The coronavirus outbreak and the fear that it could become a pandemic is crushing stocks. The Dow fell 1,000 points in back-to-back days in what it the worst week for stocks since the 2008 financial crisis, leading many to wonder if this could become a full-on stock market crash.
Stock market crashes are exactly what they sound like – short bursts of market downturns that often last as little as a single day, but can last much longer, and that routinely turn paper millionaires into bankrupt individuals living hand to mouth.
A stock market crash occurs when a high-profile market index, like the Standard & Poor’s 500 or the Dow Jones Industrial Index, bottoms out, as investors turn from buyers into sellers in an instant. Any market day where stocks fall by 10% or more is considered a market crash, and they happen on a fairly frequent basis, historically.
Historians differ in tallying the actual number of stock market crashes throughout history, but in the U.S., there have been six major market collapses recorded, where the stock market lost over 10% of its value.
The First Recorded Stock Market Crash
Historically, records of stock market crashes date back to the year 1634, when the first speculative bubble, on Dutch tulips, created the first market crash. After it was first imported from the Ottoman Empire (now Turkey) to Europe, the rare, exotic beauty of the tulip created high demand among the Dutch elite, who saw the plant as a status symbol. Prices skyrocketed from 1634 to 1637, and soon speculators – even middle-class ones – began buying up all the tulips they could as prices soared. But as interest waned in tulips, prices cratered, bankrupting speculators who had assumed the run-up in the value of tulips would last forever.
The “ripple effect” from the tulip crash sent the Dutch economy into a depressionary tailspin from which it took years to recover.
4 U.S. Stock Market Crashes
There has been no shortage of major U.S. stock market crashes – all of which were followed by recoveries (although some took much longer to recover than others). Here’s a snapshot.
1. The Stock Market Crash of 1929
The first major U.S. stock market crash was in October 1929, when the decade-long “Roaring 20s” economy ran out of steam. With commodities like homes and autos selling like hotcakes, speculators ran wild in the stock markets. In doing so, many investors became over-leveraged (i.e., they borrowed too much money to purchase stocks) and when the market bubble popped, those same investors couldn’t meet their debt obligations, and slid into bankruptcy.
The toxic brew of inflated stock prices, high leverage, and borrowed money to buy securities would be a formula for more market busts in decades to come. In this instance, the stock market fell 12.82% on the fourth day of the crash (known as “Black Monday”) and it took 12 years for the U.S. economy to recover from the Great Depression that spread after the market crash. Ironically, the second-world war was a huge factor in the nation’s long-term recovery, as the country began to ramp up the manufacturing effort needed to win a global war Uncle Sam was fighting on two fronts.
2. The Stock Market Crash of 1987
Known as “Black Monday the 2nd,” the stock market crash of 1987 once again took place in October – and has gained notoriety as the largest single-day market loss in U.S. history. This crash also had its fair share of speculators and highly-leveraged borrowers, but it added a new twist to the bubble-popping mix – technology.
As highly-leveraged corporate takeovers and buyouts took center stage, and as companies leveraged questionable financing tools like junk bonds and margin accounts, share prices boomed leading up to Black Monday, October 19, 1987. On that day, the market turned on a dime and sellers began to dominate market trading. As more investors sold, more investors panicked and sold aggressively, as well. This cycle continued roiling through the trading day, as computer trading made it easier and faster to place sale orders.
When the smoke cleared, the stock market has lost 23% of its value and market gurus began taking the first steps to install circuit breakers into computer trading platforms that would literally allow market executives to “pull the plug” on trading, and give reeling stock markets a much-needed breather in future high-risk market trading days. Once the technology market stabilized, and more long-term success stories like Apple (AAPL) – Get Apple Inc. Report , Microsoft (MSFT) – Get Microsoft Corporation Report and Cisco (CSCO) – Get Cisco Systems Inc. Report emerged, the stock market grew stronger and galloped off on another 12-year bull run.
3. The Dot.com Bust of 1999-2000
Some stock market crashes occur in lightning fashion, just like the stock market crash of 1987 which saw the market lose 23% in a single day of trading. Other crashes take longer, as losses stack up after repeated trading sessions. That was the case in the dot.com market collapse of 1999-to-2000. In this scenario, technology was again front and center, as investor interest in internet stocks boomed over the course of the 1990s, and as “new economy” companies like AOL, Pets.com, Webvan.com, GeoCities, and Globe.com saw share prices rise substantially.
Perhaps the poster child of all dot.com stocks, Globe.com was an initial public offering sensation, opening at $87 per share in first-day trading in 1998, although the original asking price was only $9 per share. Globe.com raised $28 million in its IPO and had a market cap of $842 million. Yet only two years later, Globe.com, like many dot.com companies, fell out of favor as investors fled highly-inflated tech stocks. Two years after its lights-out IPO, Globe.com was trading under $1 per share, and was soon delisted by Nasdaq. With investors furiously shedding technology stocks like Globe.com, the tech-oriented Nasdaq fell from 5,0000 in early 2001 to just 1,000 by 2002.
It only recovered after Wall Street began more accurately evaluating the real financial stability of high-tech companies – as investors grew more discerning and more conservative about which stocks and funds they purchased.
4. The “Great Recession” Stock Market Crash of 2008
Many Americans likely don’t know just how close the U.S. financial sector came to collapsing during the stock market crash of 2008 and 2009, as Wall Street banks’ high-risk trading practices nearly took down the greatest economy in the world.
The 2008 collapse was fueled by the widespread use of mortgage-backed securities, backed by the U.S. housing sector. These products – which were sold by financial institutions to investors, pension funds and to banks – declined in value as housing prices receded (a scenario that started in 2006). With fewer American homeowners able to meet their mortgage loan obligations, MBS values plummeted, sending financial institutions into bankruptcy. With investment risk in the stratosphere, investors were unwilling to provide much-needed liquidity in the nation’s financial markets.
Soon, the U.S. Congress approved a massive government funding project that, while stabilizing the markets, also bailed out “too big to fail” banks. Additionally, the Federal Reserve bought up languishing mortgage securities and steered interest rates toward zero percent. The strategy largely worked, as the stock market, after two years of jitters, began climbing again in late 2009 – and the economy began to recover, albeit at a glacial pace.
Lehman Brothers Role in the “Great Recession” Market Crash
Some economic observers point to the collapse of Lehman Brothers as a key trigger for the stock market meltdown. That’s partly true, as Lehman’s use of high-risk derivative products – like repurchase agreements(“repos”) as collateral to borrow for short-term financing purposes – certainly exemplified the high-risk leverage Wall Street firms abused in the run-up to the Great Recession.
Yet Lehman took things to extremes in mid-2008.
When so-called “repo” loans fell out of favor, investors demanded other, more-stable forms of short-term loan collateral, and stopped approving repo agreements as collateral. Many also asked Lehman Brothers to repay its short-term debt obligations in full. Additionally, Lehman’s once-ample portfolio of mortgage-backed securities declined substantially in value. That left a highly-leveraged Lehman in the breach, with no way to cover its debts. Soon the investment banking giant slid into bankruptcy.
With few suitors to bail the company out, Lehman declared bankruptcy on September 15, 2008. Only 18 months earlier, the company’s stock price was trading at $86 per share, and the company had reported net income of $4.2 billion in 2007.