Wise Wealth Advisors

D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Archive for the ‘Scams’ Category

Planting the Dream: The Anubhav Plantations Scam

Posted by Muthu on July 20, 2010

On 2nd December 1998, thousands of people from places like Shimla, Trichy, Sangli and several other Indian cities and towns converged at the New Woodlands Hotel in Chennai.

All of them were investors in the collapsed Anubhav group’s teak plantation schemes, and a majority of them were on the brink of bankruptcy.

They had come to Chennai in response to a letter from an advocate inviting them to come and check all the records and the balance sheet of the company.

The investors could be seen everywhere – sitting on the pavements, standing around the building, walking up and down the roads – all of them tense and worried. The investors had sensed wrong doings at Anubhav when the cheques issued to some of them bounced in mid-1998.

Many depositors, who went to the group’s offices to collect their deposit amount after maturity, found the doors locked and lodged complaints with the police.

Later, thousands of investors demonstrated in front of the company’s headquarters in Chennai.

But the main accused, C. Natesan, Chairman, Anubhav Group (Natesan), had already gone underground. The Anubhav group of companies was eventually found to have duped investors of over Rs.400 crores.

As details about the ‘Great Plantation Scam of the 1990s’ were revealed in the media, Natesan’s modus operandi shocked those who held the Anubhav group in high regard.

A commerce graduate from Chennai’s Vivekananda College and a chartered accountancy course dropout, Natesan was a man who dreamt big.

His ostentatious lifestyle, his cars, and his plush office in Chennai’s up market Royapettah area were frequently cited by the media as examples of his lavish tastes.

Natesan started his career in 1983 by launching a consultancy firm, ‘Yours Faithfully Consultancy.’ In 1984, he entered the construction business with three partners.

Three years later, he closed this venture and set up the Anubhav Foundation. In 1992, Anubhav Plantations Ltd. (Anubhav) was floated as a public limited company. Over the years, the Anubhav umbrella expanded to include various other companies such as Anubhav Homes Ltd., Anubhav Resorts Ltd., Anubhav Finance & Investments, Anubhav Communications & Advertising (Pvt.) Ltd., Anubhav Royal Orchards & Exports, Anubhav Hire Purchase Ltd., Anubhav Green Farms & Resorts (Pvt.) Ltd., Anubhav Agro, Anubhav Security Bureau, Anubhav Interiors and Anubhav Health Club.

By 1998, Anubhav had become a Rs. 250 crores group which, apart from its teak-plantation schemes, was involved in the timeshare, finance, and real estate businesses.

These companies were backed by a nationwide infrastructure of 91 offices and over 1,800 employees. Natesan had plans to forward-integrate from teak into furniture and to get imported machinery to make it. However, his growth strategy was focused mainly on mobilizing funds from investors. The group had already raised vast sums of money from the public in the form of fixed deposits, teak units, and a combination of fixed deposits and teak units.

Natesan was extremely secretive about the financial performance of his group. In the plantations business, Anubhav was the market leader. It operated through four companies: Anubhav Agrotech, Anubhav Green Farms & Resorts, Anubhav Plantations, and Anubhav Royal Orchards Exports.

Anubhav’s shaky financial condition could easily be seen in its books. In 1996-97, plantation income amounted to Rs. 35.32 crores and net profit was Rs. 38.69 lakhs.

The low profitability was attributed to the group’s high, non-productive, expenses. In March 1997, Anubhav’s current liabilities exceeded its current assets by Rs.6.40 crores. The company’s paid-up equity capital was just Rs. 36 lakhs while its borrowings, both secured and unsecured, amounted to Rs. 2.64 crores. Loans and advances amounted to Rs 25.95 crores, of which Rs 10.75 crores had been lent to Anubhav Foundations, Anubhav Green Farms & Resorts, Anubhav Resorts and Anubhav Communications.

In the schedule explaining the loan provisions, it was mentioned that the funds had been used for the purchase of residential apartments (Anubhav Foundations) and farmland (Anubhav Green Farms), and to meet the expenses incurred on advertising and marketing (Anubhav Communications).

