The Market Crash of 2008; Veneta Lusk Bio

The stock market crash of 2008 was the biggest single-day drop in history up to that
point. The aftermath of this catastrophic financial event wiped out big chunks of
Americans’ retirement savings and affected the economy long after the stock market
recovered.

The financial turmoil caused by the crisis impacted many sectors, leading to massive
job losses and mortgage defaults. As investment firms collapsed and automakers stood
on the verge of bankruptcy, the federal government stepped in and “bailed out”
company after company.

What caused the crisis and why? Here's what triggered the worst recession in U.S.
history since the Great Depression and what to do if a similar crisis occurs again.

About the 2008 Stock Market Crash

Easy credit and raising home prices resulted in a speculative real estate bubble. While
the market crashed in 2008, the problem started years earlier.

In the late 90s, the Federal National Mortgage Association, or Fannie Mae as it’s
commonly known, began its crusade to make home loans accessible to borrowers with
a lower credit score.

Fannie Mae wanted everyone to attain the American dream of homeownership,

regardless of credit. Lenders who extended home loans to high-risk borrowers offered
mortgages with unconventional terms to reflect the increased likelihood of default.

The relaxed lending standards fueled the housing growth and corresponding rise in
home values. People with bad credit and little-to-no savings were offered loans they
could not afford. Meanwhile, banks were repackaging these mortgages and selling
them to investors on the secondary market.

While housing prices continued to increase, the rising subprime mortgage market
thrived. Because house values rose so quickly, the increase in home equity offset the
bad debt buildup. If a borrower defaulted, banks could foreclose without taking a loss
on the sale.

The resulting seller’s market meant that if homeowners couldn’t afford the payments,
they could sell the house and the equity would cover the loss.

A crisis was virtually inevitable. Once the housing market slowed down in 2007, the
housing bubble was ready to burst.

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What date in 2008 did the stock market crash?

The 2008 stock market crash took place on Sept. 29, 2008, when Dow Jones Industrial
Average fell 777.68%. This was the largest single-day loss in Dow Jones history up to
this point. It came on the heels of Congress’ rejection of the bank bailout bill.

What happened after the stock market crash in 2008?

The build-up of bad debt resulted in a series of government bailouts starting with Bear
Stearns, a failing investment bank. Fannie Mae and Freddie Mac (the nickname given
the Federal Home Loan Mortgage Corporation) were next on the government-
sponsored bailout train.

In September 2008, investment firm Lehman Brothers collapsed because of its

overexposure to subprime mortgages. It was the largest bankruptcy filing in U.S.
history up to that point.

Later that month, the Federal Reserve announced yet another bailout. This time it was
insurance giant American International Group, Inc. (AIG), which ran out of cash
playing the subprime mortgage game.

Each bailout announcement affected the Dow Jones, sending it tumbling as markets
responded to the financial instability. The Fed announced a bailout package, which
temporarily bolstered investor confidence.

The bank bailout bill made its way to Congress, where the Senate voted against it on
September 29, 2008. The Dow plummeted 777.68%, largest single-day drop in history
up to this point. Global markets were swept up in the panic, causing global instability.

Congress eventually passed the bailout bill in October, but the damage was done. The
Labor Department reported big job losses across the board as the Dow Jones continued
its downward spiral.

Effects of the 2008 Market Crash

The economy continued to lose hundreds of thousands of jobs, and the unemployment
rate peaked at 10%, double the December 2007 national unemployment rate of 5%.

Three of the biggest automakers (known as the Big Three) were in trouble and asked
the government for help. The federal government took over the General Motors
Company and Chrysler LLC in March 2009. Ford Motor Company received a bailout
from the Term Asset-Backed Securities Loan Facility.
The housing slow down caused home prices to decline. Homeowners found themselves
“upside down” on their mortgage, meaning they owed more than their home was
worth. Faced with job losses and increasing mortgage payments, many lost their homes
to foreclosure.
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Between late 2007 and mid-2009, the period widely referred to as the “Great
Recession,” the economy lost nearly 8.7 million jobs. Consumers cut spending to a
level not seen since World War II. Many experienced a sharp decline in retirement
savings, which compounded unemployment and housing instability.

The loss of home values combined with declining stock totaled nearly $100,000 on
average per U.S. household at the peak. Slower economic growth cost the U.S.
economy an estimated $648 billion.

Dow Jones hit bottom in the first quarter of 2009 as the bad financial news continued.
The widespread panic fueled steady economic decline. Only weeks after taking office,
President Obama outlined an economic stimulus package to boost consumer spending.

Congress passed the American Recovery and Reinvestment Act of 2009 in February as
a way to jumpstart the economy and generate jobs. It had the desired effect, boosting
economic growth and investor confidence.

