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Customer Review: Investment Classics
This book is a must read for any investor. It makes clear that economic bubbles and financial crises have the same causes in all centuries: excessive debt, secured by speculative assets. Once the collateral falls in price, the lender requires to repay the debt or add more collateral. Since the borrower have used excessive leverage, he is unable to handle the debt and goes bankrupt, which leaves the lender with illiquid assets. Here are some examples:
1871: Frank Cowperwood have used stocks of Philadelphia's railroads as a collateral to huge loans, and when the Great Chicago Fire sparked a financial panic, he could neither repay the debt nor add more collateral, thus became insolvent.
1929: Widespread use of margin, of up to 90% was one of the reasons of the Great Depression. The investor could buy $100,000 worth of stock with $10,000 of own cash, borrowing the remaining $90,000 from the broker. The sharp drop of the stock price made the investors unable repay the debt, they became insolvent. The brokers were left with cheap stocks and became insolvent also.
2007: The dot-com bubble of 2000 contributed to the housing bubble. Once stocks fell, real estate became the primary outlet for the speculative frenzy that the stock market had unleashed. The families were buying houses when they knew that they cannot afford the mortgage for a long time, they were buying only to sell it to later at higher price. The rise in home prices was very attractive for construction industry: the number of newly built houses have significantly increased. When the prices of the houses have fallen due to the balance between the supply and demand, the speculators who run out of cash to repay the mortgages could no longer sell the houses at a price they bought. This essentially led homeowners to foreclosures. The great amount of foreclosures have caused huge losses to the lenders, made them insolvent or put under Government's conservatorship, when the shareholder value was diluted if not wiped out.
Although "The Financier" by Theodore Dreiser is not a skilled picture of smallest traits of a human soul when it comes to love and feelings, the financial aspects are very well covered. I recommend the sequels: "The Titan" and "The Stoic", in addition to this book.
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