Most of the plantation firms had a skewed capital structure. According to CRISIL’s findings, on an average, while Rs.35 lakhs was contributed from the promoter’s side, the public funds raised were usually above Rs. 300 crores.

Most of these companies did not even have sufficient crop insurance. Also, the offer documents of these companies did not highlight the risks involved. The lack of industry regulation made it virtually impossible for the average investor to distinguish between a fly-by-night operator and a genuine player. Most of these companies were reluctant to provide information about themselves.

During investigations conducted by Business India, officials at Parasrampuria Plantations refused to even talk to the magazine. However, when the magazine sent people posing as investors, the response was extremely enthusiastic. Investigations regarding the schemes being offered by various companies across the country indicated that things were definitely out of joint.

According to estimates, more than 4500 plantation companies had raised over Rs 25,000 crore from the public during the 1990s. The laxity of the concerned regulatory authorities was a major factor behind these scams.

In the early 1990s, setting up a finance company was very simple as there was no supervisory authority for sole trading or partnership firms, nor did they fall under any regulatory framework.

This gave them a competitive advantage vis-a-vis the other non-banking financial companies (NBFCs).

Though there was a limit on the number of depositors these sole trading or partnership companies were allowed to have, there was no ceiling on the amount of deposits they could collect. As per the Partnership Act, a partner in one company could be a partner in numerous other partnership firms.

With the stock markets performing badly and banks cutting back on interest on deposits, plantation schemes appeared very attractive for investors impatient for returns and willing to take risks.

An investor commented, ‘Why do people invest in these kinds of firms? Because people want to make more money, fast. What do we get from the nationalized banks as interest? A mere 5%-7%, whereas Anubhav was paying 21-24% interest. ‘

(Source: Excerpts- Free case studies- www.icmrindia.org)

Posted in General, Scams | 42 Comments »

The Story of Katen Parekh

Posted by Muthu on July 17, 2010

Out of the scams and bubbles happened in the last 2 decades in Indian Stock Market, the scams of Harshad Mehta and Katen Parekh are of outstanding ones.

Many of you who have started in the markets after the earlier part of this decade, may know some thing about Harshad Mehta, due to the flamboyant life style he lead and passed away in jail in the year 2002, at the age of 47, under mysterious circumstances. To start with I thought I would share with you with the story of Katen Parekh and his modus operandi. I’m also planning to write about Harshad Mehta scam, CRB Capital Markets Scam, NBFCs scam, plantation scams etc. which has happened in the last 2 decades.

Unfortunately, as is always the case, people never learn from the history, due to their greed.

Also in a country like India, where the laws against white collar crimes are not very stringent, the guilty often goes unpunished or gets the least punishment. As Warren Buffett says ‘It has been far safer to steal large sums with pen than small sums with a gun.

Some of the people who were involved in both the Harshad Mehta and Katen Parekh scams, who were levied only minor penalties and suspensions, are back in the market with vigor and are regularly seen in the media as ‘investment advisors’, ‘traders’, ‘investors’ etc. Many who are now new to the market are not even of these gentlemen’s antecedents.

They are respected, because they are rich.

One CFP recently compared one such rich person as Warren Buffett of India. This rich  person, who is a part trader and part investor and a likely market manipulator and scamster, who has a questionable history and has been indicted in the past, by Government committees probing into the scams, is compared with Buffett who commands respect not because he is the richest in the world but because of his wisdom, ethics, integrity, honesty and strength of character. This CFP could have as well admired a rich politician than this scamster who is now seen as the face of investors in India.

If this is knowledge a CFP has, what to say about common public?

All the scams are built like Ponzi schemes and a great bubble is created which are usually followed by severe bursts. People who are earlier to catch a bubble, make huge money, and become the role models and envy of others. People fail to realize that in all Ponzi schemes, that some become rich at the cost of many others. They are carried away by immense greed.

