Stock Market, History,Causes and Affects

History of U.S. Stock Market Crashes


The Crash of 2000

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.

Causes of the Crash:

  1. 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;
  2. 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;
  3. 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;
  4. 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.

A total of 8 trillion dollars of wealth was lost in the crash of 2000.

Following the Crash:

  1. 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;
  2. 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;
  3. 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.

The Crash of 1987

The markets hit a new high on August 25, 1987 when the Dow hit a record 2722.44 points. Then, the Dow started to head down. On October 19, 1987, the stock market crashed. The Dow dropped 508 points or 22.6% in a single trading day. This was a drop of 36.7% from its high on August 25, 1987.

Causes of the Crash:

  1. No Liquidity. During the crash, the markets were not able to handle the imbalance of sell orders;
  2. Overvalued Stocks;
  3. Program Trading and the Use of Derivative Securities Software. Large institutional investment companies used computers to execute large stock trades automatically when certain market conditions prevailed. Some analysts claim that the program trading of index futures and derivatives securities was also to blame.

During this crash, 1/2 trillion dollars of wealth were erased.

Following the Crash:

  1. Uniform Margin Requirements. New margin requirements were introduced to reduce the volatility for stocks, index futures, and stock options;
  2. New Computer Systems. Stock exchanges changed to new computer systems that increase data management effectiveness, accuracy, efficiency, and productivity;
  3. Circuit Breakers. The New York Stock Exchange and the Chicago Mercantile Exchange instituted a circuit breaker mechanism, which halts trading on both exchanges for one hour should the Dow fall more than 250 points in a day, and for two hours, should it fall more than 400 points.

The Crash of 1929

On September 4, 1929, the stock market hit an all-time high. Banks were heavily invested in stocks, and individual investors borrowed on margin to invest in stocks. On October 29, 1929, the stock market dropped 11.5%, bringing the Dow 39.6% off its high.

After the crash, the stock market mounted a slow comeback. By the summer of 1930, the market was up 30% from the crash low. But by July 1932, the stock market hit a low that made the 1929 crash. By the summer of 1932, the Dow had lost almost 89% of its value and traded more than 50% below the low it had reached on October 29, 1929.

Causes of the Crash:

  1. Overvalued Stocks. Some analysts also maintain stocks were heavily overbought;
  2. Low Margin Requirements. At the time of the crash, you needed to put down only 10% cash in order to buy stocks. If you wanted to invest $10,000 in stocks, only $1,000 in cash was required;
  3. Interest Rate Hikes. The Fed aggressively raised interest rates on broker loans;
  4. Poor Banking Structures. There were few federal restrictions on start-up capital requirements for new banks. As a result, many banks were highly insolvent. When these banks started to invest heavily in the stock market, the results proved to be devastating, once the market started to crash. By 1932, 40% of all banks in the U.S. had gone out of business.

In total, 14 billion dollars of wealth were lost during the market crash.

Following the Crash:

  1. The Securities and Exchange Commission (SEC) was established;.
  2. The Glass-Stegall Act was passed. It separated commercial and investment banking activities. Over the past decade though, the Fed and banking regulators have softened some of the provisions of the Glass-Stegall Act;
  3. 3. In 1933, the Federal Deposit Insurance Corporation (FDIC) was established to insure individual bank accounts for up to $100,000.

Source


Have Plunging Stocks Killed Private Accounts in Social Security?

By Dean Baker

Until the recent fall in stock prices, many people viewed the stock market as a money tree that created wealth out of nothing. This was the atmosphere in which the idea of private accounts within Social Security gained popularity. The crash has helped to clear people’s thoughts.

In reality, the stock market does not create wealth. Wealth is created when we are better able to produce goods and services. Putting Social Security dollars in the stock market through individual accounts does not increase the nation’s productive capacity by one iota, compared with putting the same dollars into the Social Security trust funds. As the crash shows, individual accounts only add risk.

