Stock Market Crash – An Examination

What is a Stock Market Crash?

A stock market crash is when then there is a sudden, rapid and uncontrollable downward turn in the price of a wide ranging section of stocks and shares that are listed on the stock exchange. They are usually driven by fear, and become an almost self fulfilling event once they begin, as investors look to take a hit as early as they can, fearing that prices are only going to go in one direction (down). This feeds into the general sense of panic, as everyone looks to sell at the one time, coupled with the absence of buyers, who realise what is happening and decide not to spend money in a rapidly declining market in which the assets that they purchase will decrease in price the moment they buy them.

A stock market is based on confidence in the values of shares, even allowing for acceptable fluctuations up or down, but if that confidence goes, you can very quickly have a situation of mass hysteria, and a group effort to dump shares onto a market that does not want them.

A stock market crash can be a short lived affair, or it can lead to a painful and protracted recovery period, resulting in recession or even depression. A recession is when business activity slows down, and as a result, overall economic activity within an economic system slows down and contracts for a period. The average recession, according to the National Bureau of Economic Activity, lasts for about one year.

The worst case scenario from a stock market crash is that of a depression, which is a more severe and longer lasting event in which gross domestic product declines by more than ten per cent, leading to major social upheaval such as declines in living standards and double digit and long term unemployment.

What are the causes of a stock market crash?

Well, given that the stock market is the centre stage for a huge amount of human activity (pensions, investments, company performance and precious metals to name but a few), and can be affected by an even greater number of outside factors, such as social, political, weather, geological or electoral events, again to name but a few; the causes can be numerous.

Thus a stock market crash can have a major effect on more than just the major institutional investors. In fact, given that those financial institutions that survive a major crash will usually bounce back, whereas society can be left to feel the effects and pick up the pieces, you could say that they are the least affected.

When they happen is a little easier to explain, albeit with the benefit of hindsight. Modern economic activity runs in waves of expansion and contraction, or boom and bust, if you prefer. As a market expands, economic activity increases, credit flows throughout the system, more people enter the market place for shares and assets, and prices increase. As people or institutions see that profits and values are going up, they want more, and so prices that people are prepared to pay (and borrow to pay for) become inflated due to demand, and out of touch with what they are realistically worth. Now we have what many people call a bubble, with activity, prices and demand stretched, and ready to burst.

Some economic theories suggest that a free market should, and will, correct itself from the highs of a fully heated economy, to a more sustainable and realistic level of activity. Given the losses of paper wealth (that which existed only on paper, i.e. that value of your shares, and not what money you have in the bank) and the knock on effects to society, a stock market crash is a very painful “correction” that politicians and economic theorists have been trying for years to iron out. Given the state of markets today, they have obviously not been successful.

A crash can happen in any market, be it a housing market, a minerals market, or even in a flower market (a crash in the tulip market once wiped out entire fortunes).

There have been many stock market crashes in the last century, but three of the big ones have been the 1929 stock market crash (often seen as the daddy of them all), the 2008 stock market crash (not far behind) and finally, the 2011 stock market crash.

The Stock Market Crash of 1929

All through the “roaring twenties”, money and people flocked to the stock markets. It was a time of excess living and seemingly unending profits, with huge gains made on the markets that attracted more investors, and feeding into the bubble that was expanding. In early September 1929, the Dow Jones market on Wall Street reached a high of 381.77 points. This was an unstable situation that, in late November, led to an 11% drop just after the start of trading that day, ending in a 9% drop by the close of business. This drop introduced fear into the mix, and people began to sell in larger numbers.

Leading bankers tried to solve the situation by buying large amounts of shares in order to restore calm but it did not work, and over the weekend of Friday the 25^th of November 1929, panic set in, followed by more huge losses the next Monday. Then “black Tuesday” during which a mass panic sell occurred, and on that day alone, 14 billion dollars was wiped from the value of the market; lost by investors, many of them small time and who had borrowed heavily. 16 million shares were traded that day, a number not matched until the mid 1960’s!

It would take 15 years for the economy to recover, years that included the Great Depression.

The 2008 stock market crash was brought about in the main by a banking crisis in America caused by sub prime mortgages, where large amounts of money were lent to people with bad or poor credit ratings, as well as banks lending much greater amounts than they actually held in deposits (known as the debt to equity ratio). Coupled with the fact that many economies were already contracting, the banking crisis spread to Europe, and once again, confidence was lost and investors pulled their money.

In that crash, the market lost 21% of its value on the week of September 16^th, followed by another 18% the following week.

Stock Market Crash 2011

Another stock market crash occurred in August 2011, when prices fell heavily across the world. The reason was a fear that the sovereign debt crises being experienced by some countries in the European Union would spread from there to other parts of the world, at a time when economies were still fragile from the banking crisis and credit crunch of 2008. Weak economic data from America also fed into investors seeking a safer place to put their money, as evidenced by soaring gold prices.