Khaled BitarWhat were the causes of the 1929 stock market crash and the 1987 stock market crash? What are the differences between the causes? In the 1920 s stock was first issued by companies. Companies issued stock after they went public in order to make money. When traders buy stock, they were buying from the company and a stake in the company. On October 24, 1929, (a.
k. a. Black Thursday) the stock market fell 9% and five days later the market fell an unprecedented 17. 3%.
About 29 million shares of stock changed owners causing, at the time, the biggest stock market crash in the history of the United States. In the decade before the crash, America was thriving and production was soaring. The GNP increased by 40% and average income grew 30% throughout the decade. There was an abnormally high level of investment and traders were overwhelmed with confidence. When the stock market crashed on Black Thursday, traders were still confident because of President Hoover's declaration that a recovery was imminent. Despite the general optimism, the market crashed again causing the great depression.
The effects were devastating. Over the next three years, the unemployment rate rose to 13. 6 million people and GNP decreased 45 million dollars. There are many causes to the 1929 stock market crash including speculation, WWI, Foreign investment, and a scandal that could have played a minor role. The 1929 stock market was a bull market fueled by speculation. Speculation inflated stock prices beyond what they were worth because of the large amount of traders.
Speculation is when traders think that a stock has much more value and potential then it really does. Traders would buy a stock that they think is thriving and when they realize that the company is losing money, they sell causing the market to decrease. (i. e. people investing in ebay and then selling after seeing ebay's earnings. ) Many investors were not very experienced and they believed that whenever their stock went down, they felt selling was the best option which fueled the crash even further.
Because of the thriving market, many loaned money from banks and invested in the stock market. When it crashed, they could not pay back the loans and the banks lost money. The market misled the banks as they thought loaning traders money would be very lucrative. The Federal Reserve was a cause of the 1929 stock market crash because it essentially owned the government and fueled the speculation. The Federal Reserve was a private organization made up of private bankers and investors.
The Federal Reserve would loan the government money and then the government would have to pay them back with taxation of all citizens of the United States. This would control inflation because all the people would be taxed and they would not be as wealthy. The Fed controlled the government because they chose how much money to coin and the government could not control the quantity of money being put into circulation. The Fed would coin more money based on how much they though people would earn; the extra money, obviously created the speculation because people were led to believe that the economy was thriving so they invested. Another cause of the 1929 stock market crash was the liquidation of British investments in the Unites States market. Many British citizens sold because of anxiety after the Haftry scandal.
Charles Haftry was a business man in England that was found guilty of a plot that issued false securities to finance companies he owned. He would lead people to speculate that his companies were thriving; however, they were losing money. When he was caught he was forced to pay the English banks more than 65 million dollars. Because he was unable to pay, British banks took the heat of the disaster prompting the government to make new laws.
The British in the US market sold their stock because of their anxiety. The British caused the market to decrease and people were starting to sell after the british did. This theory is not likely to be a significant cause; however, it did play a minor roll in the crash. Some analysts believe that WWI was a cause of the crash because the gold standard lacked the ability to support the economy after World War I.
People were in the market to recover from the war and they were using loans to buy the stock. The speculation theory is the theory with the most evidence to support it. The total value of stocks was 27 billion dollars in '25 and it increased to 87 billion in the months leading up to the crash. The Dow increased by 218. 7% from '22 to '29. The utility stocks were selling for three times more than they are worth because of the speculation.
Forty-seven years and 360 days removed from the 1929 stock market crash, the market crashed again. It fell 23%; almost twice as much as the crash in 1929. This crash was unforeseeable and it only lasted one day. Program trading has been cited as the major cause of the 1987 stock market crash.
Program trading is a very effective way to make small profits without the risk of losing a large sum of money. Traders program a computer to sell stock if it goes below a certain price. The computer does not take into account P/E ratios, analysts' opinions, or tendencies in the market. It also buys in another closely related stock at a set price. For program trading to succeed the computer has to sell the stock and buy other stock within a second; the computer can make up to 60 transactions a minute. Another popular type of program trading is buying futures.
