The 5 Crashes That Shook The Markets.A very brief look at 5 of the most significant market crashes to date, using the Dow Jones Index.
Content taken from various online sources.
Great Crash 1929
Many factors likely contributed to the collapse of the stock market. Among the more prominent causes were the period of rampant speculation (those who had bought stocks on margin not only lost the value of their investment, they also owed money to the entities that had granted the loans for the stock purchases), tightening of credit by the Federal Reserve,
the proliferation of holding companies and investment trusts (which tended to create debt), a multitude of large bank loans that could not be liquidated, and an economic recession that had begun earlier in the summer.
During the mid- to late 1920s, the stock market in the United States underwent rapid expansion. It continued for the first six months following President Herbert Hoover’s inauguration in January 1929.
The prices of stocks soared to fantastic heights in the great “Hoover bull market,” and the public, from banking and industrial magnates to chauffeurs and cooks, rushed to brokers to invest their liquid assets or their savings in securities, which they could sell at a profit.
Billions of dollars were drawn from the banks into Wall Street for brokers’ loans to carry margin accounts. The stock market stubbornly kept on climbing. That is, until October 1929, when it all came tumbling down.
Catching on to the market's overheated situation, seasoned investors began "taking profits" in the autumn of 1929. Share prices started to stutter.
They first crash on Oct. 24, 1929, markets opened 11% lower than the previous day. After this "Black Thursday," they rallied briefly. But prices fell again the following Monday. Many investors couldn't make their margin calls.
Wholesale panic set in, leading to more selling. On "Black Tuesday," Oct. 29, investors unloaded millions of shares — and kept on unloading. There were literally no buyers.
The rapid decline in U.S. stocks contributed to the Great Depression of the 1930s.
The Great Depression lasted approximately 10 years and affected both industrialized and non industrialized countries in many parts of the world.
When Franklin D. Roosevelt became President in 1933, he almost immediately started pushing through Congress a series of programs and projects called the New Deal. How much the New Deal actually alleviated the depression is a matter of some debate — throughout the decade, production remained low and unemployment high.
But the New Deal did more than attempt to stabilize the economy, provide relief to jobless Americans and create previously unheard of safety net programs, as well as regulate the private sector. It also reshaped the role of government, with programs that are now part of the fabric of American society.
Black Monday 1987
Many market analysts theorize that the Black Monday crash of 1987 was largely driven simply by a strong bull market that was overdue for a major correction.
1987 marked the fifth year of a major bull market that had not experienced a single major corrective retracement of prices since its inception in 1982. Stock prices had more than tripled in value in the previous four and a half years, rising by 44% in 1987 alone, prior to the Black Monday crash.
The other culprit pinpointed as contributing to the severe crash was computerized trading. Computer, or “program trading,” was still relatively new to the markets in the mid-1980s.
The use of computers enabled brokers to place larger orders and implement trades more quickly. In addition, the software programs developed by banks, brokerages, and other firms were set to automatically execute stop-loss orders, selling out positions, if stocks dropped by a certain percentage.
On Black Monday, the computerized trading systems created a domino effect, continually accelerating the pace of selling as the market dropped, thus causing it to drop even further. The avalanche of selling that was triggered by the initial losses resulted in stock prices dropping even further, which in turn triggered more rounds of computer-driven selling.
A third factor in the crash was “portfolio insurance,” which, like computerized trading, was a relatively new phenomenon at the time. Portfolio insurance involved large institutional investors partially hedging their stock portfolios by taking short positions in S&P 500 futures. The portfolio insurance strategies were designed to automatically increase their short futures positions if there was a significant decline in stock prices.
On Black Monday, the practice triggered the same domino effect as the computerized trading programs. As stock prices declined, large investors sold short more S&P 500 futures contracts. The downward pressure in the futures market put additional selling pressure on the stock market.
In short, the stock market dropped, which caused increased short selling in the futures market, which caused more investors to sell stocks, which caused more investors to short sell stock futures.
A key consequence of the Black Monday crash was the development and implementation of “circuit breakers.” In the aftermath of the 1987 crash, stock exchanges worldwide implemented “circuit breakers” that temporarily halt trading when major stock indices decline by a specified percentage.
For example, as of 2019, if the S&P 500 Index falls by more than 7% from the previous day’s closing price, it trips the first circuit breaker, which halts all stock trading for 15 minutes. The second circuit breaker is triggered if there is a 13% drop in the index from the previous close, and if the third circuit breaker level is triggered – by a 20% decline – then trading is halted for the remainder of the day.
The purpose of the circuit breaker system is to try to avoid a market panic where investors just start recklessly selling out all their holdings. It’s widely believed that such a general panic is to blame for much of the severity of the Black Monday crash.
The temporary halts in trading that occur under the circuit breaker system are designed to give investors a space to catch their breath and, hopefully, take the time to make rational trading decisions, thereby avoiding a blind panic of stock selling.
The Federal Reserve responded to the crash in four distinct ways: (1) issuing a public statement promising to provide liquidity, as needed, “to support the economic and financial system”; (2) providing support to the Treasury securities market by injecting in-high-demand maturities into the market via reverse repurchase agreements; (3) allowing the federal funds rate to fall from 7.5% to 7.0% and below; and (4) intervening directly to allow the rescue of the largest options clearing firm in Chicago.
