HISTORY OF MARKET CRASH
INTRODUCTION
Market crash refers to a sudden
dramatic decline of stock prices resulting
in a significant loss of paper wealth.
Crashes are usually driven by underlying economic factors and panic. The two well-known flavors of market crashes
are the ‘corrections’ which is caused by sudden onset of panic but tends to
be short-lived; and the ‘depression’ which is the more dangerous type.
Stock market bubble is often caused
the market crash where it is a type of economic bubble that takes place in
stock markets when market participants drive stock prices above their value in
relation to some system of stock valuation.
Stock market bubbles frequently produce hot markets in Initial Public
Offerings (IPO), since this is where the investment bankers and their clients
see opportunities to float new stock issues at inflated prices.
CRASHES AND BUBBLES
BUBBLES
Bubbles occur when
too much demand is being put on a stock and it drives the price of the stock
beyond any accurate or rational reflection of its actual worth. Like a soap bubble, investing bubbles appear
as though it will rise forever, but eventually they will pop. So, when it does pop, so the money invested
dissipates into the wind.A bubble is a type of investing phenomenon that
demonstrates the frailty of some facets of human emotion. Like the soap bubbles a child likes to blow, since
they are not formed from anything substantial, they eventually pop.
CRASHES
A significant drop
in the total value of a market, attributed by the popping of a bubble, which
then create a situation of investors fleeing the market and at the same time
causing massive losses is known as the crash.
Panic selling by investors worsens the situation which eventually
affects everyone and worse still, followed by a depression.
RELATIONSHIP BETWEEN BUBBLE AND CRASH
The relationship
between the bubbles and crashes is best describe as the relationship between
clouds and rain where bubbles are like clouds and market crashes are like the
rain. You can have clouds without rain
but you can’t have rain without clouds. Market
crash almost always triggered from a bubble.
The thicker the clouds, the harder its rains.
CRASHES AND BUBBLES
THROUGHOUT HISTORY
The Tulip and Bulb
Craze (1634 – 1637: Holland)
In 1593 tulips were brought from Turkey and introduced to the
Dutch. A man named Conrad Guestner
imported the first tulip bulb into Holland from Constantinople, now known as
Turkey. Tulip bulbs became a status
symbol and a novelty for the rich and famous.
It was widely sought and fairly priced.
The tulips contracted a non-fatal virus known
as mosaic, which caused ‘flames’ of color in a wide variety to appear upon the
petals. These increased the rarity of an
already unique flower which than cause the rise in the price of the tulips,
valued according to their uniqueness, or desired. Prices rose so fast and high that people were
trading their land, life savings, and anything else they could liquidate to get
more tulip bulbs. The prices do not give
an accurate reflection of the value of a tulip bulb. The tulip was said to be a conspirator in the
supply squeeze as it actually takes seven years to grow one from seed. Some prudent investors decided to sell and
crystallize their profits thus causing a domino effect. People began to panic and sell regardless of
losses as the price began to dive lower.
They began to realize that they had traded their homes for a piece of
greenery.
The government attempted to honor contracts at 10% of the
face value but the market plunged even lower.
Assembled deputies of Amsterdam nullified all of the contracts purchased
at the height of the mania and supreme judges of Amsterdam declared all tulip
speculation to be gambling, thus refused to honor these contracts. As a result, payments were not enforced by any
of Holland’s courts. This action further fueled the market crash. The effects of the tulip craze left the Dutch
very hesitant about speculative investments for quite some time. The lesson learned was that it is better to
stop and just smell the flowers than to stake your future upon one. The amount at the peak is where a single
tulip could be traded for an entire estate; and at the bottom is one tulip was
at the price of a common onion.
The South Sea Bubble (1711: United
Kingdom)
The British Empire
was the big dog on the block in the 1700s meaning the population had money to invest. The eighteenth century was a time of
prosperity whereby a large section of the population had money to invest. So, when the South Sea Company (SSC) had an
IOU to the government worth £10,000,000.00, they purchased the ‘rights’ to all
trade in the South Seas, thus had no problem in attracting investors. The SSC was at that time perceived to be the
most lucrative monopoly on earth. When
SSC repeatedly re-issues stocks, people just bought, nobody asked questions.
