Stock Market Today

The Stock Market Crash and subsequent Great Depression of 1929 were caused primarily by people investing “on margin”. This means they were buying stocks with money they did not actually have. People assumed that stock prices were only going to up, so they bought stocks on credit given to them by the brokerage houses. Investors assumed they could pay this money back at any time by selling some stocks that had increased in value. The ratio of assets to debt (the margin) became ridiculous. The stock market hiccuped and dipped. Stock prices went below what people had paid and the brokerage houses called in the margin accounts– which means they wanted all the money they were owed. People did not have enough cash on hand to cover their margin accounts so they sold their stocks at a loss. they had to sell a lot of stock to cover their losses and the market spiraled down with a flood of people selling all at once.

1987 was a little more complicated in that there wasn’t once driving force that drove the market down. In fact, the prevailing cause was probably investor panic and mass hysteria. There were a few underlying causes (fluctuating interest rates and a weak dollar) but nothing that would have accounted for such a drastic market swing.

There are a couple of safe guards in place now that should prevent such sudden downturns in the market. One such safeguard is what’s essentially a loss limit. If the market loses 10% in one day trading is halted for a period of time and again at 20%. At a 30% loss the market closes for the day. This measure is to prevent mass hysteria from taking over.

A stock market crash did happen in the fall of 2008. Investors lost a lot of money in the beginning of our current recession. The market crash was not as drastic or sudden as in 1929 or 1987 but all the same Americans lost huge amounts of money in retirement savings and overall net worth. This market downturn was caused in large part by mortgage derivative markets. When the housing bubble popped, much of the inflated wealth from these derivative markets went with it.

Future market crashes are always possible. If the underlying asset, like real estate or tulips (the Dutch economy collapsed because of tulips in the early 1700′s), the stock market where those assets are traded usually collapses with it. So anytime an industry is going crazy and things seem too good — like housing prices from 2000 to 2008– look for a market dip soon.