A market crash, to be put simply, is a period of a sharp decline in purchases of a particular commodity usually preceded by a speculative bubble of purchases (i.e., purchasing extensively, only to sell off at a higher price as market booms). Most market crashes happen due to excessive dealing in “hot-selling” commodities.
People trade in commodities to such an extreme that they reach a point where there are a lot of sellers of that commodity but not just as many buyers and due to excess supplies, the prices crash. This causes financial damage not only to the respective sellers but also to the economy as a whole. Market crashes increase unemployment and loss of paper wealth (say, stocks) to an economy.
Market crashes include but are not limited to stock market crashes. Did you know that the oldest market crash dates back to the 17th century? A time when the stock market was an alien concept to most of the people.
In the late 16th century, there was an increasing craze about tulips. A lot of people traded extensively in tulips to accumulate profits but it turns out the same was thought by way too many people. The prices increased by many folds until they reached a point where people were not interested in buying them anymore. The prices then plummeted and the market crashed.
Let’s move to stock markets, specifically.
Stock markets are said to “crash” when the stock market index falls suddenly by 10% or more in several days followed by panic selling by investors leading to further plummeting of stock prices as well as the index. Few of the greatest and the most devastating stock market crashes are-
1. Stock Market Crash of 1929
In October 1929, the New York Stock Exchange collapsed, preceded by the roaring of the market from the early 1920s. Dow Jones industrial average, which is a stock market index of the top 30 companies in the United States saw a drastic upward trend of six times increase from 1921-1929 to 381 points. In October 1929, the index saw a decline of nearly 13% on a single day (also known as the Black Monday). This was followed by consequent drops in the following days until it reached half of its value.
The market owes the crash to an increase in unemployment and a decline in productivity. While people were investing in stocks of these companies proactively, their real worth was declining. People had even borrowed money to invest in these stocks as they were on the rise until the bubble of speculating stocks to gain money popped up. This crash also added to the great depression that followed in the states.
2. Crash of 1987
The world witnessed another Black Monday in October of 1987. Known to have begun from Asia, it spread like a wildfire to London and New York. The Dow Jones industrial average saw a dip of around 22% on a single day. Experts point to multiple reasons for this financial disaster.
First, the United States Department of Commerce announced unexpectedly high trade deficit rates (i.e., an excess of a country’s imports over it’s exports) which put a negative impact on the value of the dollar. At the same time, it led to an increase in interest rates and a downward growth in the stock market.
Second, the Federal Reserves slashed the interest rates and flooded the market with liquidity (cash) which led to vast increases in investment among traders who were already showing bullish behaviour (i.e. People were thinking that investments will do better).
Third, the stock market was relatively new to using computer systems in large scale trading. These computers automatically started selling stocks as they touched certain set loss standards (stop loss value), pushing a further plunge in prices of stocks.
3. Dotcom bubble burst
During the 1990s, there was an increase in the number of computers up to 35% of US households. The dot coms were booming which led people to believe that anything with a “.com” can be successful. The interest rates were low back then which made loans available to invest cheap for people. There were low tax rates on investment gains due to the Taxpayer Relief Act of 1997. These factors increased speculation in the market which led to an investment bubble. Most of these companies were incurring net operating losses and some never achieved any material revenue either but even then they were able to raise money through an IPO.
The dot com bust was triggered by a recession in Japan which led to a global sell-off that impacted the technology sector more than others. In March 2020, an article that predicted the imminent bankruptcy of the dot com companies led to a very large volume of sale off in the market. This caused a further price drop in shares of around 62%. Also, after Microsoft was deemed guilty in the United States vs Microsoft Corp 2001 case, its stock prices fell by 15% in a single day and NASDAQ plummeted further by 8%. In the next months, investors’ confidence in the dot com companies wiped out and so did their investments. This in total whopped out $5 trillion of investors.
4. 2008 Housing Crash
Starting in 1999, when the American government introduced a new bill where banks agreed to provide loans to subprime borrowers (i.e., people who have low credit scores and a higher risk of defaulting on loans.) without any security/collateral. Thus, with easy loans, the number of people who tried to buy houses increased substantially. This created an excess demand which led to a significant price hike in houses. People had this perception that property rates will never go down. Hence, speculators started actively buying houses on loans.
Further, these loans were grouped into MBS (Mortgage-backed security) bought by commercial investors who benefited every time the payments were made by individual mortgages.
At the peak of the bubble, housing prices increased by a number as high as 25% in a single year in the states of Hawaii, Nevada, Arizona, Florida, and California.
Between 2004 to 2006, the Federal Reserve increased the interest rates to 6.25% from a meagre 1% which increased the cost of taking loans. Also, in 2005, the government took measures that cut the availability of loans to subprime borrowers. Henceforth, the housing prices started to go down. People started defaulting on their loans and more people went bankrupt as they had a loan obligation to bear even as the value of their house went down. The excess supply as people began to try and sell their houses, further, gave the housing market a downward push.
This went on until the market finally crashed in 2008.
Thenceforth, the market has also seen many more crashes. Some of them are the 2010 flash crash where billions of dollars were wiped out in the time span of half an hour and the 2015-16 Chinese market crash where trillions of dollars were lost.
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