The Deal on Tulips

March 9, 2008

"The Deal" on Tulips

(c) copyright, View from Silicon Valley, 2008. All rights reserved.

A subscription to, "The Deal," magazine is mostly an exercise is reading how the other half lives. Stories about leveraged buy-outs and private equity, and legal maneuvers used to justify same, are the daily bread. The underlying assumption is often that a "success" is graded by the size of the fee extracted or the entree gained to the next deal (and fee, of course).

This magazine is not targeted at those of us are left making deals work after the titans of finance have extracted their pound of supposedly-bloodless flesh. If you have to make the product or the sale for the underlying company, "The Deal," may not be your cup of tea.

Even so, the highlights are read fairly regularly around here. Sometimes you catch a guy seeming to admit it was mainly his firm's fee off the top that justified the deal. Or you read about a judge's ruling, even in Delaware, highlighting the hollow arguments and legal sophistry employed to justify a takeover.

Once in awhile, you come across a historical perspective which is informative. We learned something from this article about Holland's tulip bubble and also about a recent popular book distorting the subject.

We hope you enjoy: "When Tulips Mattered."
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When Tulips Mattered
By David Marcus
Jan-11-2008

The Dutch tulip craze of the 1630s has become the archetypal example of financial speculation gone mad. In a matter of months — from the summer of 1636 to the market's collapse in February 1637 — Holland experienced a speculative frenzy for exotic flowers from the Ottoman Empire whose value lay in their beauty and rarity. Prices spiked, from 125 guilders for a pound of Switser bulbs on Dec. 31, 1636, to 1,500 guilders five weeks later. Then they collapsed.

The fall made even contemporary observers question the tulip traders' state of mind. "Our descendents doubtless will laugh at the human insanity of our age, that in our time the tulip flowers have been so revered," an historian of Haarlem, one of the centers of the tulip trade, wrote prophetically in 1648. Thanks to Charles Mackay's 1841 work "Extraordinary Popular Delusions and the Madness of Crowds," the tulip became a metaphor for any market, financial or otherwise, where prices became unmoored from realistic valuations: technology stocks, real estate, maybe even private equity.

In "Tulipmania: Money, Honor, and Knowledge in the Dutch Golden Age," Anne Goldgar, a reader in early modern history at King's College, London, challenges aspects of this view as overly simplistic and historically uninformed. In fact, Goldgar argues, the Netherlands as a whole was not consumed by flower mania, and the crash of the market did not deal an economic body blow. "Most of what we have heard about [the tulip craze] is not true," writes Goldgar, and she sets about proving that with close readings of the intellectual, artistic, and commercial aspects of early-17th-century Dutch culture.

Goldgar examines two related, but distinct, phenomena: First, the development of a market for tulips in the Netherlands and second, the interpretation and commentary on that market after its sharp fall. Goldgar's study, with its careful weighing of evidence and perusal of lawsuits and notary documents, also casts a light on our current situation. While she engages in considerable revisionism about the tulip craze, her book also implicitly suggests commonalities between speculative manias, from tulips to subprime mortgages.

By the 17th century, the Dutch, continually threatened by Spanish armies, had built a prosperous, even booming, mercantile culture. They were remarkably sophisticated financially. Dutch merchants conducted their grain trade in the Baltic — some even specialized in the "Muscovy" trade — as a futures market from the mid-16th century on, and in trading with the Americas and the East Indies they were willing not only to accept the risks of storms and piracy but to engage in risk management: Marine insurance was available in Amsterdam as early as 1592. Even after a ship docked, much could go wrong, thanks to murky arrangements with captains about the disposition of goods or the grasping hands of government officials. No wonder gambling was a popular hobby of the era.

Indeed, confronted by risks of all kinds — financial, political, natural — the Dutch leaned heavily on consensus and arbitration. Despite their success, they were deeply afraid their diverse and relatively tolerant society would spin out of control.