The emergence of the Mississippi Company (MC), a company established
in France, the brainchild of an exiled Brit named John Law switching the
monetary system from gold and silver into a paper currency system. Soon the MC's stock was worth 80 times more
than all the gold and silver in France.
This success stirred British pride, thus blinding them to many
indications of poor management in SSC. In
1720, the SSC’s management team sold their stocks after realizing that the
value of the shares was not reflecting the actual value of the company. The leak of the sales caused the panic selling of worthless
certificates. This causes a huge hole in
the south sea bubble and it also punctured the MC's unrealistic value and both
companies came crashing down. The amount
at the peak was traded for 1,000 British pounds; and was reduced to nothing by
the latter half of 1720.
The Florida Real
Estate Craze (1926: Florida)
Florida was the popular U.S.
destination/residence in 1920 for people who don't like the cold. Prices of houses doubled and tripled in some
cases due to demand. This situation attracts
speculators so much so people began pumping huge amounts of money into the real
estate market. However, as time goes,
there were no ‘greater fools’ to buy the disgustingly overpriced land, thus
forcing the prices to adjust ever so subtly.
As soon as the speculators realized this, they began to sell their
properties to solidify their profits while they could. Then everybody simultaneously saw it and panic
selling ensued. Imagine the situation
where there are thousands of sellers and very few buyers, prices of real estate
came down with a sickening thud, twitched a bit, and then crawled down even
lower. At the peak, land bought for
$800,000, can within a year could be sold for $4 million before crashing back
down.
The Great Depression
(October, 1929: USA)
Despite the Florida crash, the
stock market was guaranteed to make everyone rich as the First World War had
been won, and industrialization was resulting in previously-unimaginable
luxuries. The stock market was believed
to be a no-risk and no-brain world where everything went up. People start pouring all their savings into stock
market without really learning about the system or the underlying companies. With the flood of uneducated investors, the
market was ripe for some manipulation and swindling. There exist opportunities for investment
bankers, brokers, traders, and sometimes owners banded together to manipulate
stock prices to obtain gains. The
intention was to get the public to notice the progression of price on the
ticker tape, so that everyone would buy the stock. Thus
the market manipulators would sell off their
overpriced shares for a healthy profit.
Behavioral finance shows that the
less an investor knows, the easier it is for them to be swept up in popular
opinion (herd mentality). Little known to the investors, this behavior is a
double-edged sword to them because the ignorant are also easily spooked into
panic, thus causing the trampling of the market. The stock market drop more than 40% from the
beginning of September 1929 to the end of October 1929, and continues to
decline until July 1932 nearly 90% from its 1929 highs.
The Crash of 1987 (19
October, 1987: USA)
The Crash of 1987 was the crash that everyone expected but could not
justify. The
Securities and Exchange Commission (SEC) could
take investors to the proper information but they couldn't make them
think. Investors did not look at the
value of the company but at the appeal of its public image and the vernacular
used to describe it. Market
continued to rise unabated due to SEC unable to halt the shady IPOs and
conglomerations.
Early 1987, there was a rash of SEC investigations into insider
trading which rattled investors. They
then decided to move into the more stable environment offered by bonds or, in
some cases, junk bonds. The mass exodus
out of the market caused the computer programs began to kick in which put a
stop loss on stocks and sent a sell order to the NYSE computer system, DOT
(designated order turnaround). The
transmission of instantaneous many sell orders are too overwhelming for the DOT
printers causing the whole market system to lag, leaving investors on every
level (institutional to individual) effectively blind. This caused panic and thus people started
dumping their stock in the dark without knowing what their losses were or
whether their orders would execute fast enough to keep up with plummeting
prices. The largest one-day
percentage drop in history that is 508.32 points, 22.6%, or $500 billion lost
in one day.
