The Great Kuwaiti Crash

In 1982, the third largest stock market in the world crashed, losing 60% of its value over three months. This occurred not in America or Japan, but in Kuwait. The tiny Persian Gulf state of a million and a half people had become enriched by oil money which flooded into its financial sector from investors at home and abroad. Much of this money was leveraged by means so simple it would seem impossible to succeed and was invested in stocks, not on the official stock exchange, but in an informal market set up in an air-conditioned parking garage. It was one of history’s most peculiar financial bubbles.

Oil Money

The backdrop to one of the most extraordinary stock market crashes in recent times was the spectacularly fast run-up in oil prices following the Arab oil embargo in the 1970s. The embargo, which started three years into that decade, lifted oil prices from $3.50 to $15 per barrel. The events enriched petrostates like Kuwait, whose oil fields were developed forty years earlier but by the time of the oil boom were producing two million barrels per day. Tiny Kuwait alone held 10% of the world’s proven petroleum reserves.

Incomes in Kuwait grew as oil export receipts flowed into the country, much of it spent lavishly by the state on infrastructure projects and other schemes. It wasn’t all spent on national improvement though. A great deal of this money found its way into some of the most unchecked stock market speculation in history. All this happened in a relatively developed market; indeed, this helped make the mania there possible. In the late 1970s and early 1980s, Kuwait became the financial center of the Persian Gulf thanks to its relative stability and advanced regulatory system.

Souk Al-Manakh

Kuwait established a stock exchange in 1977 and the trading of shares there opened to an underwhelming start. The market suffered a modest retreat in its first year, something in the neighborhood of 16%, hardly a sharp drop but enough to prompt government intervention in the country where the state chaperoned so much of its economic activity. The government put further initial public offerings on hold, believing that excessive offerings of new equity was depressing the market.

Almost unbelievably, even the incorporation of new shareholding companies was suspended from 1977 to 1979 and the government purchased some 150 million Kuwaiti dinars worth of shares, roughly equivalent to $550 million at the time. After this intervention, the government owned 40% of the listed companies’ stock and it was not quick to sell. The state’s proclivity for cushioning even the most modest financial and economic problems, by extreme means if necessary, helped to create the spectacular bubble that was to follow.

Partially as a result of new financial regulations rolled out in this period of financial development in Kuwait, a new stock exchange was formed the year after the official Kuwait Stock Exchange had launched. This new market opened for business in 1978 in, of all places, an air-conditioned parking garage built on the site of a former camel trading market. It was called the Souk Al-Manakh, translating literally into ‘the market at the resting place for camels’. This informal stock exchange was an over-the-counter market, not a true stock exchange but a market where large dealers, holding an inventory of shares, traded with smaller speculators in the market.

The Souk Al-Manakh saw shares traded in at least 46 Kuwaiti companies and 38 foreign firms, many of which would not have qualified for listing on the official exchange. The market caught the eye of the state early on and, though unregulated, it was tolerated by the government which was primarily concerned with simply quarantining it from the rest of the financial system. Banks, for example, were barred from lending against shares of companies traded on the Souk Al-Manakh but not listed on the Kuwait Stock Exchange.

Boom

In 1979 and 1980, the Iranian Revolution and Iran-Iraq War caused oil prices to surge again as production fell in the belligerent countries. Prices reached nearly $40 a barrel in 1980 and that meant that even more oil money flowed into Kuwait. At the same time, there was a pent-up demand for more equity capital caused by the suspensions put in place by the government. This caused a sharp increase in activity in the country’s informal equity markets. To avoid regulation, many firms looking to raise capital opted to be domiciled outside the country and their shares traded not on the official exchange but at the Souk Al-Manakh.

In the early 1980s, prices of stocks trading on the Souk rose sharply, in spite of a global recession underway elsewhere. Foreign money from other Middle Eastern countries also enriched by higher oil prices found its way to Kuwait. Billions of dinars were invested in companies with tiny operations; it was a case of too much money chasing too few real investment opportunities. So extraordinary was the speculative mania that the market value of companies traded on the Souk Al-Manakh rose to make the unofficial stock market the third largest in the world after the New York Stock Exchange and the Japanese Stock Exchange.

