Isaac Newton "could not calculate the madness of the people."

http://www.blogger.com/blogger.g?blogID=8566757574668004451#editor/target=post;postID=6801139842303440214

"From winter to spring 1720, London, England, was delirious, entranced, rolling in money.

It seemed as if riches were so easily gained that only fools would not buy into that brand new engine of wealth, the stock exchange, and especially into shares of the enterprise leading the boom, a banking concern called the South Sea Company.

As spring turned into summer, no one, it seemed, could deny the obvious, not even the most rational of men.

So, in June and again in July, Sir Isaac Newton -- the inventor of calculus (the branch of mathematics that describes change over time, which is to say, an awful lot of what matters in both science and life); the man who framed the laws of motion and set physics on its modern trajectory; a pioneering chemist, an inventor (virtually all present-day telescopes derive from his design), a religious historian -- and even a financial thinker -- put a sizable chunk of his personal fortune into shares of the South Sea Company.

The bubble burst that September. Newton lost 90 percent of his stake -- a substantial fraction of his total worth.

...What happened to him, or rather, how he acted, reveals a fundamental truth of economic and emotional life: At the point of crisis, when clear thought and a cool head matter most, no one is in fact a rational actor -- not even the greatest scientific mind of his or any other age.

So what brought Newton low?

Desire, perhaps envy, or, in other words, human nature.

Newton had been an active trader in the new stock market for years before the bubble year of 1720. He made his first investment in the South Sea issue early, in 1713, and held it for several years, marking a modest paper profit. He held on through early 1720, as the company pursued a new and increasingly risky banking deal -- and as insiders began to talk up the (as it turned out, fictitious) trading profits the company expected from another venture.

That got the desired result, a sudden leap in stock prices. Starting at £128 in January, the price for South Sea securities rose to £175 in February and then £330 in March. Newton kept his head -- at first. He sold in April, content with his (quite spectacular) gains to date. But then, between April and June, share prices tripled, reaching over £1,000 ... which is precisely when he could stand it no longer. Having "lost" two thirds of his potential gain, Newton bought again at the very top, and bought more after a slight decline in July.

...The South Sea stock price held up through August 1720, and then in September, the gap between the possible income from all the purchased debt and the returns promised to investors became too obvious to ignore.

The bubble burst, and South Sea share prices collapsed to roughly their pre-bubble level. Newton's losses totaled as much as £20,000, between $4 million and $5 million in 21st century terms...

...After the disaster, he could not bear to hear the phrase "South Sea" mentioned in his presence. But just once he admitted that while he knew how to predict the motions of the cosmos, "he could not calculate the madness of the people."

We still can't."

Thomas Levenson

http://www.cnn.com/2009/POLITICS/07/29/levenson.finance.regulation/