The most serious stock market crashes in history have been triggered by a number of different causes, such as unemployment, high inflation, high speculation, the dramatic rise of oil prices and the collapse of banking systems.
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Wall Street Crash (1929)
A market crash is a sharp decline in the total value of the stock market as a result of a decline in investor confidence. As investors struggle to get out of the market collectively, massive market losses are caused. In their attempt to avoid more losses, investors keep on unloading stocks, thus causing a further decline in the stock market, which ultimately crashes.
Typically, a crash is followed by a depression in the economy. Undoubtedly, the Wall Street Crash in October 1929 is one of the most famous stock market crashes in history. Falling by 89 percent between 1929 and 1932, the 1929 Crash plunged the global economy into the Great Depression.
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Causes of the 1929 Crash
Sharp decline of land prices, mainly in Florida, combined with the excessive production of goods. Both caused a sharp decrease in the prices of goods. People could not afford to buy the goods and as supply exceeded demand, there was a surplus, which in the absence of a government regulation to impose a regulatory price floor, caused prices to constantly fall until they reached an equilibrium.
Collapsing banking system, mainly consisting of small banks with insufficient funds that could not anticipate the sudden need for the withdrawing of savings in September 1929.
Intense speculation in the stock market in the late 1920s to the extent that investors would buy on margin by borrowing funds from their brokers to purchase stocks. However, brokers would lend to smaller investors at an inflated price, often by more than 66 percent the actual value of the stock. As more and more investors were focusing on quick profits rather than on corporate results, the Dow Jones Industrial Average climbed to 381.17 on September 3, 1929. Yet, the rise of the stock market was unsustained and the huge investment profits were superficial.
On October 21, 1929, due to the fear of great losses, a lot of investors sold their stocks massively, causing a free fall on the U.S stock market.
On October 24, 1929, the NYSE system collapsed as both institutional and individual investors sold collectively. In spite of the efforts of big banking blocks to stop the forthcoming crash, the U.S. Stock Exchange could not initiate its correction mechanisms.
On Tuesday, October 29, 1929, also known as “Black Tuesday", Dow Jones recorded a decline of 12%, while the stock volume of 16.4 million shares was a historic high for almost 40 years.
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Effects of the 1929 Crash
Following the collapse of the U.S economy, the European economy collapsed as the United Stated recalled the huge loans they had lent to many European countries during the years of stability and growth.
Sharp rise in unemployment – 13 million people were out of work.
Sharp decline in industrial production – 45% between 1929 and 1932.
Sharp decline in real estate prices – 80% between 1929 and 1932.
Inability of investors to repay their loans.
Losses of 16 percent of U.S.households.
Limited access to credit.
Depressed consumer spending that led many businesses to bankruptcy.
Default of the U.S. banking system with 5,000 banks going out of business between 1929 and 1932.
Deaths from starvation, under-nutrition and illnesses.
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Dow Jones Stock Index Crash (1987)
On October 19, 1987, also referred to as “Black Monday," stock markets worldwide plummeted following a crash of the Dow Jones Stock Index (DJIA) by 508 points (22.6 percent) in a single day. This was the second largest value decline as the stock market lost $0.5 trillion dollars.
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Causes & Effects of the 1987 Crash
Causes of the 1987 Crash
Lack of liquidity due to the large volume of sell orders. Investors were selling collectively, thus causing massive market losses.
High volatility of the stock market.
Overvaluation of stocks as investment decision-making was mostly based on P/E ratios rather than on corporate results.
Trading automation and the launch of derivatives led to the extensive use of computer software that could automatically handle large volumes of stock trades. However, the possibility of wrong-doing was extremely likely.
Effects of the 1987 Crash
Standardized margin requirements were initiated to eliminate stock volatility and stock options.
Traders were forced to acquire advanced data management skills, and to demonstrate accuracy and efficiency in using trading automation systems to improve productivity.
A circuit breaker mechanism was initiated by the New York Stock Exchange (NYSE) and the Chicago Mercantile Exchange (CME) to halt trading for one or two hours if the Dow Jones average fell more than 250 points or more than 400 points in a single day, respectively.
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Asian Crisis (1997)
In 1997, major Thai financial institutions faced the event of default due to intense borrowing of U.S. dollars from international banks at low interest rates, which were then exchanged in Thai baht and lent at higher interest rates to local property developers. Yet, property developers could not sell commercial and residential properties to local buyers due to intense speculative overbuilding. As a result, property developers defaulted on their debt and Thai financial institutions experienced serious insolvency as foreign investors sold their stocks collectively and converted their Thai baht to U.S. dollars, causing the Thai stock market major losses.
Other countries that experienced major financial crises and currency depreciation besides Thailand, were Korea, Indonesia and Malaysia.
Causes of the 1997 Asian Crisis
Non-performing loans constituted a large proportion of total loans for each Asian economy, even up to 14 percent for the Philippines, Malaysia and Thailand. Yet, excessive bank lending sustained the speculative environment that ultimately led to the Asian financial crisis.
Having demonstrated a rapid growth, mostly due to foreign direct investment and high investment rates, the Asian economies constituted the Asian miracle. This attracted more and more investors, but also more foreign borrowing with low interest rates. Excessive borrowing led to huge debt that sustained the Asian economies and was necessary to finance investments. Eventually, when the economies could not borrow anymore, they defaulted on their debt obligations.
