What is a Market 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, though any market can crash, for example, the international oil market in 2016.
- A market crash can happen in any market, including bond markets and commodities markets, but they are most often associated with stock markets.
- Crashes usually happen when market participants start selling assets in a panic or to cover over-leveraged investments that need to be unwound to cover debts and margin calls.
- There have been several famous market crashes in the 20th century. The most recent stock market crash happened on March 12, 2020.
How a Market Crash Unfolds
A crash can be caused by economic conditions, like the unwinding of too much leverage within a market, and by panic, which is when a market that is moving downward starts to induce fear in participants who want to sell at any cost. Some crashes, like the flash crash of 2010, are created by problems with the underlying mechanics of a market.
Crashes oftentimes have a cascading, systemic effect that moves from one area of market weakness to other areas that don't appear weak. For example, investors who are experiencing losses in the stock market may sell off other securities as well, leading to the possibility of a vicious downward spiral in asset prices across the board. In order to reduce the effect of a crash, many stock markets employ circuit breakers designed to halt trading if declines cross certain thresholds.
Crashes are distinguishable from a bear market by their rapid decline over a number of days, rather than a decline over months or years. A crash can lead to a recession or depression in the overall economy and subsequent bear market.
Historic Market Crashes
There have been a number of historic crashes in the 20th and 21st centuries. The following is a list of the most famous.
Black Monday, October 28, 1929
The Stock Market Crash of 1929, which began on October 24 and ended its first phase on November 13th, resulted in panic-selling and significant losses that occurred over the following two years.
Two-and-a-half years later 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 mostly repealed in 1999. After the financial crisis of 2008, many of its functions were replaced by the Dodd-Frank Act of 2010 that included the Volcker Rule, named after former Federal Reserve Bank president Paul Volcker, that seeks to reduce systemic risk in the banking system by restricting banks' ability to engage in speculative trading and eliminating the ability to trade from their proprietary accounts.
Black Monday 1987
In 1987, the U.S. stock market had been in a bull market for five years. On October 19, 1987, the Dow Jones Industrial Average of blue-chip stocks sold off 22.6% (508 points), and many other markets around the world followed.
The crash was the worst in history in terms of a one-day percentage drop. It had many causes, including political instability in the Middle East and the threat of rising interest rates, but historians point to the relatively new use of computerized trading as a significant source for the crash. After Black Monday, 1987, exchanges instituted circuit breakers to halt panic trading that could be exacerbated by computer-based algorithmic trading that are in effect to this day.
2008 Financial Crisis and Stock Rout
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.
Stock Crash of March 2020
On February 19, 2020, the S&P 500 reached the peak of its eleven-year bull market. A gradual sell-off intensified over the next few weeks until on March 12, the S&P fell 10%, its worst single-day performance since the crash of 1987.
There were many underlying reasons for the crash, including the reversal of bullish sentiment that had been growing for many months. In September of 2019, Mark Hulbert, an opinion columnist for Marketwatch warned investors to start preparing for the end of the 11-year-old bull market. Investors worried that the inverted yield curve of U.S. treasury bonds, a slowdown in corporate earnings and more speculative investing in stock markets indicated the end of the bull market was close.
But the unexpected spread of a novel coronavirus that causes the disease COVID-19 was the pin that finally burst the stock market bubble. The World Health Organization declared the spread of COVID-19 to be a pandemic on March 11th, which was the sufficient condition for a global stock market rout.