Traders would buy the value of a certain industry (such as pork) and sell it at a date later. Whenever it appeared that the market was headed downward, the computer was programmed to sell the future and buy another future. This way no one would lose more they are comfortable losing. There is a spread called a premium between the futures market of the S&P 500 futures market and the S&P 500 stock market. When the premium reaches a certain level, the computer buys in the future market and the stock market; whichever was higher. The computer is programmed to buy the higher end of the spread and sell the lower end of the spread.
On Black Monday, the market fell below a certain price and all of the computers started to trade. There was an abundance of computer training, so all of the computers crashed and could not trade. On other computers, they would trade stock that they were not supposed to and there were billions of transaction per computer. When the future market was dissipating, the computer would buy stocks, and traders would jump around from market to market. That would lead to a discount in whichever market was being sold that most and that would eventually lead to a demise of the stock market. Most of the percentage declines were blamed on arbitragers; people who would switch from the future market to the stock market and visa versa.
Portfolio insurance is a form of investment that caused also caused the stock market crash. A trader would consult a portfolio insurer who would buy stocks passed on their instincts. The insurer would sell a stock when it was at a high price, and then wait for that same stock to come down to a lower price. The spontaneous selling would cause stocks to be worth much less that what people thought they were.
This resulted in a crash because people finally realized that their stocks were not worth as much and they would all sell. Speculation could have been a contributor; however, it is likely it only played a minor. It has been proven that speculation is not alone the cause because the P/E (Price per Earnings ratio) was higher in the week before the crash. Because the P/E ratio was so high, stocks were not worth what people thought they were worth. The decreasing value of the dollar against foreign currencies is one of the possible causes of the stock market. The dollar was high against foreign currencies in the years leading up to the crash, but in '87 it started to decrease.
Foreign investors are discouraged from the American market when the dollar is weak. The weekend before the crash, the government announced that the dollar was going to fall even more and that caused foreign investors to sell their stock the following Monday. Since the market is closed on Sundays, investors could not sell and the impact to the market was on Monday. This is a very plausible cause because the market fell Monday only, and there was abundance of traders who were going to sell when the market opened. Analysts predicted that foreign investors would sell, and advised other traders to sell causing a 23% drop.
The 1987 was very different from the 1929 crash because of the new technologies. The only cause of the crashes that were similar was speculation; which is involved in every stock crash that has ever taken place. Foreign investors had a hand in fueling both crashes; but they were not the sole cause or the major cause. In 1929, foreign investors pulled out of the market because of a scandal, in 1987, foreign investors sold because of the decreasing dollar. The crash of '29 was more gradual than the crash of '87. The market of 1929 was declining in the months leading up to Black Thursday.
In 1987, the stock crash was all in one day and it was not a precursor to a depression. The market went up the next day and continued to do so. I believe that the stock market crashed in 1987 because of the announcement that the dollar was going to decrease even more. The foreign investors sold, which prompted other traders to sell their stock.
When the computers saw that the market was going down, there was so many people selling that they could not sell. Brokers left their post and the NYSE lost all of their workers. The stock could not trade until 10: 00 AM that morning. The computers crashed and started selling all of the stock, not just the stock they were programmed to sell. It took so long for people to sell their stock because no one wanted to buy. The 1987 crash caused the federal reserve to impose other laws so another sudden crash would not happen again.
Circuit breakers and limits were the two fastest precautions that the federal reserve imposed. Circuit breakers slow down trading so that their cannot be a decline so sudden. If the Dow changed 50 points, program trading is stopped for five minutes. This nullifies the large amounts of computer trading so computer trading cannot be a cause of a future stock market crash. It is not sure if circuit breakers work because they have not been tested yet and they are very controversial.
Also, many believe that program trading was not the cause of the market so people think that circuit breakers are pointless. Instead of panicking and immediately selling, with intermittent selling under circuit breakers, traders can contemplate about what to do with their stocks. Some make the argument that they have held the stock market from a large crash because there has not been one yet. Conversely, there has not been a large crash so they have not been fully tested yet. After the crash, the head of the Federal Reserve has always been available incase the market crashes. Also, companies have expanded their phone capacity so trading can take place..