Dotcom Bubble 2000
The dotcom crash was triggered by the rise and fall of technology stocks. The growth of the Internet created a buzz among investors, who were quick to pour money into start-up companies.
These companies were able to raise enough money to go public without a business plan, product, or track record of profits. These companies quickly ran through their cash, which caused them to go under.
The Internet bubble, grew out of a combination of the presence of speculative or fad-based investing, the abundance of venture capital funding for start-ups, and the failure of dotcoms to turn a profit.
Investors poured money into Internet start-ups during the 1990s hoping they would one day become profitable. Many investors and venture capitalists abandoned a cautious approach for fear of not being able to cash in on the growing use of the Internet.
With capital markets throwing money at the sector, start-ups were in a race to quickly get big. Companies without any proprietary technology abandoned fiscal responsibility. They spent a fortune on marketing to establish brands that would set them apart from the competition. Some start-ups spent as much as 90% of their budget on advertising.
Record amounts of capital started flowing into the Nasdaq in 1997. By 1999, 39% of all venture capital investments were going to Internet companies. That year, most of the 457 initial public offerings (IPOs) were related to Internet companies, followed by 91 in the first quarter of 2000 alone.
The high-water mark was the AOL Time Warner megamerger in January 2000, which became the biggest merger failure in history.
As investment capital began to dry up, so did the lifeblood of cash-strapped dotcom companies. Dotcom companies that reached market capitalizations in the hundreds of millions of dollars became worthless within a matter of months. By the end of 2001, a majority of publicly-traded dotcom companies folded, and trillions of dollars of investment capital evaporated.
The bubble ultimately burst, leaving many investors facing steep losses and several Internet companies going bust. Companies that famously survived the bubble include Amazon, eBay, and Priceline.
The US government would date the start of the dot-com recession as beginning in March 2001. And by the time of the economic shock from the terrorist attacks of September 11, 2001, there was no longer any doubt. In that tragic month of September, for the first time in 26 years, not a single IPO came to market. The dot-com era was over.
Global Financial Crisis 2008-2009
The crisis, often referred to as “The Great Recession,” didn’t happen overnight. There were many factors present leading up to the crisis, and their effects linger to this day.
The foundation of the global financial crisis was built on the back of the housing market bubble that began to form in 2007. Banks and lending institutions offered low interest rates on mortgages and encouraged many homeowners to take out loans that they couldn’t afford.
With all the mortgages flooding in, lenders created new financial instruments called mortgage-backed securities (MBS), which were essentially mortgages bundled together that could then be sold as securities with minimal risk load due to the fact that they were backed by credit default swaps (CDS). Lenders could then easily pass along the mortgages – and all the risk.
Outdated regulations that weren’t rigorously enforced allowed lenders to get sloppy with underwriting, meaning the actual value of the securities couldn’t be established or guaranteed.
Banks began to lend recklessly to families and individuals without true means to follow through on the mortgages they’d been granted. Such high-risk (subprime) loans were then inevitably bundled together and passed down the line.
As the subprime mortgage bundles grew in number to an overwhelming degree, with a large percentage moving into default, lending institutions began to face financial difficulties. It led to the dismal financial conditions around the world during the 2008-2009 period and continued for years to come.
Financial stresses peaked following the failure of the US financial firm Lehman Brothers in September 2008. Together with the failure or near failure of a range of other financial firms around that time, this triggered a panic in financial markets globally.
Many who took out subprime mortgages eventually defaulted. When they could not pay, financial institutions took major hits. The government, however, stepped in to bail out banks.
The housing market was deeply impacted by the crisis. Evictions and foreclosures began within months. The stock market, in response, began to plummet and major businesses worldwide began to fail, losing millions. This, of course, resulted in widespread layoffs and extended periods of unemployment worldwide.
Declining credit availability and failing confidence in financial stability led to fewer and more cautious investments, and international trade slowed to a crawl.
Eventually, the United States responded to the crisis by passing the American Recovery and Reinvestment Act of 2009, which used an expansionary monetary policy, facilitated bank bailouts and mergers, and worked towards stimulating economic growth.
Covid Crash 2020
The 2020 crash occurred because investors were worried about the impact of the COVID-19 coronavirus pandemic.
The uncertainty over the danger of the virus, plus the shuttering of many businesses and industries as states implemented shutdown orders, damaged many sectors of the economy.
Investors predicted that workers would be laid off, resulting in high unemployment and decreased purchasing power.
On March 11, the World Health Organization (WHO) declared the disease a pandemic. The organization was concerned that government leaders weren't doing enough to stop the rapidly spreading virus.
Investors had also been jittery ever since President Donald Trump launched trade wars with China and other countries.
Under both the Trump and Biden administrations, the federal government passed multiple bills to stimulate the economy. These included help directed at specific sectors, cash payments to taxpayers, increases in unemployment insurance, and rental assistance.
These measures further soothed investors, leading to additional gains in the stock market. Investors were also encouraged by the development and distribution of multiple COVID-19 vaccines, which began under the Trump administration.
The driving forces behind the stock market crash of 2020 were unprecedented. However, investor confidence remained high, propelled by a combination of federal stimulus and vaccine development.