You might not have forgotten the recent ‘Gold Quest’ scam. A relative of mine was persuaded by a seller of this scheme, to participate in the meetings conducted by the ‘Gold Quest’ teams. He got carried away by seeing some people who made  huge money in short period of time wanted to join the club.

I warned him so many times about not to get carried away by these luring. As Buffett says ‘ Nothing sedates rationality like large doses of effortless money’. Despite my repeated advice, he joined the scheme and lost the money. To my knowledge, he feels so shy even to lodge a police complaint, that his hope of recovering the above money is zilch. The icing to the cake is that he invited me couple of times to attend their meetings citing that this company is the one which makes gold medals for Olympics etc. I refused the bait and I wish that he had emotional strength not to be lured by easy money.

Now let us to go to the story of Katen Parekh (KP).

KP was a chartered accountant by profession and used to manage a family business, NH Securities started by his father. Known for maintaining a low profile, KP’s only dubious claim to fame was in 1992, when he was accused in the stock exchange scam. He was known as the ‘Bombay Bull’ and had connections with movie stars, politicians and even leading international entrepreneurs like Australian media tycoon Kerry Packer, who partnered KP in KPV Ventures, a $250 million venture capital fund that invested mainly in new economy companies. Over the years, KP built a network of companies, mainly in Mumbai, involved in stock market operations.

The rise of ICE (Information, Communications, and Entertainment) stocks all over the world in early 1999 led to a rise of the Indian stock markets as well. The dotcom boom contributed to the Bull Run led by an upward trend in the NASDAQ.

The companies in which KP held stakes included Amitabh Bachchan Corporation Limited (ABCL), Mukta Arts, Tips and Pritish Nandy Communications. He also had stakes in HFCL, Global Telesystems (Global), Zee Telefilms, Crest Communications, and PentaMedia Graphics KP selected these companies for investment with help from his research team, which listed high growth companies with a small capital base.

According to media reports, KP took advantage of low liquidity in these stocks, which eventually came to be known as the ‘K-10’ stocks. The shares were held through KP’s company, Triumph International. In July 1999, he held around 1.2 million shares in Global. KP controlled around 16% of Global’s floating stock, 25% of Aftek Infosys, and 15% each in Zee and HFCL. The buoyant stock markets from January to July 1999 helped the K-10 stocks increase in value substantially. HFCL soared by 57% while Global increased by 200%. As a result, brokers and fund managers started investing heavily in K-10 stocks.

Mutual funds like Alliance Capital, ICICI Prudential Fund and UTI also invested in K-10 stocks, and saw their net asset value soaring. By January 2000, K-10 stocks regularly featured in the top five traded stocks in the exchanges. HFCL’s traded volumes shot up from 80,000 to 1,047,000 shares. Global’s total traded value in the Sensex was Rs 51.8 billion. As such huge amounts of money were being pumped into the markets, it became tough for KP to control the movements of the scrips. Also, it was reported that the volumes got too big for him to handle. Analysts and regulators wondered how KP had managed to buy such large stakes.

According to market sources, though KP was a successful broker, he did not have the money to buy large stakes. According to a report, 12 lakh shares of Global in July 1999 would have cost KP around Rs 200 million. The stake in Aftek Infosys would have cost him Rs 50 million, while the Zee and HFCL stakes would have cost Rs 250 million each. Analysts claimed that KP borrowed from various companies and banks for this purpose. His financing methods were fairly simple. He bought shares when they were trading at low prices and saw the prices go up in the bull market while continuously trading. When the price was high enough, he pledged the shares with banks as collateral for funds. He also borrowed from companies like HFCL.This could not have been possible out without the involvement of banks. A small Ahmedabad-based bank, Madhavapura Mercantile Cooperative Bank (MMCB) was KP’s main ally in the scam. KP and his associates started tapping the MMCB for funds in early 2000. In December 2000, when KP faced liquidity problems in settlements he used MMCB in two different ways. First was the pay order route, wherein KP issued cheques drawn on Bank of India (BoI) to MMCB, against which MMCB issued pay orders. The pay orders were discounted at BoI. It was alleged that MMCB issued funds to KP without proper collateral security and even crossed its capital market exposure limits. As per a RBI inspection report, MMCB’s loans to stock markets were around Rs 10 billion of which over Rs 8 billion were lent to KP and his firms.

