, bubbles and their aftermaths are watershed economic events that require -- and reward -- both intense study and, more important, intelligent action. As a good friend of mine often says, "Forewarned is forearmed." That should be the mantra of all investors who hope to make, and keep, money in the market.

Salutary Effects

Of course, the innovations, economic growth, and general euphoria that seem to help inflate the bubble can be positive developments. Massive technological change often lays the foundation for a burst of creative economic renewal and creates previously unthinkable opportunities for the rich and not-so-rich alike. Venture capitalists, financial professionals, individual investors, and even governments often reap great rewards from the flowering of new industries, thriving markets, and turbocharged economies that emerge during a period of speculative euphoria. By the same token, it is the very excitement that creates so-called new paradigm thinking which, in turn, leads to "irrational exuberance" and the great expectations that can never be completely satisfied by the most marvelous inventions or strongest economic expansions.

Bubbles, fads, and financial market manias are, by their very nature, double-edged swords. They can help to finance entirely new industries, such as automobile, radio, biotechnology, and the Internet. But overinvestment and instability pose great risks to national and global economies if left to spin out of control. We have, in recent years, again witnessed the fallout from a financial market meltdown. Thanks to the work of monetary policy-makers in this country, the collapse of the technology bubble has not and most likely will not cause the same sort of economic dislocation that cripples the Japanese economy today or led to a global Great Depression in the 1930s. But that's not to say that there won't be long-term consequences for stock-market investors, who should not expect the market to provide the unprecedented returns of the peak bubble years.

Borrowed Robes

One of the great problems in both identifying and dealing with bubbles, fads, and manias is that they all appear to be "different this time." Old rules of investing and old laws of economics seem archaic and inapplicable to the current trend. Policy-makers may fail to appreciate how an emerging market crisis, dressed in borrowed robes of prosperity, may ultimately undermine ...

TrendWatching. Copyright © by Ron Insana. Reprinted by permission of HarperCollins Publishers, Inc. All rights reserved. Available now wherever books are sold.