Who Predicted the Market Crash of 2008?

While the housing market slowed down in 2007, many missed the warning bells of the
impending recession. The World Bank sounded the alarm in Jan 2008 predicting that
global economic growth would slow down as a result of the credit crunch.

Few envisioned the severity of the market crash or the steep economic decline caused
by the recession. Even among those who foresaw a steep decline got the timing wrong.

Wall Street bankers, the Federal Reserve, banking regulators, politicians & economists
top the long list of those who failed to see the financial crisis brewing. While some
warned of a housing bubble, few could predict the effect it would have on the economy
and the stock market.

What to Do if the Market Crashes

Since the stock market goes through cycles, another market crash is very likely at some
point. The economy is currently experiencing the longest period of uninterrupted
gains in American history, hitting the 10-year mark in the first quarter of 2019.
While living through a market crash makes some investors panic, it’s important to stick
to your plan. The stock market is cyclical and the quickest way to lose money is to
cash in investments when stocks lose value.
Avoid letting your emotions rule your actions. Stick to your investment plan and stay
the course even if you are worried about your portfolio. As the stock market rebounds,
so will your portfolio... but only if you leave it alone.
Diversify your investments. This should help smooth the curve if there is a sharp
decline in stocks and help your portfolio weather the storm.
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The Bottom Line

The stock market crash of 2008 was a result of a series of events that led to the failure
of some of the largest companies in U.S. history. As the housing bubble burst, it
affected banks and financial institutions who were betting on the continued increase in
home prices.

Many lost their jobs, homes, and retirement savings during this period. It was the
greatest economic slowdown since the Great Depression. Those who were heavily
invested in real estate and stocks saw the biggest losses to their portfolio.

This is why it’s important to diversify your investments and spread your risk. A solid
investment plan that accounts for the ups and downs of the stock market has a better
chance of producing steady gains over the long term.

Ready to invest in a diversified portfolio? Wealthsimple Invest can help you build an
intelligent portfolio of low-fee funds designed to meet your financial goals. Minimize
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based on your risk tolerance. Get started today and put your money on autopilot.

Why stock markets crash – lessons from recent history; February 8, 2018

Author: Enrico Onali, Reader in Finance, Aston University

Stock markets around the world suffered sudden, heavy losses on February 5 and 6.
Following a 4.6% drop in the Dow Jones on the Monday, the Japanese Nikkei index fell
by 4.6%, and European markets followed suit, with the FTSE 100 down around 2% in the
first hour of trading on Tuesday. There was a rebound on February 7, but things remain
turbulent. The phrase “when the US sneezes, the rest of the world catches a cold” comes
to mind.

The main culprit seemed to be fears of inflation hikes in the US. If inflation is up, the
government may soon start raising interest rates to contain it. And when interest rates
increase, this reduces the return investors get on stocks, making them less desirable –
hence the sell-off. This means that, historically, when interest rates rise, stock prices tend
to decrease.

But markets do not only follow economic reasoning. They also follow human emotions
and out-of-control algorithms. Here are some of the lessons from recent history’s big
crashes.

Flash crash, October 2016

If a crash is unrelated to the economic fundamentals, it will quickly be corrected. This

was the case of the flash crash in October 2016 when the pound plunged by 6% against
the dollar in a mere two minutes of trading.
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This phenomenon can occur because of large sell orders from computer program trading,
which may lead to sudden drops in liquidity. A lack of buyers to match the large sell
orders pushes the price down, making the market illiquid.

In this type of crash, the market mistakenly believes that the sell orders are driven by new
information on fundamentals, while it may be due to a wrong algorithm in a computer
program. Once the market understands that the sell orders did not originate from
genuinely bad news, stock prices should rebound.

Black Monday, October 1987

The biggest and most famous stock market crash is known as Black Monday, and took
place on October 19, 1987. Stock markets around the world were hit, with the Dow
plummeting 22.6% – still its largest one-day percentage decline.

The Black Monday crash has been attributed in part to a large number of “stop loss
orders” – orders that are in place to sell a security once it falls below a certain limit (to
stop your losses). Computer programs, being used for large-scale trading, were relatively
new to Wall Street at the time and they began to liquidate stocks as soon as loss targets
were hit. A domino effect took place – when many investors submit stop loss orders
simultaneously, this drags the price of stocks down, resulting in a crash.

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Things got more complicated when computers were introduced. shutterstock.com

This alone does not explain the extent of the crash. New regulatory restrictions may also
have caused a lack of liquidity in the market, pushing down the price of stocks.

Unlike with the 2016 flash crash, the market did not rebound immediately after the Black
Monday crash. This suggests that it also reflected the fundamentals at play. Similar to the
recent crash, the Black Monday crash was accompanied by expectations of interest rate
hikes.