The Asian Crisis
(1989: Southeast Asia, primarily Japan)
The Japanese economy gained extreme
strength after its long recovery from the war and the atomic bombs making the Asian
economy an alternative for investors who were recently bruised by 1987. Although some have realized that Japan was
becoming a bubble but the high level of collusion between the government and
business was believed to be able to sustain the growth forever. Land prices in Japan appreciated by 70 times
and stocks increased
100 times over between the year 1955 and 1990. The crisis started when landowning
firms started using the book value of their land to buy stocks which in turn was
used to finance the purchase of American assets. Soon corruptions began to spread throughout
the political and business realms in Japan.
Japan’s government strategy then was to raise interest rates in order to
put a halt to the inflammatory growth of stocks and real estate. But the strategy backfired when the Nikkei
index plunged down to more than 30 000 points.
Percentage of 63.5% as of 2003.
The Dotcom Crash (March
11, 2000 to October 9, 2002: Silicon Valley)
The internet started to catch on in
1995 with an estimation of 18 million users all over the world. Speculators were barely able to control their
excitement over the untapped market of the ‘new economy’. Soon words like networking, new paradigm,
information technologies, internet, consumer-driven navigation, tailored web
experience, and many more filled the media and investors with a rabid that hunger
for more. The IPOs of internet companies
emerged with much ferocity and frequency making investors grabbing blindly at every
new issue without even looking at the business plan to find out how long the
company would take before making a profit.
The first shots through this bubble
came when the companies themselves reported huge losses and some even folded
outright within months of their offering.
There were 457 IPOs in the year 1999, where most were internet and
technology related companies. Only 117
doubled in price on the first day of trading.
The Nasdaq Composite fell from 5046.86 to 1114.11 thus losing 78% of its
value.
Housing Bubble and
Credit Crisis (2007-2009)
For several years, global financial
markets entered a period of ‘Great Moderation’ due to the above-average returns
and below-average volatility of by a wide variety of asset classes. Rising home prices led to rampant real estate
speculation, and fueled excessive consumer spending. As home prices soared and many homeowners ‘stretched’
their mortgage payments. The possibility
of a collapse and the true extent of the danger were hidden because the
mortgages were turned into AAA-rated securities.
When home prices started to
plunged, it prompting large losses for banks and other financial institutions
which then spread to other asset classes.
Events reached their climax with the bankruptcy of Lehman Brothers in
September 2008. The aggressive actions
by governments around the world eventually helped avoid financial collapse, but
the credit freeze forced the global economy into the worst recession since WW2. The S&P 500 declined 57% from its high in October 2007
of 1576 to its low in March 2009 of 676.
CONCLUSION
People create most of the risk in
the market place by inflating stock prices beyond the value of the underlying
company. Most market volatility is our
entire fault. The unreasonable belief in
the possibility of getting rich quick is the primary reason people get burned
by market crashes. Investing in high
potential investments for returns means investors must also be willing to bear
a high chance of losing it all. The best
thing is be educated, informed, and well-practiced in doing research.
Be alert when suddenly stocks are
flying through the stratosphere like rockets, because it is usually a sign of a
bubble. Stocks can legitimately enjoy a
huge leap in value, but this leap should be justified by the prospects of the
underlying companies, not just by a mass of investors following each
other. The unreasonable belief in the
possibility of getting rich quick is the primary reason people get burned by
market crashes. Remember that high
potential returns for investments bear a high chance of loss.
The stock markets are primarily a
mechanism for the redistribution of wealth.
It is a gambling game on the table of a game of chance. It was observed that the time between crashes
has decreased. Greed is a human
characteristic, and it will not go away so easily. The one lesson learned from all of these
crashes is that humans may overact frequently with small effects, but computers
do it only once in a big way. History is
a great teacher, people just never learn from it! It was said that those who ignore history are
doomed to repeat it.
REFERENCES
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