The second route was borrowing from a MMCB branch at Mandvi (Mumbai), where different companies owned by KP and his associates had accounts. KP used around 16 such accounts, either directly or through other broker firms, to obtain funds. Apart from direct borrowings by KP-owned finance companies, a few brokers were also believed to have taken loans on his behalf. It was alleged that Madhur Capital, a company run by Vinit Parikh, the son of MMCB Chairman Ramesh Parikh, had acted on behalf of KP to borrow funds. KP reportedly used his BoI accounts to discount 248 pay orders worth about Rs 24 billion between January and March 2001. BoI’s losses eventually amounted to well above Rs 1.2 billion.

The MMCB pay order issue hit several public sector banks very hard. These included big names such as the State Bank of India, Bank of India and the Punjab National Bank, all of whom lost huge amounts in the scam. It was also alleged that Global Trust Bank (GTB) issued loans to KP and its exposure to the capital markets was above the prescribed limits. According to media reports, KP and his associates held around 4-10% stake in the bank. There were also allegations that KP, with the support of GTB’s former CMD Ramesh Gelli, rigged the prices of the GTB scrip for a favorable swap ratio before its proposed merger with UTI Bank.

KP’s modus operandi of raising funds by offering shares as collateral security to the banks worked well as long as the share prices were rising, but it reversed when the markets started crashing in March 2000. The crash, which was led by a fall in the NASDAQ, saw the K-10 stocks also declining. KP was asked to either pledge more shares as collateral or return some of the borrowed money. In either case, it put pressure on his financials. By April 2000, mutual funds substantially reduced their exposure in the K-10 stocks. In the next two months, while the Sensex declined by 23% and the NASDAQ by 35.9%, the K-10 stocks declined by an alarming 67%. However, with improvements in the global technology stock markets, the K-10 stocks began picking up again in May 2000. HFCL nearly doubled from Rs 790 to Rs 1,353 by July 2000, while Global shot up to Rs 1,153. Aftek Infosys was also trading at above Rs 1000.

In December 2000, the NASDAQ crashed again and technology stocks took the hardest beating ever in the US. Led by doubts regarding the future of technology stocks, prices started falling across the globe and mutual funds and brokers began selling them. KP began to have liquidity problems and lost a lot of money during that period.

It was alleged that ‘bear hammering’ of KP’s stocks eventually led to payment problems in the markets. The Calcutta Stock Exchange’s (CSE) payment crisis was one of the biggest setbacks for KP. The CSE was critical for KP’s operation due to three reasons. One, the lack of regulations and surveillance on the bourse allowed a highly illegal and volatile badla business . Two, the exchange had the third-highest volumes in the country after NSE and BSE. Three, CSE helped KP to cover his operations from his rivals in Mumbai. Brokers at CSE used to buy shares at KP’s behest.

By mid-March, the value of stocks held by CSE brokers went down further to around Rs 2.5-3 billion. The CSE brokers started pressurizing KP for payments. KP again turned to MMCB to get loans. The outflow of funds from MMCB had increased considerably form January 2001. Also, while the earlier loans to KP were against proper collateral and with adequate documentation, it was alleged that this time KP was allowed to borrow without any security.

By now, SEBI was implementing several measures to control the damage. An additional 10% deposit margin was imposed on outstanding net sales in the stock markets. Also, the limit for application of the additional volatility margins was lowered from 80% to 60%. To revive the markets, SEBI imposed restriction on short sales and ordered that the sale of shares had to be followed by deliveries. It suspended all the broker member directors of BSE’s governing board. SEBI also banned trading by all stock exchange presidents, vice-presidents and treasurers. A historical decision to ban the badla system in the country was taken, effective from July 2001, and a rolling settlement system for 200 Group A shares was introduced on the BSE.

