A stock market crash

(1) Introduction

(1.1) What is a stock market crash and how is it related to the economic bubble?

A stock market crash is a sudden decline in stock prices, which occur due to panic or major economic factors. They often follow a speculative stock market bubble i.e. when investors, seeing an upward trend in prices, quickly enter the market and buy stocks in an attempt to participate in the stocks’ profitability. Typically, once the prices begin to decline a majority of the investors will try to exit the market at the same time and as a result cause the bubble to burst and gain massive losses. Hoping to avoid further losses, investors during a crash will start panic selling i.e. they will try to unburden themselves from their declining stocks and pass the problem onto other investors. This panic selling contributes to the declining market, which eventually crashes and affects everyone. Typically crashes in the stock market have been followed by a depression.

(1.2) Why are stock market crashes crucial?

A stock market crash is crucial because the most important part of the ultimate value of a stock market index is realized during these events; however identifying crashes is not an easy task. Some similar price differences do not have the same impact in a stable financial period as it will have in a highly unstable period.

This essay aims at letting the reader know more about the history of the stock market’s crashes; how they came about and what happened during these periods.

(2) History of Stock Market Crashes

(2.1) List of Stock Market Crashes to be discussed:

Due to the page limit, not all stock market crashes that took place in the 20th – 21st century will be used in this essay and only on the crashes that took place in the United States will be talked about. Below is a list of stock market crashes that will be discussed.

• Panic of 1901.
• Panic of 1907.
• Wall Street Crash of 1929.
• Black Monday 1987.
• Dot-com bubble 2000.

(2.2) Stock market crash timeline:

The graph below represents the timeline of the occurrence of stock market crashes from the year 1900 till 2009.

(2.3) Panic of 1901

The panic was caused when Jacob Schiff, E. H. Harriman and J. P. Morgan/James J. Hill started a bidding war for the financial control of the Northern Pacific Railroad. The First National City Bank (Citibank) attempted to corner the stock market and bought $115 million of Northern Pacific Railroad’s stock which in turn triggered a stock market panic. As a result of the panic a lot of small investors were cleaned out.

On May 17th, 1901 the stock market crashed on the New York Stock Exchange for the first time. This crash was a result of the struggle over control of the Northern Pacific Railroad.

Post Crash:

After reaching a compromise, the four industrialists formed the Northern Securities Company. The Northern securities company, a holding company that was formed to hold a controlling part of the stock of other companies, gained the control of America’s four big railroads of the northwest, creating a monopoly. However this company was dissolved in 1904 by the U.S. government.

(2.4) Panic of 1907

In the summer of 1907 prices sharply fell on the New York Stock Exchange. The following panic lead to runs on banks i.e. a large number of bank customers withdrew their deposits because they believed that their bank might become broke. These runs lead to extensive liquidations of loans used to finance stock market investments. As a result, thousands of businesses and banks failed.

The weaknesses in the financial system were exposed due to the panic, particularly the incapability of banks to obtain money during urgent situations.

Post Crash:

The then president Theodore Roosevelt provided J.P. Morgan with $25-30 million in government funds to use to control the panic; Morgan used this money to act as a central bank (since the U.S. lacked a central bank at the time unlike its European counterparts). He organized a team of bank and trust executives, who redirected money between banks and bought falling stocks of healthy companies, in doing so deciding which companies will carry on and which will be shut down due to insolvency. Morgan helped prevent a shutdown of the New York Stock Exchange and also financially bailed out New York City. Within a few weeks the panic calmed down, with only insignificant effects. By early 1908, investors’ confidence was restored.

(2.5) Wall Street Crash of 1929

On September 3 1929, the flourishing rise of the market came discreetly to a halt. Even though a few stocks later reached new highs, the market began a sluggish decline. Soon the decline would become a collapse. It would wipe out the speculators, stop the economy, and lead to the greatest depression in the United States history.

During October the stock market had some bad days. Then, suddenly, on October 24 (which was called “Black Thursday”) prices began to plummet, and investors started selling their stock due to panic, the rush to sell made prices fall even more rapidly.

On Black Thursday New York’s most powerful bankers met and raised $30 million to support the stock market. Prices began to move up again and by the end of the day the market had recovered much of its earlier losses, the panic seemed over. Prices remained stable on the following days. But on Monday prices again dropped rapidly. The bankers decided that they could do nothing this time and on October 29 (“Black Tuesday”) some 16.5 million shares changed hands, a record high volume as prices continued their steep decline. The following day prices improved to an extent, only to plummet again the day after. In the weeks that followed the price of stocks sank lower and lower. The average price of 50 leading stocks sank by half their pre crash value. In the last four months of 1929 the overall value of stocks fell below $40 billion and their fall would continue.