High and quick growth increased consumer confidence and consumer spending. In addition, borrowing in U.S. dollars created more optimism in consumers and made the Asian financial institutions stronger. However, as most Asian currencies were fixed, they became overvalued, making exports more expensive and less competitive. As export growth declined, Asian economies suffered losses.
Asian governments had small foreign reserves. When investors sold their currencies, collectively switching Thai baht to U.S. dollars, Asian institutions could not defend local currencies, thus defaulting on their foreign debt.
Effects of the 1997 Asian Crisis
The stability of the global financial system was highly questioned because of the collapse of the Asian economies. The price of oil declined sharply to $11 per barrel by the end of 1998, causing serious financial issues to OPEC nations and oil exporters. It is believed that the oil price decline contributed to the 1998 Russian financial crisis.
It is also believed that the Asian crisis is responsible for the 1997 Japan financial crisis and the 1994 Mexican crisis, which both started earlier. In addition, major Latin American economies in Argentina and Brazil experienced a financial crisis in the late 1990s. It is widely accepted that the Asian crisis of 1997 has been a primary policy concern for the International Monetary Fund (IMF) in regards to financial stability and efficiency of global financial markets.
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Dot-Com Bubble (2000)
In the period 1992-2000, the IPO market experienced a major expansion with technology companies that traded with a + $1bl market cap, but had less than $1ml profits. Gradually, the lack of profits caused the dot-com bubble and the NASDAQ crash in 2002.
Causes of the Dot-Com Bubble
The tremendous growth in Internet users in the 1990s practically forced technology companies to target their customers through the Internet. The expansion of their customer base focused on engaging their target groups through their .com websites in an effort to become leaders in the industry.
Most technology companies inflated their profits and demonstrated illusionary market growth, although they faced huge debt issues. In addition, corporate corruption evolved in the form of possession of stock options that diluted the company.
Investors evaluated companies based on their historical data and P/E ratio. Given that profits were falsely reported, companies with losses were evaluated as profitable, thus causing investors to lose huge amounts of money.
The evolution of the Internet created a new generation of day traders, who were looking for easy and cheap ways to perform profitable trading, while lacking the experience to trade.
Favorable rating on stocks enabled companies to raise capital although they faced serious financial problems.
In 2001, a sharp decline by 41 percent equalized the illusionary market growth, putting most technology companies out of business.
In October 2002, NASDAQ collapsed by 78 percent, mostly as a result of a declining investor confidence in the dot-com companies. From 2000 to 2002, $8 trillion was lost.
Effects of the Dot-Com Bubble
The major effect of the dot-com bubble was a harsh global recession that started in 2001. Cutbacks on salaries, rises in unemployment, soaring oil and food prices, a decline in foreign direct investment, a decline in export revenue and a decline in tourism revenue for the period 2003 – 2009 were the main consequences of a recession that practically hit the global economy.
It is interesting to note that, nowadays, due to the quick and global expansion of social networking sites and relevant Internet activities that attract an increasing number of broadband users every minute, experts fear that there is a high risk of another dot-com bubble, which is being referred to as Bubble 2.0.
On the upside, the NASDAQ crash forced several accounting reforms including the disclosure of balance sheets for listed companies to facilitate better investment decision-making. In addition, restrictions were imposed for active trading with a minimum of $25,000, whereas companies that deliberately implemented deceptive practices were given big fines.
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Housing Bubble and Credit Crisis (2006)
The housing bubble of 2006 is considered the biggest bubble in history. According to Newsmax, the Economist suggests that real estate prices have skyrocketed more than 100% of many countries' GDP. That's more than the Asian crisis in 1997 (80% of GDP) and the 1929 Crash (50% of GPD).
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Causes of 2006 Housing Bubble Crisis
The main cause of the subprime mortgage crisis was speculative borrowing in residential real estate. People could very easily get a mortgage to buy a house, thus increasing housing demand and consequently real estate prices. More people were attracted to real estate investment, looking to buy rental properties as an investment with an aim to sell it later and make a profit. This boosted demand and prices for real estate.
However, this also makes a typical speculative housing bubble because people were getting loans they could not afford and to cover for delayed payments, they were given new loans against the value of their property. In fact, real estate was broadly viewed as discretionary income. When home prices started declining, prices on mortgage securities plunged, causing huge loses to banks and other financial institutions. And property values had already depreciated because of the ongoing costs involved in owning a rental property. As a result, many homeowners ended up in default.
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Effects of 2006 Housing Bubble Crisis
Stocks declined by 50 percent of their value, dragging down global financial markets and fixed income markets. Due to high volatility, many corporate bond companies declared bankruptcy, reaching the levels of 1929 and the Great Depression. Oil prices declined 70 percent, but then skyrocketed 140 percent as soon as financial markets stabilized.
Until today, the effects of the housing bubble and credit crisis are highly visible in the United States. Consumers and investors remain highly leveraged and try to repay their mortgages, although the housing market hasn’t recovered yet. There has been a serious deterioration of consumer spending due to the huge amounts of money lost in the housing bubble and credit crisis. Large budget deficits remain a major problem of the U.S. government.