Toward Rational Exuberance: The Evolution of the Modern Stock Market. (Stock Markets Grow Up).(Review)

Toward Rational Exuberance: The Evolution of the Modern Stock Market By B. Mark Smith Farrar Straus & Giroux, 342 pages, $25

Let's skip to the punch line: Toward Rational Exuberance is the best history of the stock market that I have ever read, and I have already reserved a conspicuous and easily accessible spot for it on my bookshelf. Mark Smith, a former Wall Street executive, is a man who has a practitioner's understanding of financial markets. From start to finish, the book is chock full of fascinating and well-documented historical anecdotes. What astonishes, however, is the way Smith skillfully weaves these into a coherent tapestry. This book makes a genuine intellectual contribution to the debate about the nature of financial markets.

Smith's view, captured in the title, is that U.S. financial markets have gradually become more and more efficient and transparent. He suggests that since the stock market has changed so much in recent years, one must be extremely cautious about using old yardsticks to measure current challenges. The book effectively skewers many of the academic finance professors lately applying standards from distant history to argue that today's stock market is irrational.

Smith starts at the beginning. In the spring of 1792, 24 businessmen signed "the Buttonwood Agreement" (named after the Wall Street tree under which they met) and started trading several bank and insurance stocks. The agreement launched a vibrant financial market, which quickly fell into disrepute. In early March, just after trading took off, an audit uncovered shady dealings by Assistant Secretary of the Treasury William Duer and the market collapsed in a panic. Losses were estimated at $3 million. Alexander Hamilton referred to the stock traders as "unprincipled gamblers," foreshadowing the criticism that financial market participants would receive over the subsequent 200 years.

Next, Smith introduces us to the first professional bear. Jacob Little made a fortune off of short-term fluctuations in markets. He invented the short sale. He would sign a contract promising to deliver a certain number of shares six to 12 months hence, and in the interim work to make sure the price of those shares declined. He was dubbed a "bear" after the then well-known phrase "to sell the bear's skin before you've caught the bear." Short sellers employed quite a few devious tricks in Little's day. Businessmen could (and did) short their stocks, announce they were closing their factories, make a fortune when the shares ...