The small investors who lost their life’s savings felt that all parties in the functioning of the market were responsible for the scams. They opined that the broker-banker-promoter nexus, which was deemed to have the acceptance of the SEBI itself, was the main reason for the scams in the Indian stock markets. 

SEBI’s measures were widely criticized as being reactive rather than proactive. The market regulator was blamed for being lax in handling the issue of unusual price movement and tremendous volatility in certain shares over an 18-month period prior to February 2001. Analysts also opined that SEBI’s market intelligence was very poor. Media reports commented that KP’s arrest was also not due to the SEBI’s timely action but the result of complaints by BoI.

A market watcher said, “When prices moved up, SEBI watched these as ‘normal’ market movements. It ignored the large positions built up by some operators. Worse, it asked no questions at all. It had to investigate these things, not as a regulatory body, but as deep-probing agency that could coordinate with other agencies. Who will bear the loss its inefficiency has caused?” An equally crucial question was raised by media regarding SEBI’s ignorance of the existence of an unofficial market at the CSE.

Many exchanges were not happy with the decision of banning the badla system as they felt it would rig the liquidity in the market. Analysts who opposed the ban argued that the ban on badla without a suitable alternative for all the scrips, which were being moved to rolling settlement, would rig the volatility in the markets. They argued that the lack of finances for all players in the market would enable the few persons who were able to get funds from the banking system – including co-operative banks or promoters – to have an undue influence on the markets.

KP was released on bail in May 2001. The duped investors could do nothing knowing that the legal proceedings would drag on, perhaps for years. Observers opined that in spite of the corrective measures that were implemented, the KP scam had set back the Indian economy by at least a year. Reacting to the scam, all KP had to say was, “I made mistakes.” It was widely believed that more than a fraud, KP was an example of the rot that was within the Indian financial and regulatory systems. Analysts commented that if the regulatory authorities had been alert, the huge erosion in values could have been avoided or at least controlled.

After all, Rs 2000 billion is definitely not a small amount – even for a whole nation.

(with inputs from ICMR India)

Posted in General, Muthu's Musings, Scams, Stock Market | Leave a Comment »

The South Sea Bubble

Posted by Muthu on July 9, 2010

Thanks for your overwhelming response to my blog on ‘Random Thoughts’.

I’m surprised that many of you have been forced to live for others expectations on what your standard of living or life style should be. Some of you have thanked me that you’ve got a conviction of not living for others, from my above article.

If someone is going to respect you, based on your possessions, care a damn about them. They do not deserve your attention and nor their respect has any value. They do not respect you, but your house or car or Blackberry or jewellery etc. No one except your Auditor and your Personal Finance Advisor, needs to know about your wealth. If ostentatious display of your wealth is only going to get you appreciation from your relatives, friends, peers or society, do you think that appreciation has any value? It is always better to maintain a low profile and it is good for you if people do not know about your wealth.

Since I’m in the profession of ‘Personal Finance’ and usually have access to all the information pertaining to wealth of my clients, I know people who live an ordinary life style but have few crores of financial assets other than their residential house. No one other than me and their Auditor would know about their wealth. Likewise I’ve seen people with bungalows in posh area, having really good income, high end cars, lead a life style which makes society envies them, actually having negative networth. They are into huge debts and have no networth to speak about. Again this information would be known only to me and their Auditor, and not to the society.

There is no need to get respect from anyone based on your possessions. If they can respect you for what you are, fine. If they are going to respect you for what you have, simply ignore them.

For those of you who want to know more on above, I suggest you a very popular personal finance book ‘The Millionaire Next Door’. It is available in Eloor lending library, can be purchased at ‘Land Mark’. Read it, you would to be amazed to know the insights the book offers you.  

Now we will discuss about the famous ‘South Sea Bubble’

Let us hear what the famous scientist, Sir Isaac Newton who last significant portion of his wealth in ‘The South Sea Bubble’.