Many proponents of private accounts actually want to cut benefits. Since Social Security is fully solvent until 2041, and the shortfalls projected for later years are comparable to past shortfalls, benefit cuts seem hard to justify. But if politicians want to advocate cuts in benefits, they should be forced to do so explicitly, and not hide behind the Enron-like accounting of private accounts.

The market crash also clarified which part of the retirement system needs fixing. Millions of workers who saw much of their retirement savings disappear in the crash are now very glad that they can still count on their “Social Security“. On the other hand, we now recognize that the system of private pensions is in disarray.

Pensions have been manipulated to their administrators’ benefit and are subject to high fees, and many workers lack pension coverage altogether. If the Bush commission’s individual accounts were offered as a voluntary add-on to Social Security—instead of taking money from Social Security revenues and cutting benefits to make up for the lost revenues—they could be very useful. Such accounts would instantly make a low-cost, fully portable, defined contribution pension plan available to every worker in the country.

Dean Baker is the co-director of the Center for Economic and Policy Research and co-author of Social Security: The Phony Crisis (University of Chicago Press, 1999).

Source


Stock Market History

History of stock market trading in the United States can be traced back to over 200 years ago. Historically, The colonial government decided to finance the war by selling bonds, government notes promising to pay out at profit at a later date. Around the same time private banks began to raise money by issuing stocks, or shares of the company to raise their own money. This was a new market, and a new form of investing money, and a great scheme for the rich to get richer. A little futher on the history tumeline, more specifically in 1792, a meeting of twenty four large merchants resulted into a creation of a market known as the New York Stock Exchange(NYSE). At the meeting, the merchants agreed to meet daily on Wall Street to daily trade stocks and bonds.

Further in history, in the mid-1800s, United States was experiencing rapid growth. Companies needed funds to assist in expansion required to meet the new demand. Companies also realized that investors would be interested in buying stock, partial ownership in the company. History has shown that stocks have facilitated the expansion of the companies and the great potential of the recently founded stock market was becoming increasingly apparent to both the investors and the companies.

By 1900, millions of dollars worth of stocks were traded on the street market. In 1921, after twenty years of street trading, the stock market moved indoors.

History brought us the Industrial Revolution, which also played a role in changing the face of the stock market. New form of investing began to emerge when people started to realize that profits could be made by re-selling the stock to others who saw value in a company. This was the beginning of the secondary market, known also as the speculators market. This market was more volatile than before, because it was now fueled by highly subjective speculation about the company’s future.

This was the pretext for appearance of such stock market giants as NYSE. History books tell us that the reason the NYSE is so highly regarded among stock markets was primarily because they only trade in the very large and well-established companies. It acted as a more stable investment alternative, for people interested in throwing their capital into the stock market arena. The smaller companies making up the stock market formed into what eventually became the American Stock Exchange (AMEX). Contrary to the 80-year old history, today the NYSE, AMEX, NASDAQ and hundreds of other exchange markets make a significant contribution to the national and global economy.

The growth in the number of market participants led the government to decide that more regulation of the stock market was needed to protect those investing in stock. History was made in 1934, when following the Great Crash, Congress passed the Securities and Exchange Act. This act formed the Securities and Exchange Commission (SEC), which, through the rules set out by the act and succeeding amendments, regulates American stock market trading with the help of the exchanges. It also includes overseeing the requirements for a company to issue stock shares to the public and ensures that the company offers relevant information to potential investors. The SEC also oversees the daily actions of market exchanges and how they trade the securities offered.

Although historically, investing in stocks was a “hobby” for the rich, an average person too soon came to realize the value of the investing in stocks vs. traditional assets like land or a house.

Source

Panic Affect

Various explanations for large price movements have been promulgated. For instance, some research has shown that changes in estimated risk, and the use of certain strategies, such as stop-loss limits and Value at Risk limits, theoretically could cause financial markets to overreact.