Bursting bubbles

If stocks keep rising in price, but their fundamental values do not also rise, then they are
overvalued and a bubble forms. This could be a result of speculation or technical traders
who focus more on the price history of the stock and what the market is doing.

The key here is that while many market participants may agree that stocks are
overvalued, they may think that others are unaware of this and they can capitalize on it.
But sooner or later there will be a correction, when stock prices fall in line with their
fundamental value.

This bursting is often preceded by a sharp increase in prices. The sudden drop occurs
when the market suddenly realizes that they have been mispriced, thanks to some new
piece of information – the straw that breaks the camel’s back.

There is also the effect of herd behavior at play. Just as traders can buy stocks because
everyone else is, traders can also follow the herd and sell, if they see everybody else
doing so. This leads to a race to the bottom.

This happened with the dot-com bubble in the late 1990s, which involved stocks of high-
tech companies. Optimistic individual investors are thought to have created the bubble,
based on unrealistic expectations on the future performance of dot-com stocks. But the
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bubble burst once large institutional investors started selling off their dot-com stocks,
making individual investors quickly change their mind and leading to large sell-offs.

When bubbles burst, stock prices will not rise to the previous level until the fundamentals
improve again. There will be no immediate rebound, as the drop is a correction of a
previous mispricing.

The latest tumble in global stock markets does not appear to be a full on crash – yet.
Following the volatility of February 5, stocks did rebound, but it is hard to say whether
the trouble is over.

What We Can Learn from Stock Market Crash of ’87

Gerelyn Terzo @cryptogerelyn; October 20, 2019 16:09 UTC

It’s been more than 3 decades since the bottom fell out in the stock market in 1987,
and one thing remains clear, the more things change, the more they stay the same.

On Oct. 19, 1987, the Dow Jones index plummeted more than 22%, marking the
worst single-day performance in the New York Stock Exchange’s history, including
the start of the Great Depression, and earning the nickname Black Monday. These
days, the global economy is suffering from what Wall Street Veteran Ray Dalio
describes as a “great sag.” While the stock market faces headwinds that have
made volatility the new normal, it’s hard to imagine an imminent collapse, the likes
of which we haven’t seen either since the eighties or the Great Recession. That
doesn’t mean that people aren’t worried and there aren’t lessons to glean from the
stock market crash of ’87.

What’s Changed?

Many things have changed since the crash, not the least of which is the trend of
globalization, which was just a glimmer in the eye of economists back then.
Meanwhile, Janus Henderson Investors Director of Research Carmel Corbett Wellso
recently described how the globalization tied has turned amid U.S./China trade war.

One of the obvious changes since the 1987 stock market crash is that stock prices are
no longer quoted as fractions after the SEC-mandated switch to decimals in 2001. At
the time, stocks such as Teledyne, CBS, IBM, and Kodak saw their shares slashed by
49 3/4, 42 1/8, 31, and 27 1/4, respectively. Each of those stocks is still trading
today and lived to tell about Black Monday.

Another big change since the stock market crash of ’87 is the number of traders on
the floor of the NYSE. Since the rise of electronic trading, there are only a few dozen
brokerage firms represented vs. hundreds of firms and thousands of traders that
flooded the floor back then.

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What’s Stayed the Same?

Basically, if you listen close enough, you will hear the two themes woven into the
fabric of the stock market then and now — buying the dip and the Fed. Whether or
not investors would buy the dip was a question that was soon answered in 1987, after
stocks recouped more than half of their losses in a pair of trading sessions. By 1989,
the stock market would be trading higher than pre-crash levels.

Despite a rocky October, investors have proven to buy the dips in 2019, with the
S&P 500 up a solid 20% year-to-date. Before the crash of ’87, stocks were said to
be trading in a bubble, which is a similar theme that trickles into analysis today.

The stock market crash of ’87 was just that – a collapse in the shares of publicly
traded companies. It was not considered a systemic risk to the broader economy. In
fact, some argue it was then that the Fed gained its reputation as a stock market
superhero for instilling confidence in investors who were otherwise rightly spooked.
A report in Federal Reserve History quotes economist and former Fed Vice
Chairman Donald Kohn as saying:

“Unlike previous financial crises, the 1987 stock market decline was not associated h
a deposit run or any other problem in the banking sector” (Kohn 2006). On the other
hand, some argue that the Fed’s response set a precedent that the potential to
exacerbate moral hazard.”

No wonder President Trump is expecting so much hand-holding from Fed officials.

The Fed shouldn’t move markets too much this week, considering that monetary
policymakers are in a quiet period with the media before next week’s highly
anticipated FOMC meeting.

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