“I can calculate the motions of the heavenly bodies, but not the madness of people.”
 
What Warren Buffet has to say about above?
 
“Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the fourth law of motion: For investors as a whole, returns decrease as motion increases.”
 
So what is this South Sea Bubble?
 
Irrational exuberance pervades the stock market. Speculators pay ever-higher prices for shares despite scant evidence of underlying value. Skeptics warn that the bubble will burst.

The amount the market declined from peak to bottom: Stocks in the South Sea Company were traded for 1,000 British pounds (unadjusted for inflation) and then were reduced to nothing by the later half of 1720. A massive amount of money was lost.

In the 1700s, the British empire was the big dog on the block, and that particular block spanned the entire globe. For the British, the eighteenth century was a time of prosperity and opulence, meaning a large section of the population had money to invest and were looking for places to put their money. So, the South Sea Company (SSC) had no problem attracting investors when, with an IOU to the government worth £10,000,000.00, the company purchased the “rights” to all trade in the South Seas.

The few companies offering stock at that time were all solid but difficult investments to buy. For example, the East India Company was paying out considerable tax-free dividends  to their mere 499 investors. The SSC was perched on top of what was perceived to be the most lucrative monopoly on earth.

The first issue of stock didn’t even satiate the voracious appetite of the hardcore speculators, let alone the average investors who were assured of this company’s coming dominance. The popular conception was that Mexicans and South Americans were just waiting for someone to introduce them to the finery of wool and fleece in exchange for mounds of jewels and gold! So nobody questioned the repeated re-issues of stocks by the South Sea Company. People just bought the expensive stocks as fast as they were offered. It didn’t matter either to investors that the company wasn’t headed by experienced management. Those who lead the company, however, were born public relations directors, who set up offices furnished with affluence in the most extravagant quarters. People, once they saw the wealth the SSC was “generating,” couldn’t keep their money from gravitating towards the SSC.

Not long after the emergence of the SSC, another British company, the Mississippi Company, established itself in France. The company was the brainchild of an exiled Brit named John Law. His idea wasn’t so much based in trade, but in switching the monetary system from gold and silver into a paper currency system. The Mississippi Company caught the attention of all the continental traders and gave them a space to put their hard-earned dollars. Soon the worth of the Mississippi Company’s stock was worth 80 times more than all the gold and silver in France. Law also began collecting defunct companies to add to his massive conglomerate.

This success on the continent stirred British pride, and, believing that British companies could not fail, British investors were desperate to invest their money. They were blind to many indications that the SSC was run too poorly to break even (whole shipments of wool were misdirected and left decaying in foreign ports), and people wanted to buy even more stocks. The South Sea Company and others made a point of giving people what they wanted. The demand for investments caused IPOs to sprout out of everything, including companies that promised to reclaim sunshine from vegetables and to build floating mansions to extend Britain’s landmass. They all sold like mad.

Eventually the management team of SSC took a step back and realized that the value of their personal shares in no way reflected the actual value of the company or its dismal earnings. So they sold their stocks in the summer of 1720 and hoped no one would leak the failure of the company to the other shareholders. Like all bad news, however, the knowledge of the actions of SSC management spread, and the panic selling of worthless certificates ensued. The huge hole in the south sea bubble also punctured the Mississippi Company’s unrealistic value and both came crashing down.

A complete crash, which would be heralded by the folding of banks, was avoided due to the prominent economic position of the British Empire and the government’s help in stabilizing the banking industry. The British government outlawed the issuing of stock certificates, a law that was not repealed until 1825.

(with inputs from Investopedia)

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The Tulip Mania (1634-1637)‏‏

Posted by Muthu on July 7, 2010

Warren Buffett never participated in the famous ‘Internet Bubble’ which happened early in the year 1998-2000.

All the fund managers were ecstatic at the time when stock prices multiplied by tens of times in a span of less than 2 years. There were virtually no Fund Managers and Investors, who were not holding ‘Internet Stocks’.

