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Market
Crash History
2000 Crash
Intro:
From 1992-2000 the markets and economy had a record period of
expansion. The IPO market had new companies trading at over a
1 billion dollar market cap, with no profits and less than 1
million dollars in revenue.
The
NASDAQ was trading at 4234.33 on September 1, 2000. From
September of 2000 the NASDAQ dropped 45.9% to 2291.86 by Jan
02, 2001. In Oct. of 2002, the NASDAQ dropped as low as
1,108.49 which is a 78.4% drop from its all-time high of
5,132.52 in Mar. of 2000. A total of 8 trillion dollars of
wealth was lost in the market decline.
Causes
of the Crash:
1. Corporate Corruption
A lot of
companies inflated their profits by means of fraud and
accounting loopholes and they hid their debt. Corporate
officers had outrageous stock options that diluted the
company.
2.
Stocks were overvalued
Stocks
were trading in the hundreds and some in the thousands on a
P/E basis. Some companies, which were losing tons of money
with no hope of profit for many years, had over a 1 billion
dollar market cap.
3. A
Wave of New Daytraders and Momentum Investors
The
advent of the Internet and online trading provided a quick and
cheap way to trade the markets. This led to millions of new
investors hitting the markets with little or no experience.
4. Conflict
of Interest by Research Firms
Analysts
and investment bankers worked very closely together. Whenever
a company was trying to raise capital, the investment bankers
made sure their research firms would put favorable ratings on
stocks. This led to companies having favorable ratings even
though they were in serious financial trouble. In some cases
analysts had favorable ratings on a stock less than a month
before the company filed for chapter 11.
Reforms
after the Crash
1. New Rules for Daytraders. Investors need at least
$25,000 in their account in order to actively trade the
markets. New restrictions were placed on marketing methods for
daytrading firms.
2. CEO
and CFO accountability for their balance sheets. CEO's and
CFO's are now required to sign-off on their statements. Also,
the punishment for fraud has been beefed up.
3. Accounting
reform. This includes more disclosure of balance sheet info.
Things such as stock options and offshore companies are to be
disclosed so investors can better judge if the company is
really producing a positive cash-flow.
4. Separation
of Investment Banking and Analyst Research.
Fines
were given to the big firms that were mainly responsible for
deceptive practices. There was major reform to ensure separate
research from the investment banking business.
1987
Crash
Intro:
The markets peaked on August 25, 1987 with the Dow hitting a
record 2722.44. Then the Dow started to head down and by
September 22nd the Dow was down 8.4%. Then the markets
rebounded and on October 2nd the Dow was up 5.9% from
September 21st. Over the next 7 days the Dow would drop 13.5%
from its high on August 25th. On October 19th, 1987 the market
crashed. The Dow dropped 508 points or 22.6% for the day. This
was a drop of 36.7% from the record high of 2722.44 on August
25, 1987. The stock market had lost 1/2 trillion dollars of
wealth.
Causes
of the Crash:
1. No Liquidity
During the crash, the markets were not able to handle the
large volume sell orders. Most common stocks on the NYSE were
not traded until late in the morning of October 19th. No one
knows why investors all wanted to sell at the same time.
2.
Stocks were overvalued
Stocks were trading at a historically high P/E ratio. Though
from 1960 - 1972 stocks were also trading at a high P/E ratio
yet no crash happened. So high P/E ratios don't always trigger
a crash.
3.
Computer Trading and Derivative Securities
Large institutional investing companies used computers in
order to automatically order large stock trades when certain
market trends prevailed. Some analysts also claimed that index
futures and derivatives securities buying were to blame.
Reforms
after the Crash
1. Uniform Margin Requirements
This was done to reduce the volatility for stocks, index
futures and stock options.
2.
Computer Systems
It used to take 20 - 25 keystrokes to enter a trade. With new
computer systems, a trade could be done with one keystroke.
And if something was wrong, the system would just reject it.
This increased data-management effectiveness, accuracy,
efficiency, and productivity.
3. The
NYSE and the Chicago Mercantile Exchange instituted a
"circuit breaker" mechanism. Trading would be halted
on both exchanges for one hour if the Dow Jones average fell
more than 250 points in a day, and for two hours if it fell
more than 400 points.
1929
Crash
Intro:
On September 4, 1929 the stock market hit an all time high as
a result of the American industrial revolution. At that time
banks were invested heavily in stocks and individual investors
borrowed heavily on margin to buy stocks. By October 24, 1929
the stock market was down 20%. On October 28, 1929 the stock
market was down another 13.5%. On the historical day of
October 29, 1929 the stock market dropped 11.5% to bring the
Dow down a total of 39.6% from its high. The market had lost
14 billion dollars of wealth. A quote from the Wall Street
Journal said "STOCKS STEADY
AFTER DECLINE Bankers State Support Continues-
Spokesman Expresses View Hysteria is Passing. " Wall
Street Journal, 10/30/29
(The trading floor of the
New York Stock Exchange just after the crash of 1929)
Causes
of the Crash:
1. Stock were overvalued
Some people thought that, according to P/E ratios and
price/dividend ratios, stocks were overbought. In 1929, stocks
were trading at an average P/E of 60.
2.
Margin Buying
At that time, you could put 10% down to buy stock. Thus if you
wanted $10,000 in stock of GE, you would only need $1,000.
Then you could make monthly payments to pay for the rest.
Margin buying accounted for 5% of the total stock market value
in 1929. This was not enough to drag the entire market down.
3.
Fed Policy
Adolph Miller was the new president of the Federal Reserve
Board and he set out to tighten monetary policy. He
aggressively raised interest rates on broker loans.
4.
Bad Banking Structure
In the 1920's, banks were opening up at the rate of 4 to 5 per
day. There were few federal restrictions to determine start-up
capital needed for a new bank, or how much of its reserve
could be lent. As a result, most of these banks were highly
insolvent. Banks were closing at the rate of 2 a day between
1923 and 1929. When banks moved to invest heavily in the stock
market, it proved to be a disaster when the market crashed. By
1932, 40% of all banks were wiped out.
Reforms
After the Crash:
1. The Securities and Exchange Commission (SEC) was
established to lay down the law and punish violators.
2.
The Glass-Stegall Act was passed which banned any connection
between commercial banks and investment banking. Over the past
decade though, the fed and banking regulators have softened
some of the Glass-Stegall Act.
3.
FDIC was established to insure individual bank accounts for up
to $100,000.
Aftermath:
After October 29, 1929 the market began to slowly mount a
comeback. By the summer of 1930 the market was up 30% from the
low of October 29, 1929. But no one could anticipate the
nightmare that would follow. By July of 1932 the stock market
would hit a low that made the 1929 crash look like hiccup. By
the summer of 1932 the Dow had lost almost 89% of its value,
which was more than 50% lower than the low of October 29,
1929. This drop erased almost every gain from the stock market
since its birth in 1897. It would take the stock market about
30 years to make it back to the 1929 highs, though most
investors would have recovered their losses in the 30's
through dividend returns.
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