A significant loss of wealth in financial market is known as stock market crash. There is always a reason behind any great stock market bubble. Let us see which is the biggest stock market crash, what is the reason for market fall, speculative bubbles in stock market, stock market crashes timeline, great depression of stock market, cause of stock market crash along with the effects of stock market crash
Not all stock market crashes are followed by a bear market or economic recession but a bear market usually begins with a stock market crash. Bear markets occur when the stock prices decline continuously for months or years. Since the stock market goes through cycles, it’s important to stick to your investment plan. Stay the course and don’t let your emotions rule the actions.
What is Stock Market Crash?
A stock market crash is usually an unanticipated and rapid drop in stock prices across stock market. A stock market crash can be due to an economic crisis or collapse of a speculative bubble or some other major catastrophic event.
Although there is no specific percentage threshold defined for the collapse but when a stock market index declines by a double digit percentage over a period of few days it is considered as a stock market crash. In this article we will look at few of them.
- Great Depression of 1929
- Housing bubble of 2008
- Stock market crash of 1987
- Dotcom bubble of 2000
As the stock market rebounds after the crash, so will your portfolio. That is the reason it’s important to diversify your investments and spread your risk. You can maximize the rewards and minimize the risk by investing your money in exchange traded funds based on your risk tolerance.
Stock Market Crash of 1929
Stock market crash of 1929, also known as Wall Street Crash of 1929 or Great Crash, is considered as one of the worst economic event in the world history. In the four days of collapse Dow Jones declined by 25% losing $30 billion in market value.
The cost was more than the total cost of World War 1. It destroyed the confidence of Wall Street as well as the stock markets all over the world and led to the beginning of Great Depression that lasted for 10 years from 1929 to 1939.
The stock market crash of 1929 was spread over four days. On the first day Dow Jones declined by 11% signaling a stock market correction. That day, October 24th, is also known as Black Thursday.
Around 13 million shares were traded on that day which was three times the average volume. The Wall Street bankers started buying the shares to arrest the decline and by the end of the day Dow Jones was down by only 2%.
On October 28th, Black Monday, Wall Street declined again by 13%. On the next day, Black Tuesday, the stock market fell by over 12%. More than 16 million shares were traded on that day, a record that would not be broken for next 40 years.
During the 1920s, there was a rapid increase in stock market prices which was caused by the irrational exuberance of the investors, overconfidence in the economic growth and buying shares on margin and credit.
Due to this Dow Jones increased by more than 200%, from 1922 to 1929, resulting in an average annual gain of 20%. This eventually led to stock market crash of 1929 and the Great Depression of 1930s.
After the World War 1 there was a period of economic growth and unemployment was low. Companies were making huge profits by exporting to Europe and the sale of automobiles was at an all time high.
Encouraged by the strength of the economy, there was a rapid growth in loans and bank credit in US. Some consumers used this money to buy shares. Eventually they were exposed when the share prices collapsed and had to sell their shares to repay the debt.
Some people also bought the shares on margin by paying just 10% to 20% of the total value. But when the stock market declined, these margin millionaires were wiped out. This also affected the banks and investors who had lent the money to buy the shares.
But the biggest cause of the market meltdown was the speculative bubble which was formed because of the false expectations and irrational exuberance of the investors in the years leading up to 1929.
People bought shares with the expectations of making huge gains. As the stock prices increased people borrowed money from banks to invest in stock market. Due to this, stock prices were divorced from reality and eventually collapsed in 1929.
The stock market crash of 1929 was followed by the Great Depression which lasted for almost 10 years from 1929 to 1939. Together they formed one of the largest financial crises in the history of stock market.
By 1932, Dow Jones was down 90% from the record high. People lost the faith in Wall Street. They were forced to sell their businesses to find enough money to pay the brokers. Many lost their jobs and their savings were wiped out.
The beginning of Great Depression resulted in real economic hardship with falling prices and rising unemployment. American citizens were left with poor jobs and wages. Many of them lost their retirement savings.
The stock market collapse greatly affected the banks. People started pulling out their money. They no longer had any confidence in the US banking system. Instead they preferred buying gold or simply hoarding the money.
People started closing their bank accounts. Banks did not have enough money to cover for the withdrawals. Bank runs became normal and banks started collapsing. More than 9000 banks failed resulting in the loss of billions of dollars.
Stock Market Crash of 2008
The financial crisis of 2008 was caused due to the collapse of the speculative housing bubble which crashed the stock market. The bear market which began after the meltdown lasted for 18 months from October 2007 to March 2009.
The Dow Jones and S&P 500 declined by more than 50% in the period of 18 months. On 29 September 2008 after the federal government rejected $700 billion bank bailout bill, Dow Jones dropped by more than 700 points destroying almost $1.2 trillion in market value.
The government finally passed the bill in October but the damaged had already been done. The FED had dropped the funds rate to lowest level in history. The credit markets had frozen and governments all around the world were forced to provide liquidity to credit markets.
Stock market crashed in 2008 as lot of individuals with poor credit score had access to the loans which they couldn’t afford. Easy credit and increasing home prices resulted in a speculative real estate bubble.
Lenders had relaxed the lending standards which fuelled the growth in housing market. The home prices nearly doubled from 1996 to 2006. As long as the home prices kept on increasing, these poor lending standards were simply ignored.