Post Crash:

The Wall Street crash of 1929 would go on to be the greatest financial crisis of the 20th century and lead to the Great Depression which only ended at the start of World War II, almost 10 years later. World War II helped end the depression by creating the much needed jobs. The stock market crash also quickly spread around the world affecting almost every country.

(2.6) Black Monday (1987)

The stock market crash in 1987 was one of the most severe financial events since the Wall Street crash of 1929. Optimistic by an improving U.S. economy, the price of stocks began moving upwards in the summer of 1982. Five years later, the Dow Jones Industrial Average, which is an indicator of the financial environment, had gone up by 230 percent. The rising market was called a “bull market” because investors expected an increase in profits and thus were “charging” ahead to buy more stock.

In August 1987, the stock market began to decline slowly. After the U.S. government reported a trade deficit of $1.5 billion higher than expected on October 14, the Dow Jones Average suddenly fell a record 95 points. The next day the market fell another 57 points and on Friday it was down by an additional 108 points. On Monday the market collapsed by an astonishing 508 points! In just one day stocks lost over 20% of their value. This drop was the largest one-day percentage decline in stock market history.

Post Crash:

Discussion as to the cause of the crash still continues to this day, with no firm agreement reached. Ironically, The Dow Jones Industrial Average ended up closing positive by the end of 1987, Closing 48 points higher by 31 December 1987 then it started at 2 January 1987. The Dow Jones Industrial Average did not recover its pre August 1987 closing high until almost two years later in 1989.

(2.7) Dot-com bubble (2000)

The dot-com bubble was a stock market speculative bubble taking place from 1998 to 2000 (with a climax on March 10, 2000) which burst to a near-overwhelming effect in 2001. It was caused by the rise of Internet sites and the tech industry in general, and when the bubble finally burst many of these companies became insolvent or altered their philosophy. Many investors lost considerable sums of money on the dot-com bubble, which helped in generating a small economic recession in the early 2000s.

A number of factors caused the dot-com bubble. The year, 1995, marked the beginning of growth in the amount of Internet users, who were seen by companies as potential customers also the low interest rates in 1998-99 helped people gain easy access to start up capital. As a result, many Internet companies were founded in the late 1990s. These companies were referred to as “dot coms” due to the “.com” in many of their web addresses.

Most of these companies employed bizarre and daring business practices with the hopes of cornering a market and becoming a monopoly. Most aimed at gaining a huge customer base (thus market share) first before attaining any profit and in doing so most of these dot coms operated at a loss. They anticipated that if they could raise enough brand awareness they can charge profitable rates for their services later or sell their business at a profit to larger companies.

The bubble finally burst when the tech heavy NASDAQ Composite index collapsed after its March 10 2001 peak, partially due to the findings of the U.S. versus Microsoft case in which Microsoft was declared a monopoly.

One of the possible causes that can be attributed for the collapse was the multi-billion dollar sell orders for major high tech stocks that happened unintentionally to be taking place at the same time on the morning following the March 10 weekend. This early set of sell orders that took place caused a chain reaction with investors selling out of the market.

Post Crash:

Although there were a few dot com companies that did manage to become a success, only 50% of the dot com companies survived the bubble’s burst, some being bought by bigger companies and others filing for bankruptcy. The dot com bubble burst occurred due to the impractical expectations and unfeasible business strategies. The crash lowered the market value for tech companies by $5 trillion. Some stock prices that used to sell for hundreds of dollars fell in value to just $1.

Many people working in the tech/dot com market were laid off, with a majority going back to school to become lawyers or accountants.

(3) Conclusion

To wrap up, we should all learn from these past tragedies, most stock market crashes were caused by people who raise the price of stocks beyond the worth of the company offering it. When stock prices are rapidly increasing it is usually a sign of an economic bubble, not to say that stocks can’t rightfully have the benefit of a huge leap in value, but this leap should be reasonable by the projection of the company offering these stocks, not just by a mass of investors copying each other in anticipation of getting rich quick. The idea in the unrealistic opportunity of getting rich quick is the number one reason why people themselves create stock market crashes. People fail to keep in mind that when they put their money into investments with a high possibility for returns they also risk a chance of incurring massive loses.

We should also keep in mind that the time between stock market crashes has decreased over the past few centuries, it used to take a century for another crash to happen, but in the early 20th century this time gap was reduced to decades and currently its reduced to mere years for another stock market crash to proceed another. The best thing for people to do is remain educated and learn from past mistakes in hopes of avoiding a major catastrophe in the future if similar events do take place.

(4) Sources

1. Holt Economics by Holt, Rinehart and Winston.
2. www.Wikipedia.com
3. www.FDIC.gov
4. A History of the United States by Boorstin and Kelly
5. Google News and Search
6. www.Ac360.blogs.cnn.com
7. Social Science Research Network (www.hq.ssrn.com)