The Souk Al-Manakh also developed something of a stock futures market; however, it functioned through a very simple instrument, the post-dated bank check. A buyer in this market would purchase shares from a seller using a post-dated check, locking in a price but settling the transaction at a future date. That said, the concept of post-dating a check was a legal fiction in Kuwait; under the country’s commercial law, the checks were payable upon presentation to a bank regardless of the date, which was honored only on the good-faith of the holder. In the meantime, a seller could often borrow money against the checks received in payment, a way around margin lending rules which prohibited banks from lending money against the value of shares traded in the informal market. This borrowing provided traders with a source of leverage.

However, the post-dated check was a source of leverage itself because speculators could always write bad checks, something they often did. Because checks often had ‘maturities’ a year off, traders had plenty of time to raise the money needed before settlement, a seemingly easy task with stock prices surging higher. It was rumored that one former employee of Kuwait’s passport office in his early twenties was able to buy $14 billion in stock by issuing post-dated checks; if true, he became perhaps the largest individual debtor in the world.

The checks had another important attribute that allowed them to become the fuel that fed the boom on the Souk. Traders would use the checks they obtained from sales to buy more stock by passing on the check; the checks were negotiable instruments circulating as money. In this way, the system of post-dated checks linked the credit of traders together and the credit of these speculators with that of the financial system. Despite all these dangers, attempts to regulate this market were unsuccessful.

Bust

The bubble burst in 1982; an index of stocks traded on the Souk Al-Manakh fell 60% from May to July that year. Oil prices had by now begun to slide but the steep fall in stock prices was also caused by post-dated checks failing to clear. Widespread attempts to cash the checks before their ‘maturity’ accelerated the process of discovering just how fictional the wealth created in the past few years had been, but the day of reckoning would have come regardless. The government initially refused to bailout the speculators, many of whom found it impossible to get out of positions as trading volumes contracted sharply; accounts of the panic suggest that the informal market practically shut down completely.

The crash triggered somewhere between 350 and 400 bankruptcies and all but one of the country’s banks was at least briefly insolvent. Through all this, the official Kuwait Stock Exchange held up much better at first, sliding just 6.5% over the same period. However, the formal market was not isolated from the crisis outside its doors and this drop continued through 1984, by which point the official market had also halved in value. Despite the government’s initial restraint, another bailout was in fact organized. A $1.7 billion fund was established to compensate ‘small’ investors for losses of up to $1.7 million per head.

New agencies were established to sort out the mess in the Souk and its associated futures market. Trading data and all dubious checks had to be turned over to the government so they could figure out who was solvent and who was not, untangling the messy web of overlapping and opposing obligations. An initial tally found that defaulted obligations summed to $93 billion, over four times Kuwait’s GDP, from thousands of investors. However, perhaps more stunning still, two-thirds of this was owed by a set of just nine dealers operating in the market; one owed over $10 billion alone. The aggregate sum was equivalent to $90,000 for every Kuwaiti at a time when American per capital income was just $14,000 by comparison.

The financial impact of such a disaster was, unsurprisingly, almost boundless. In Kuwait, the banks were bailed out when 200 million dinars, or almost $700 million, was deposited in banks as part of a rescue. The government, charitable as usual, even offered to buy land from investors looking to cover their losses, in order to limit damage to the real estate sector. Not all was forgiven though and dozens of dealers operating in the Souk Al-Manakh were arrested in the weeks and months following the crash. Nonetheless, the previously high-flying economy experienced a severe recession.

Lesson

Almost completely absent from this story of the Souk Al-Manakh boom and bust is any description of the companies that traded there. Whatever their operations and industries, they quickly became a forgettable part of this financial saga. What was more remarkable was the effect of billions of dollars flooding into a small market with limited traditional, and well-regulated, investment opportunities. The Souk Al-Manakh experienced the effect of too much money chasing too few investments, or perhaps it was nothing more than the most popular casino in the Persian Gulf region. Nonetheless, it was the unlikely setting of one of history’s most massive and ridiculous manias.

More from the Tontine Coffee-House

The Persian Gulf region has made even more financial market history. The invasion of Kuwait by Iraq a few years after the Souk Al-Manakh bust helped create one of the most curious stories in the history of money, the Iraqi ‘swiss dinar‘. Also read about the sites of other stock market bubbles, including London’s ‘Exchange Alley’.