Other research has shown that psychological factors may result in exaggerated stock price movements. Psychological research has demonstrated that people are predisposed to ‘seeing’ patterns, and often will perceive a pattern in what is, in fact, just noise. (Something like seeing familiar shapes in clouds or ink blots.) In the present context this means that a succession of good news items about a company may lead investors to overreact positively (unjustifiably driving the price up). A period of good returns also boosts the investor’s self-confidence, reducing his (psychological) risk threshold.

Another phenomenon—also from psychology—that works against an objective assessment is group thinking. As social animals, it is not easy to stick to an opinion that differs markedly from that of a majority of the group. An example with which one may be familiar is the reluctance to enter a restaurant that is empty; people generally prefer to have their opinion validated by those of others in the group.

In one paper the authors draw an analogy with gambling. In normal times the market behaves like a game of roulette; the probabilities are known and largely independent of the investment decisions of the different players. In times of market stress, however, the game becomes more like poker (herding behavior takes over). The players now must give heavy weight to the psychology of other investors and how they are likely to react psychologically.

The stock market, as any other business, is quite unforgiving of amateurs. Inexperienced investors rarely get the assistance and support they need. In the period running up to the recent Nasdaq crash, less than 1 percent of the analyst’s recommendations had been to sell (and even during the 2000 – 2002 crash, the average did not rise above 5%). The media amplified the general euphoria, with reports of rapidly rising share prices and the notion that large sums of money could be quickly earned in the so-called new economy stock market. (And later amplified the gloom which descended during the 2000 – 2002 crash, so that by summer of 2002, predictions of a DOW average below 5000 were quite common.)

Irrational behavior

Sometimes the market tends to react irrationally to economic news, even if that news has no real effect on the technical value of securities itself. Therefore, the stock market can be swayed tremendously in either direction by press releases, rumors, euphoria and mass panic.

Over the short-term, stocks and other securities can be battered or buoyed by any number of fast market-changing events, making the stock market difficult to predict.

A stock market crash is often defined as a sharp dip in share prices of equities listed on the stock exchanges. In parallel with various economic factors, a reason for stock market crashes is also due to panic. Often, stock market crashes end speculative economic bubbles.

There have been famous stock market crashes that have ended in the loss of billions of dollars and wealth destruction on a massive scale. An increasing number of people are involved in the stock market, especially since the social security and retirement plans are being increasingly privatized and linked to stocks and bonds and other elements of the market.

Source



Greed Is Fine. It’s Stupidity That Hurts.

By Steven Pearlstein

During financial crises like this one, after people have had their fill of discussions about margin calls and credit-default swaps, they experience a strong desire to have the whole thing put in some larger and more human context. Invariably they come around to some variation of, “Isn’t this really just a story about excessive greed?”

I’ve never really figured out how to answer that question. In a capitalist economy like ours, the basic premise is that everyone is motivated by a healthy dose of economic self-interest — the shopper looking for the best bargain on tomatoes and the farmer looking to get the highest price for his produce, the grocery clerk looking to earn the highest wages for restocking shelves and the investor looking to earn the biggest profit from Safeway stock. Without some measure of greed and the tension it brings to most economic transactions, capitalism wouldn’t be as good as it is in allocating resources and spurring innovation.

Perhaps that’s why most definitions of greed refer to an excessive desire for wealth that is beyond what anyone really needs or deserves. The obvious problem with that, of course, is that those are terribly subjective criteria. Do you draw the greed line at two cars, a three-bedroom house, two weeks at the beach in the summer and college tuition for the kids? Or is it at seven houses, 50 pairs of designer shoes, a yacht, two Bentleys and a Renoir?

Others suggest that for greed to really be greed, the money or goods that are desired have to be denied to somebody else who might want, need or deserve them. A landowner who gets rich by overcharging tenant farmers who can barely feed and clothe their families — he’s obviously greedy. But somehow the owner of a restaurant in the Hamptons who overcharges his millionaire patrons for lobster salad and foie gras is a lot less greedy.