The tulip market grew up within that culture. Contrary to Mackayesque legends of milkmaids swapping tulip bulbs, a relatively compact group of merchants and craftsmen were the backbones of the trade, Goldgar writes, just as the well-off today buy and sell wine futures or contemporary art. (Buying and selling art was a popular pastime in 17th-century Holland, one indulged in by a number of tulip connoisseurs, though not one that featured significant speculation. Tulips, in fact, inspired their own genre of painting.) "The group of tulip dealers and buyers was closely knit," she writes, not surprising where commercial alliances often followed family and religious lines.

Far from being an overnight obsession, the tulip trade was flourishing by 1610, mostly among a small band of early botanists. As the innumerable 17th century still life paintings of flowers attest, gardening evolved into an integral part of Dutch culture. Amsterdam's monied class not only had gardens behind their homes but also bought tracts of land outside the city to indulge their passion, which led to the emergence of dozens of different kinds of tulips, from the General Gouda to the Schoone Helena and the sjery nabij ("nearly silk"). That genetic variability fed a market that chased after rapidly changing standards of beauty. Bulbs that produced blooms rarely seen began to attract high prices, even if their cachet quickly faded or their ability to produce that exact bloom failed.

The combination of a commercial culture comfortable with risk and a passion for tulips as a luxury good makes the events of 1637 seem predictable, if not inevitable. And yet Goldgar struggles to explain why the craze happened when it did. Perhaps the 1635 plague that struck Leiden, then Haarlem and Amsterdam, made the survivors unusually ebullient — not to say wealthier, through inheritance — but such outbreaks had been common in Europe.

Perhaps it was the combination of a growing connoisseurship dovetailing with a trading mentality and a strong upward mobility.

Whatever the reason, the timing of the crash clearly related to the tulip's annual growth cycle. The flowers bloom for a week or two in April, May or June, after which 17th-century horticultural theory (still correct on this point) suggested they should be taken out of the ground, dried off and kept wrapped indoors before being replanted in September. A seller would only deliver tulip bulbs to a buyer in this period. But the tulip trade went on all year — usually on a futures rather than a spot market, to use the language of commodities trading.

The February 1637 collapse thus created a significant problem. Prospective buyers, it turned out, had agreed to overpay for goods that would not be delivered for months. Their incentives to restructure or void agreements were as strong as those of sellers to enforce them.

That enforcement could be legal, though court records are silent on the issue in the first two months after the crash despite the significant litigation the trade generated in 1636 and early 1637, when many buyers simply refused to pay for the radically depreciated asset.

Judicial wishes to the contrary, the gridlock the crash created didn't disappear. Instead, Goldgar writes, "there was a kind of strength in numbers that made it easier for defaulting buyers to stand up to their sellers. If payment was made at all, it was at a fraction of the original price."

Dutch courts refused to involve themselves in the disputes, and by early 1638 Haarlem's burgemeesters were so desperate they established the Commissarissen van de Bloemen Saecken, literally, "the Commissioners for Flower Affairs," which had the power to summon disputants on penalty of a fine for failure to appear.

Within five months, the CBS concluded it would settle contracts that came before it with a so-called rouwkoop ("grieving money") of 3.5% — "the same fee given to compensate a seller in the cancellation of a normal sale of goods," Goldgar writes. A modern-day M&A lawyer would call this a breakup fee.

As relevant as Goldgar's analysis of the market and its demise is, her discussion of the widespread reaction and interpretation of the crash — an interpretation that has survived for nearly 400 years — may be more important. Goldgar finds no evidence that tulip trading was widespread. But she unearths plenty of evidence from contemporary critics that saw in the rise and fall of the tulip trade a dark critique of Dutch prosperity. Tulip investors were not working; they were getting rich off a useless, evanescent, abstract asset; they were rising beyond their station, dressing in fine clothes and making it difficult to discern "real value." They hung around taverns, drinking wine and beer, engaged in a kind of blasphemous, nonproductive frenzy. Tulipmania purportedly seduced weavers to leave their looms and husbands to abandon their families.

Trust eroded. Tulipmania was thus a kind of moral scourge that spread far beyond Haarlem's gardens.

The critique was, of course, an exaggeration, but one that found fertile ground in 17th-century Holland — and one that's regularly trafficked today. Any study that significantly revises Mackay and his followers — accepted wisdom in financial circles — serves to make this Ur episode in market history even more fascinating.