History of U.S. Stock Market
Crashes
The Crash of 2000
From 1992-2000, the markets and the economy
experienced a period of record expansion. On September 1, 2000, the
NASDAQ traded at 4234.33. From September 2000 to January 2, 2001, the
NASDAQ dropped 45.9%. In October 2002, the NASDAQ dropped to as low as
1,108.49 - a 78.4% decline from its all-time high of 5,132.52, the level
it had established in March 2000.
Causes of the Crash:
- Corporate Corruption. Many companies fraudulently
inflated their profits and used accounting loopholes to hide debt.
Corporate officers enjoyed outrageous stock options that diluted
company stock;
- Overvalued Stocks. There were numerous examples
of companies making significant operating losses with no hope of
turning a profit for years to come, yet sporting a market
capitalization of over a billion dollars;
- Daytraders and Momentum Investors. The advent of
the Internet enabled online trading –a new, quick, and inexpensive
way to trade the markets. This revolution led to millions of new
investors and traders entering the markets with little or no
experience;
- Conflict of Interest between Research Firm
Analysts and Investment Bankers. It was common practice for the
research arms of investment banks to issue favorable ratings on
stocks for which their client companies sought to raise capital. In
some cases, companies received highly favorable ratings, even though
they were actually in serious financial trouble.
A total of 8 trillion dollars of wealth was lost in
the crash of 2000.
Following the Crash:
- New Rules for Daytraders. Under the new rules
that were introduced, investors need at least $25,000 in their
account to actively trade the markets. In addition, new restrictions
were also placed on the marketing methods daytrading firms are
allowed to use;
- CEO and CFO Accountability. Under the new
regulations, CEOs and CFOs are required to sign-off on their
statements (balance sheets). In addition, fraud prosecution was
stepped up, resulting in significantly higher penalties;
- Accounting Reforms. Reforms include better
disclosure of corporate balance sheet information. Items such as
stock options and offshore investments are to be disclosed so that
investors may better judge if a company is actually profitable;4.
Separation between Investment Banking and Brokerage Research. A
major reform was introduced to avoid conflicts of interest in the
financial services industry. A clear split between the research and
investment banking arms of brokerage houses was mandated.
The Crash of 1987
The markets hit a new high on August 25, 1987 when the
Dow hit a record 2722.44 points. Then, the Dow started to head down. On
October 19, 1987, the stock market crashed. The Dow dropped 508 points
or 22.6% in a single trading day. This was a drop of 36.7% from its high
on August 25, 1987.
Causes of the Crash:
- No Liquidity. During the crash, the markets were
not able to handle the imbalance of sell orders;
- Overvalued Stocks;
- Program Trading and the Use of Derivative
Securities Software. Large institutional investment companies used
computers to execute large stock trades automatically when certain
market conditions prevailed. Some analysts claim that the program
trading of index futures and derivatives securities was also to
blame.
During this crash, 1/2 trillion dollars of wealth
were erased.
Following the Crash:
- Uniform Margin Requirements. New margin
requirements were introduced to reduce the volatility for stocks,
index futures, and stock options;
- New Computer Systems. Stock exchanges changed to
new computer systems that increase data management effectiveness,
accuracy, efficiency, and productivity;
- Circuit Breakers. The New York Stock Exchange and
the Chicago Mercantile Exchange instituted a circuit breaker
mechanism, which halts trading on both exchanges for one hour should
the Dow fall more than 250 points in a day, and for two hours,
should it fall more than 400 points.
The Crash of 1929
On September 4, 1929, the stock market hit an all-time
high. Banks were heavily invested in stocks, and individual investors
borrowed on margin to invest in stocks. On October 29, 1929, the stock
market dropped 11.5%, bringing the Dow 39.6% off its high.
After the crash, the stock market mounted a slow
comeback. By the summer of 1930, the market was up 30% from the crash
low. But by July 1932, the stock market hit a low that made the 1929
crash. By the summer of 1932, the Dow had lost almost 89% of its value
and traded more than 50% below the low it had reached on October 29,
1929.
Causes of the Crash:
- Overvalued Stocks. Some analysts also maintain
stocks were heavily overbought;
- Low Margin Requirements. At the time of the
crash, you needed to put down only 10% cash in order to buy stocks.
If you wanted to invest $10,000 in stocks, only $1,000 in cash was
required;
- Interest Rate Hikes. The Fed aggressively raised
interest rates on broker loans;
- Poor Banking Structures. There were few federal
restrictions on start-up capital requirements for new banks. As a
result, many banks were highly insolvent. When these banks started
to invest heavily in the stock market, the results proved to be
devastating, once the market started to crash. By 1932, 40% of all
banks in the U.S. had gone out of business.
In total, 14 billion dollars of wealth were lost
during the market crash.
Following the Crash:
- The Securities and Exchange Commission (SEC) was
established;.
- The Glass-Stegall Act was passed. It separated
commercial and investment banking activities. Over the past decade
though, the Fed and banking regulators have softened some of the
provisions of the Glass-Stegall Act;
- 3. In 1933, the Federal Deposit Insurance
Corporation (FDIC) was established to insure individual bank
accounts for up to $100,000.
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