A stock market crash begins with a slow rise in prices – collapses in hours. Economists trace the collapse to leverage, fraud, or policy errors. The decisive element remains panic – a nineteenth century term for the instant when traders stampede for the exits. Prices plummet. Household savings evaporate.
A crash occurs when a broad index such as the S&P 500 or the Dow Jones Industrial Average drops at least ten percent within a few trading sessions. The descent outruns a normal correction. Sellers swamp buyers. Quotations gap lower. The shock spreads through clearing houses, brokerages along with bank balance sheets.
The crash of October 1929 erased eighty nine percent of the Dow’s value. Output contracted for forty three months. Unemployment reached twenty five percent. The collapse of 2000 erased seventy eight percent of the Nasdaq Composite. Eight trillion dollars in paper wealth disappeared. The collapse of 2008 cut fifty seven percent from the S&P 500. Eight million jobs vanished. Each episode followed a surge in speculation financed by borrowed money. Each ended only after the Federal Reserve supplied emergency liquidity, purchased assets, or recapitalised banks.
Contemporary exchanges deploy circuit breakers. A seven percent decline in the S&P 500 before 3:25 p.m. halts trading for fifteen minutes. A thirteen percent decline triggers a second pause. A twenty percent decline ends the session. The pauses grant traders time to post collateral, price risk in addition to absorb news. The safeguards moderate velocity – they do not remove fragility.
Every historic crash combines an external trigger with latent fragility. The trigger may be a bankruptcy, a surprise rate hike, or a geopolitical shock. Fragility hides in leverage, concentration, or opaque derivatives. The interaction detonates the market.
A typical crash unfolds in four phases. Phase one – prices climb on credit. Brokers report record margin debt. Initial public offerings price at multiples of sales that lack revenue. Phase two – a catalyst arrives. A large borrower defaults. A central bank tightens. Headlines warn of recession. Sellers overwhelm bids. Phase three – feedback loops accelerate. Falling prices force leveraged investors to liquidate. Mutual funds face redemptions. Algorithms amplify momentum. Phase four – exhaustion. Valuations fall below replacement cost. Balance sheets rebuild. Bargain hunters return.
The pattern recurs because human responses repeat. A trader who loses a month’s salary in one morning remembers the pain for decades. Policy makers who rescue the system today plant the seeds of tomorrow’s excess.
Fast Fact
Margin calls forced Long-Term Capital Management to liquidate one hundred billion dollars in positions in 1998. The fund held thirty-to-one leverage. A ten percent loss erased its capital.
After the initial plunge the market enters a lull. Bargain hunters probe for a bottom. Short-covering rallies lift prices ten percent in two days. Television commentators declare the worst over. Volume subsides. Retail investors check retirement balances. Headlines tally layoffs. The lull ends when quarterly reports reveal collapsing cash flow. Prices resume their descent.
Robert Shiller labels the phenomenon herding. Individuals abandon private analysis and mimic the crowd. The same pattern appears in laboratory experiments. A subject who sees five peers choose a wrong answer often concurs.
Selling pressure exhausts when forced sellers finish liquidating. Central banks cut rates. Treasuries inject capital. Corporations announce buybacks. The market probes a low, rallies, retests next to finally establishes a bottom. The trough in March 2009 occurred after the S&P 500 fell to 6.6 times forward earnings. Dividend yields exceeded the yield on ten year Treasuries for the first time since 1958.
The chronology below lists the principal U.S. crashes, their triggers, their policy responses.
Chronology
May 1792: The Panic begins when banker William Duer defaults on half a million dollars in obligations. Duer had speculated in Revolutionary War scrip. Prices of Bank of New York but also Bank of the United States shares fall fifty percent. Alexander Hamilton directs the Treasury to purchase government securities and supply banks with gold. Stability returns within weeks.
March 1907: The Knickerbocker Trust fails after a failed corner in United Copper shares. Depositors withdraw eight million dollars in one day. The stock exchange falls fifteen percent. J. P. Morgan convenes bankers in his library; they pledge personal funds to support banks and purchase equities. The panic ends in six weeks. The episode spurs creation of the Federal Reserve in 1913.
October 1929: Brokers lend investors fourteen billion dollars, equal to eighteen percent of gross domestic product. The Dow peaks at 381.17 on September 3. On October 24, volume reaches twelve million shares. Prices fall eleven percent. Bankers led by Thomas Lamont meet at J. P. Morgan & Co. They pledge to purchase blue chip stocks. The rally lasts one day. On October 28 the Dow falls thirteen percent. On October 29 it falls twelve percent. Margin clerks liquidate customer accounts. The Dow bottoms at 41.22 in July 1932, down eighty nine percent. Congress passes the Glass-Steagall Act in 1933 and creates the Securities besides Exchange Commission.
October 1987: Portfolio insurance programs sell futures automatically as prices fall. On October 19 the Dow drops 22.6 percent, the largest one day percentage decline. Volume reaches six hundred four million shares. The Federal Reserve issues a statement: âThe Federal Reserve, consistent with its responsibilities as the nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.â The Fed supplies thirty billion dollars in credit to banks. Markets recover within months.
March 2000: The Nasdaq Composite peaks at 5,048.62 on March 10. The index contains companies with no earnings. Venture capital funds invest ninety billion dollars in startups during 1999. The telecom firm NorthPoint files for bankruptcy on March 17. The Nasdaq falls seventy eight percent by October 2002. Congress passes the Sarbanes-Oxley Act in 2002. The Fed cuts the federal funds rate from 6.5 percent to 1.0 percent.
September 2008: Lehman Brothers files for bankruptcy on September 15. Money-market funds face withdrawals of one hundred sixty nine billion dollars in one week. The Reserve Primary Fund breaks the buck. The S&P 500 falls twenty percent in eight sessions. Congress approves the seven hundred billion dollar Troubled Asset Relief Program on October 3. The Fed lends two point three trillion dollars to banks and broker-dealers. The S&P 500 bottoms in March 2009.
March 2020: Global cases of COVID-19 rise. Oil prices collapse after Saudi Arabia or Russia fail to agree on production cuts. The S&P 500 falls thirty four percent in twenty three trading days. The Fed cuts the federal funds rate to zero – it purchases six hundred billion dollars in Treasuries and mortgage-backed securities. Congress passes the two point two trillion dollar CARES Act. The S&P 500 recovers to new highs by August.
Fast Fact
The Dow required twenty five years after 1929 to reclaim its peak. The S&P 500 required four years after 2008. The index required five months after the March 2020 low.
Crashes impose costs that linger. Households postpone purchases. Firms cancel investment projects. Banks tighten credit. Economists debate root causes. Excess leverage, lax regulation along with misaligned incentives recur in every episode.
Advice to hold through downturns serves long term savers. It does not absolve policy makers from repairing structural flaws. The historical record shows that markets do not self correct. Intervention determines depth and duration.
Circuit breakers now operate at three thresholds. A seven percent decline in the S&P 500 before 3:25 p.m. halts trading for fifteen minutes. A thirteen percent decline triggers a second pause. A twenty percent decline ends the session. The rules apply only to equities. Options in addition to foreign exchange trade continuously.