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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.