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A Brief History of U.S. Stock
Market Crashes
(Causes, Costs, and Results)
The Crash of 2000
A total of 8 trillion dollars of wealth was lost in
the crash of 2000.
Causes of the Crash:
- Corporate Corruption. Many companies fraudulently
inflated their profits and used accounting loopholes to hide debt.
Corporate officers enjoyed outrageous stock options that diluted
company stock;
- Overvalued Stocks. There were numerous examples
of companies making significant operating losses with no hope of
turning a profit for years to come, yet sporting a market
capitalization of over a billion dollars;
- Daytraders and Momentum Investors. The advent of
the Internet enabled online trading –a new, quick, and inexpensive
way to trade the markets. This revolution led to millions of new
investors and traders entering the markets with little or no
experience;
- Conflict of Interest between Research Firm
Analysts and Investment Bankers. It was common practice for the
research arms of investment banks to issue favorable ratings on
stocks for which their client companies sought to raise capital. In
some cases, companies received highly favorable ratings, even though
they were actually in serious financial trouble.
From 1992-2000, the markets and the economy
experienced a period of record expansion. On September 1, 2000, the
NASDAQ traded at 4234.33. From September 2000 to January 2, 2001, the
NASDAQ dropped 45.9%. In October 2002, the NASDAQ dropped to as low as
1,108.49 - a 78.4% decline from its all-time high of 5,132.52, the level
it had established in March 2000.
Following the Crash:
- New Rules for Daytraders. Under the new rules
that were introduced, investors need at least $25,000 in their
account to actively trade the markets. In addition, new restrictions
were also placed on the marketing methods daytrading firms are
allowed to use;
- CEO and CFO Accountability. Under the new
regulations, CEOs and CFOs are required to sign-off on their
statements (balance sheets). In addition, fraud prosecution was
stepped up, resulting in significantly higher penalties;
- Accounting Reforms. Reforms include better
disclosure of corporate balance sheet information. Items such as
stock options and offshore investments are to be disclosed so that
investors may better judge if a company is actually profitable;4.
Separation between Investment Banking and Brokerage Research. A
major reform was introduced to avoid conflicts of interest in the
financial services industry. A clear split between the research and
investment banking arms of brokerage houses was mandated.
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