Buffett made a passionate appeal to fund managers, Private Equity players and common investors not to get carried away by absurd and unsustainable valuations.

Internet stocks were commonly quoting at a PE ratio of 2000 and above. This means that an investor was willing to pay 2000 years of earnings to get a piece of stock. Many companies, which had negative PE, as they were just formed and yet to even start their operations, attracted billions and millions of dollars. Nobody listened to the ‘old man’ Buffett.

But both print and visual media sided with investors in internet stocks and increased the frenzy of once in life time opportunity to easily multiply wealth, severely ridiculed Warren Buffet for loosing touch with reality. Fund Managers commonly mentioned in their interviews that Buffett is dumb that he is unable to see a dawn of new era.

Warren Buffett’s investment vehicle ‘Berkshire Hathaway’ under performed even the most mediocre fund manager’s performance for more than 3 years. Buffett who is known for his emotional discipline informed his share holders that he would not invest a single dollar in these Internet Companies and said that they should be ready to embrace under performance till the internet party is over.

You all know about the subsequent great dot com burst in the year 2000.

Then the media started heaping praises on Buffett for his even temperament and intelligence, not being carried away by the frenzy.

When Medias asked his opinion after the bubble, he quipped ” The world went mad. What we learn from history is that people don’t learn from history.” 

So we will look at history of such bubbles dating back to few centuries. A good friend and wellwisher of mine suggested that why don’t I write about one of the earliest bubble ‘ The Tulip Mania’.

Today I’m going to write about the great tulip craze and tomorrow I’m planning to write about the great South Sea Bubble, in which even one of the world’s famous scientists, Sir Isaac Newton, lost his entire wealth.

The tulip mania happened during the years 1634-1637 in Holland.

The amount the market declined from peak to bottom: This number is difficult to calculate, but, we can tell you that at the peak of the market, a person could trade a single tulip for an entire estate, and, at the bottom, one tulip was the price of a common onion.

In 1593 tulips were brought from Turkey and introduced to the Dutch. The novelty of the new flower made it widely sought after and therefore fairly pricey.

After a time, the tulips contracted a non-fatal virus known as mosaic, which didn’t kill the tulip population but altered them causing “flames” of colour to appear upon the petals. The colour patterns came in a wide variety, increasing the rarity of an already unique flower. Thus, tulips, which were already selling at a premium, began to rise in price according to how their virus alterations were valued, or desired. Everyone began to deal in bulbs, essentially speculating on the tulip market, which was believed to have no limits.

The true bulb buyers (the garden centres of the past) began to fill up inventories for the growing season, depleting the supply further and increasing scarcity and demand. Soon, prices were rising so fast and high that people were trading their land, life savings, and anything else they could liquidate to get more tulip bulbs. Many Dutch persisted in believing they would sell their hoard to hapless and unenlightened foreigners, thereby reaping enormous profits. Somehow, the originally overpriced tulips enjoyed a twenty-fold increase in value – in one month!

Needless to say, the prices were not an accurate reflection of the value of a tulip bulb. As it happens in many speculative bubbles, some prudent people decided to sell and crystallize their profits. A domino effect of progressively lower and lower prices took place as everyone tried to sell while not many were buying. The price began to dive, causing people to panic and sell regardless of losses.

Dealers refused to honour contracts and people began to realize they traded their homes for a piece of greenery; panic and pandemonium were prevalent throughout the land. The government attempted to step in and halt the crash by offering to honour contracts at 10% of the face value, but then the market plunged even lower, making such restitution impossible. No one emerged unscathed from the crash. Even the people who had locked in their profit by getting out early suffered under the following depression.

The effects of the tulip craze left the Dutch very hesitant about speculative investments for quite some time. Investors now can know that it is better to stop and smell the flowers than to stake your future upon one.

(with inputs from Investopedia)

Posted in Muthu's Musings, Scams, Stock Market, Warren Buffett | Leave a Comment »