Tulip bulb mania, one of the earliest signs of “Crowd Madness,” began in the 17th century. Tulip bulbs were first introduced into Holland from Turkey by Conrad Guestner and the plants quickly attained prestige among the upper class.
By accident, a virus (mosaic) infected the tulip bulbs and resulted in amazingly beautiful tulip petals, increasing their rarity. Soaring prices elevated tulip bulbs from collectors’ items to the darling of speculators.
Mounting interest spurred local market exchanges to allow tulip bulbs trading, much like stocks. Profits seem so easy to make, just buy low and sell high. After all, prices of tulip bulbs increased more than twenty-fold in a matter of weeks, and a decline seem improbable.
By 1634, tulip mania had gripped the entire nation and everybody was risking their land, livestock, farms and life savings in exchange for a piece of tulip bulb. What made the mania worse was the use of options which allowed people of lesser means to speculate in tulip bulbs. Using leverage, buyers could control larger amounts of tulip bulbs for a portion of the asking price.
As in all bubbles, perfectly rational people trusted that the tulip market was immune to a crash and prices will always goes up. However, unknown to most people, the undercurrents of this mania were actually shifting.
Firstly, tougher regulations were developed. Secondly, several smart speculators began to liquidate their tulips bulbs and contracts, exiting the market with huge profits. And thirdly, more tulip bulbs were added to the supply due to bountiful harvests.
Tulip bulbs were no longer a rare item and prices start to fall. Panic spread like wildfire among speculators as they started realizing that tulips were not worth the exorbitant prices.
Fortunes were lost overnight and many went into bankruptcies as they were left with a virtually worthless plant after exchanging their land and savings.
The Dutch government only advised calm among tulip speculators to stabilize prices and restore public confidence. Unfortunately, tulip prices continue to plummet, and when the courts refuse to honor tulip contracts and classify such activity as gambling, a market crash was inevitable.
The Dutch economy was crippled for decades by the financial destruction from the tulip bulb mania. The price of tulips fell from $76,000 to less than $1 and the only people who prospered from this madness were those who liquidated near the peak.
Most investors tend to act irrationally in market manias. Excessive profits causes people to feel infallible, thus making unwise decisions that cause financial ruin.
Madness of crowds can happen in stock, property or commodities market. However, as seen in the latest residential property bubble and the orgies of write-downs among financial firms, we never learn from mistakes. In fact, turning a blind eye to speculative risks when everybody is doing it seem to be the correct thing to do.
Anyway, let’s not fret over it, this crisis will blow over and history has shown that another mania will engulf us again.
My takeaway lesson from the tulip bulb mania is that there are only two options, either you stay on the sidelines forever or you know when to exit. As investors, we cannot let let our profits ride forever, especially when a bubble is developing. Prices may rise as you exit but seek solace in the knowledge that the fallout will be much worse if you wait longer.