The subprime mortgage market thrived. People with bad credit and no savings were given loans beyond their ability to repay. On the other hand, banks were repackaging these subprime mortgages and selling them to investors in secondary market.
It was a seller’s market and the lenders could afford to write bad loans as long as the prices were increasing. If the borrowers failed to repay the loan, the lenders could always foreclose on the home.
The problems began when the housing prices started to decline in 2007. Suddenly the house was worth less than the loan value and homeowners started to abandon their homes instead of repaying the debt.
As the mortgage defaults started to rise, lenders started fearing that borrowers would not be able to repay the loans. Credit markets froze and Bear Stearns became the first investment bank to be bailed out by government.
Fannie Mae and Freddie Mac were next to be bailed out. In September 2008 another investment bank Lehman Brothers collapsed because of its exposure to subprime mortgages. It was one of the biggest bankruptcy filing in US history up to that point.
Government bailout. Credit crisis. Bank collapse. Mortgage crisis. Phrases like these started appearing frequently across various financial websites and magazines. The period between 2007 and 2009 was widely known as the Great Recession.
People started losing their jobs. Unemployment rate increased to 10%. The biggest automakers were in trouble and were bailed out by government. More than 8 million people lost their jobs during Great Recession.
The housing prices declined significantly. Homeowners found that their homes were worth less than what they owed to the banks. Faced with increasing mortgage payments and job losses, many people lost their homes to foreclosures.
As the housing bubble burst, many financial institutions and banks were also affected who were betting on the rising home prices. Many people lost their retirement savings. Those who had invested in stocks and real estate saw biggest losses in their portfolios.
The stock market crash of 2008 resulted in the failure of some of the largest companies in the US. This period ranks as one of the greatest economic recession in the history of the financial crisis.
Stock Market Crash of 1987
The stock market crash of 1987 started on 19th October 1987 which is forever known as Black Monday. The Dow Jones declined by 23% in one of the worst declines in the history of stock market crashes.
Leveraged investors were forced to sell their stocks to meet the margin calls from their brokers. Then there were all kinds of mutual funds who were forced to sell to cover mutual fund redemption. Finally the portfolio insurance holders were also forced to sell in order to protect their portfolio.
The crash of 1987 ended the five year bull market run during which Dow Jones more than tripled in its value. Program trading, lack of liquidity and over valuation of stocks are considered as few of the causes for the collapse of stock market.
The initial cause of the stock market crash was thought to be the interconnection between equities and derivatives market. Post crash investigation concluded the failure of stock market to operate in sync with derivatives market as a major cause of stock market crash.
However, one of the most remarkable causes of the stock market crash of 1987 was program trading or computerized selling of portfolio insurance hedges. In program trading, computers use a predefined algorithm to place high frequency trades.
At that time the idea of using computer systems for deploying large scale trading strategies was relatively new. Wall Street had never tested and seen the consequences of placing high frequency trades earlier.
These computer programs automatically started selling the stocks trading below stop loss resulting in the cascading effect of more stop loss orders getting triggered. Since these same programs automatically shut off the buying, there were no bids in the market which resulted in the rapid decline of stock market prices.
During the crash, the trading infrastructure in financial markets was not able to handle such huge number of sell orders. Trading in many stocks was terminated and the liquidity vanished immediately. This resulted in the significant drop in the stock markets across the world.
Another important trigger for stock market crash was the high budget and trade deficit in third quarter of 1987. Foreign investors started pulling out their money from dollar denominated assets fearing the decline in dollar value.
Many people feared that the stock market collapse of 1987 would trigger a recession but the fallout from the crash was surprisingly small. This was due to the timely intervention of Federal Reserve. Around 15,000 jobs were lost in Wall Street.
Black Monday led to the number of reforms across financial markets around the world. Stock exchanges developed, what is today known as circuit breaker, to temporarily pause the intraday trading in the event of rapid stock market selloff.
Stock Market Crash of 2000
The dot com bubble, known as tech bubble or internet bubble was a rapid increase in the stock prices of internet based companies during the bull market of 1990s. The NASDAQ index increased from 1000 to 5000 in less than 5 years.
In 2001 and 2002 the dot com bubble burst and equities entered into bear market. Many well known stocks lost more than 80% of their value. Stock market crash wiped out $8 trillion of market value.
The biggest cause for the collapse of dot com bubble was the overvaluation of internet companies. The venture capital was available in abundance and investors started giving the money to internet based startups during 1990s without proper due diligence.
With abundant capital available from stock markets, startup companies were in a race to grow big and grow fast. They abandoned fiscal responsibility and started spending huge amount of money on advertising and marketing.
The tech bubble finally burst in 2000 and many internet companies were forced to declare bankruptcy. Very few companies survived the meltdown but their market value dropped significantly.
By the end of 2002, NASDAQ index declined by more than 75% and Dow Jones had lost almost 27% of the value. It would take more than 15 years for NASDAQ to regain its dot com peak.
After the crash lot of reforms were started to stabilize the stock market. One of the reasons for the stock market crash of 2000 was considered to be the huge increase in intraday traders and online trading.
A rule was formed for these intraday traders. According to the rule the individual should have at least $25000 to their name in any bank account. This would ensure that the individual is not insolvent.
Another reform was started by closing the loopholes in companies accounting. According to the rule all the companies were required to maintain a clear balance sheet and disclose all the information about the transactions and investment in other companies.