What is a Crash
A crash is a sudden and significant decline in the value of a market. A crash is most often associated with an inflated stock market.
BREAKING DOWN Crash
A crash is both an economic phenomenon and a psychological one. Investors who see a rapid decline in the value of a particular stock may sell off other securities as well, leading to the possibility of a vicious spiral marked by negative crowd behavior. In order to reduce the effect of a crash, many stock markets employ circuit breakers designed to halt trading if declines cross certain thresholds.
Causes for a crash may include an economic bubble in which securities, or other investments, are trading at prices far above their intrinsic value, or a highly leveraged market in which debt is used to finance further investment. Crashes are distinguishable from a bear market by their rapid decline in a number of days, rather than a decline over a longer period of time. A crash can lead to a depression in the overall economy and subsequent bear market.
Historic Market Crashes
There have been a number of notorious, crashes throughout the history of the stock market. There was, of course, the crash that led to the Great Depression: the Stock Market Crash of 1929, which began on October 24, resulting in rapid panic-selling and significant falls that occurred over the following two years. In July 1932, the Dow Jones Industrial Average bottomed out, having fallen 89 percent from its September 1929 peak, the biggest bear market in the history of Wall Street. The Dow Jones did not return to its 1929 high until over 30 years later, in 1954. Many important federal regulations came out of this crash, including the Glass Steagall Act of 1933, which prohibited commercial banks from investment banking. This act was partially repealed in 1999, and its resurrection is now championed by politicians such as Senator Elizabeth Warren. Other regulations that came out of this period included the Securities and Exchange Act of 1934, establishing the Securities and Exchange Commission (SEC), and the Public Utility Holding Companies Act of 1935, which regulates electric utility companies.
The Great Recession was preceded by the crash of 2007, when the stock market lost more than 50 percent of its value. This was due to a housing market bubble created by banks packaging loans into mortgage-backed securities. When defaults began to increase, traders and investors questioned the high credit ratings of the packaged loans and they became unsalable. This led to a financial crisis that impacted economies all over the world.