In many minds, greed may have less to do with the amount of wealth or possessions someone has, or aspires to have, than it does with the way in which it is earned. Even before they decided to give away most of their money, nobody seemed to begrudge Bill Gates or Warren Buffett their billions or criticize them for their “unbridled” greed. That seems to have a lot to do with the fact that Gates and Buffett made their money on the basis of their own ingenuity, skill and hard work. On the other hand, when people line up to buy tickets to a Powerball lottery with a $10 million payout, we don’t consider them particularly greedy just because they want to get rich through dumb luck.

If the person who wins that lottery, however, doesn’t send some of that money to his struggling Aunt Mildred or offer to fix up the local Little League field, most people would call him greedy. But no matter how many millions the overpaid corporate chief executive gives away to charity, in the minds of many, greed will always be his middle name.

Which brings us to the now widespread belief that the cause of the current financial crisis has been “the greed on Wall Street.” Both John McCain and Barack Obama believe that. So do Joe Biden and Sarah Palin. A clip search of major publications over the past month turns up about 2,700 stories that contained the words “Wall Street” and “greed.” The month before, there were less than 200.

If there is a surprise here, it is that anyone should be surprised by the level of greed on Wall Street. Wall Street is nothing if not an organized system of greed, a high-stakes game in which the object is to take advantage of customers and counterparties by buying pieces of paper from them at less than they are really worth and selling them to others for more than they are worth. And while it’s hard to see a grand social purpose in all that, it has proven a relatively efficient process for connecting people who have money with the households and businesses that want to borrow it.

The big problem with Wall Street isn’t that it’s greedy– it’s that it keeps making the same mistakes over and over. Each cycle, the masters of finance start out with reasonably good products and good intentions, only to get swept away by their success. They become arrogant, take too many risks and begin to believe their own marketing spiels. Then, when the cycle turns against them and the risks turn sour, they try to cover it up and begin lying to their customers, to regulators and to each other. Trust erodes, and the whole thing collapses.

In the populist “greed” fantasy, it is ordinary people who are the losers while the Wall Street bigwigs walk off with all the loot. But in the real life version, most of the bigwigs lose as well. They lose their jobs, their stock becomes worthless, their reputations are ruined. They spend the next several years shelling out $700 an hour to lawyers to defend themselves against lawsuits and regulatory inquiries and $250 to psychiatrists to help figure out where they went wrong. Bottom line: They wind up worse off than they would have been if they had simply done their jobs well, put their customers first and managed their companies for the long term.

To some, that may be a story of greed. To me, it looks more like old-fashioned incompetence.

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Privatization of Social Security can leave you without any retirement savings.

Investing in the Stock market is like gambling. If you can’t afford to loose it you don’t want to invest. The markets can crash anytime.

Who profits?

There are some who do profit from market crashes. I would assume those who probably created the panic, in the first place.

Profit certainly can be made from a stock market crash. Maybe one of these days someone will take the time to find out Who?

When you find out who, then you have the criminals.

Why do they do it?

For profit of course.

When will they be stopped?

Well when the power hungry, rich, greedy manipulative, liers are caught and when Governments around the world, finally do something to stop them.

Until then they will let you win for a while and then steal your hard earned money.

Personally it seems they manipulate a bunch of innocent folks into investing in the market, then after they have invested a whole lot of money, it crashes.

Those who manipulated the innocent investors into buying into the market, make the profits from it.

There seems to be a growing pattern emerging.

The stock market is somewhat like a Casino.

The owners, operators and the very wealthy are the House.

You are the gambler hoping, to make a fortune.

Like a Casino let you win for a little while.

Then they take all your money.

That is the pattern that seems to be emerging.

Just an observation.

The Stock Market was created by the wealthy, for the wealthy and controlled by the wealthy.

So what has changed since it’s creation other then nothing?

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Published in: on October 8, 2008 at 9:52 pm  Comments Off  
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