The Dot-Com Bubble and the Lehman Shock

In the previous episode, we saw Japan’s bubble and its collapse. When assets swollen to their limit are pulled back to reality, how long the pain lingers — Japan demonstrated this firsthand. Yet the market never learns its lesson. At the threshold of the new century, the world stepped once again into another frenzy.

The first decade of the twenty-first century is bracketed by two enormous collapses. One is the dot-com bubble, which swelled on expectations for the internet and then burst. The other is the Lehman Shock, in which the complex products born of financial engineering ran wild and shook the world economy itself. In this episode, we will look at two events of differing character: a bubble born of hope, and a crisis born of financial precision.

A dream of the new century — the dot-com bubble

In the latter half of the 1990s, as the internet began to spread into ordinary homes, people grew convinced that this new technology would transform the world. That conviction took on a new form as explosive frenzy in the stock market. Merely by having ‘dot-com’ in their company names, the share prices of start-ups that had not earned a single yen in profit leapt skyward without ceiling. America’s market for emerging companies, the NASDAQ Composite Index, kept soaring and was said to have recorded a high of 5,048 on March 10, 2000.

This frenzy crossed the Pacific and spread to Japan as well. Internet-related companies such as SoftBank, Yahoo, and On the Edge (later Livedoor) led the market, and in February 2000 the share price of a certain internet company was reported to have reached a level exceeding 100 million yen per share. The word ‘new economy’ came into vogue, and an atmosphere covered the market: that old yardsticks no longer applied, that value lay not in profit but in growth potential.

The summit did not last long. When America’s central bank shifted to raising interest rates and threw cold water on the overheating, NASDAQ began to plunge. From 2000 to 2002, the index was said to have fallen to nearly one-fifth of its peak. In Japan too, the stocks of emerging companies crashed one after another, and there were reportedly companies whose shares — including that one that had exceeded 100 million yen — sank to nearly one-hundredth of their peak. Countless dot-com companies vanished. Yet a handful of companies that survived this collapse would later grow into giants that would dominate the world.

The other bubble that swelled quietly

While the wounds of the IT bubble had not yet healed, in an entirely different place the next bubble had begun to swell. This time the stage was not the stocks of emerging companies, but American housing and the financial products made from it.

Against a backdrop of low interest rates, housing prices in America kept rising. If prices keep rising, then even lending to people of low creditworthiness can be recovered by selling the house if it comes to that — on such logic, subprime loans, home loans aimed at the low-creditworthiness segment, were arranged in great quantity. Up to this point, the structure closely resembles Japan’s bubble, which believed in the land myth.

But from here on, something was new. Financial institutions bundled these home loans in great quantity, sliced them apart as securities, and sold them off to investors around the world. Mortgage-backed securities (MBS), and collateralized debt obligations (CDO) that combined those further still. These intricately processed securitized products were given high marks by rating agencies and spread to banks and pension funds around the world as safe places to invest.

September 2008 — the day the world froze

When housing prices peaked out around 2006, the premise quietly began to crumble. Repayments on loans that had banked on rising prices fell into arrears, and defaults on subprime loans increased. Then the value of the securitized products made from them fell all at once. The ‘safe assets’ that were supposed to have spread around the world suddenly turned into bad assets that no one could put a price on.

And on September 15, 2008, the storied American investment bank Lehman Brothers went bankrupt. Its total liabilities came to about 600 billion dollars, said to be the largest-scale bankruptcy in American history. The collapse of a venerable firm with more than 150 years since its founding called forth a bottomless terror in the market. Which financial institution would fall next — everyone fell into mutual suspicion, and even the lending and borrowing of funds between banks froze. The world’s financial system itself stood at the brink of breakdown.

The shock did not stop at America. European banks holding securitized products also fell into crisis, and stock prices crashed around the world. The real economy cooled rapidly as well, and nations tried to halt the chain of crisis with large-scale monetary easing and fiscal spending. It was a global financial crisis, said to be the gravest since the Great Depression of 1929 we saw in Episode 4. In a world where markets are linked across borders, the fraying of one country’s home loans shakes the entire globe in an instant. The convenience of linkage was, in the same breath, the peril of contagion.

What the two collapses taught

The dot-com bubble and the Lehman Shock. The two events, differing in character, nonetheless share the same core: the fact that human beings want to believe that the rise before their eyes will ‘keep going.’ Whether it is hope in new technology or trust in housing prices, the story that prices keep rising washes away calm calculation.

At the same time, this decade carved a new lesson. When financial engineering made the market more complex than ever before, and subdivided risk to a point where no one could see through it, the market can run wild in unforeseen forms. The more sophisticated the mechanisms become, the harder it grows even for experts to see what is happening inside them. The market’s protagonist had begun to enter a domain that could no longer be followed by the human eye alone.

After the crisis, the world strengthened regulations and tightened its oversight of financial institutions. Yet from this point on, the very shape of the market quietly, but decisively, changes. An era in which, in place of human judgment, computers and algorithms advance to the center of trading — the next episode is the story of that unseen protagonist.