General Question

elchoopanebre's avatar

Why did the stock market just crash?

Asked by elchoopanebre (3069 points ) September 25th, 2008

Forgive me for being very late but I haven’t really been paying attention to anything the last couple weeks.

Why did the stock market crash and why don’t we have people killing themselves and businesses going under left and right like on Black Tuesday?

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10 Answers

EmpressPixie's avatar

Well, I’ll answer your second question:
The general speculation on the lack of an increase in Wall Street suicides has a serious answer and a non-serious answer.

Non-serious: They threw themselves out of windows back in the day. In this day, you can’t open the windows of business buildings.

Serious: Back in the day those people had to personally tell their clients, who they also knew, that they’d lost all of the money. There was immense trust placed in them and they’d betrayed it.

Today, we all know that Wall Street is full of greed and corruption. There is distance between a trader and his clients as well as the expectation that they won’t really care about the little people, just themselves. We may yet see some suicides from traders, but it won’t be because they’ve lost Anna Marie Smith’s nest egg and now she can’t retire. It’ll be because they lost their own riches.

I know it is a lot of stereotyping of Wall Street types, but basically some of the speculation about why there haven’t been suicides is that the traders just don’t care as much about the people they’ve ruined. And there isn’t as much public distaste and disdain heaped upon them because we already had notions of them as sleazy, they’re just living up to those notions now.

jca's avatar

i don’t think it’s actually crashing (yet), i think it’s not doing well but if it crashed it would be down to zero.

EmpressPixie's avatar

Russia. Russia’s stock market crashed. (They might have re-opened it, but at one point last week they weren’t opening it because every time they did it just sold, sold, sold.)

Ours just took a bit of a dip. And actually ended last week where it began—two days of immense selling and two days of immense rallying.

fireside's avatar

I think a big part of the reason is that there is still hope of a turnaround.

I don’t have any facts at hand right now,. but the percentage drop in the market was about equal in 1929 and in the late 80s.

It took years to recover from the first crash, but it only took a matter of days to recover from the second.

@empress – Russia is funny, they not only closed their market when the stocks were going down, they also closed the market when the stocks were going up. Their big problem is that investors pulled about $30billion out of their market after they sent tanks into Georgia.

tonedef's avatar

I think the first part of the question, which I’m also interested in, hasn’t been answered yet:

WTF happened? How did all these enormous investment firms crash and burn in the span of one week? Why did it all happen at once? These questions might be too big for one Fluther answer, but any information to help us understand this crisis is welcome.

SquirrelEStuff's avatar

http://www.youtube.com/watch?v=3qLefrvxbq8

This is the reason I supported Ron Paul. He has been talking about the financial crisis for many years. A good president must see the threat before the threat is there. Neither candidate saw the threat or still see the real problem.

http://www.campaignforliberty.com/blog/?p=577

SquirrelEStuff's avatar

http://www.cnn.com/2008/POLITICS/09/23/paul.bailout/index.html?iref=newssearch

By Ron Paul
Special to CNN
Decrease font Decrease font
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Editor’s note: Ron Paul is a Republican congressman from Texas who ran for his party’s nomination for president this year. He is a doctor who specializes in obstetrics/gynecology and says he has delivered more than 4,000 babies. He served in Congress in the late 1970s and early 1980s and was elected again to Congress in 1996. Rep. Paul serves on the House Financial Services Committee.
Rep. Ron Paul says the government’s solution to the crisis is the same as the cause of it—too much government.

(CNN)—Many Americans today are asking themselves how the economy got to be in such a bad spot.

For years they thought the economy was booming, growth was up, job numbers and productivity were increasing. Yet now we find ourselves in what is shaping up to be one of the most severe economic downturns since the Great Depression.

Unfortunately, the government’s preferred solution to the crisis is the very thing that got us into this mess in the first place: government intervention.

Ever since the 1930s, the federal government has involved itself deeply in housing policy and developed numerous programs to encourage homebuilding and homeownership.

Government-sponsored enterprises Fannie Mae and Freddie Mac were able to obtain a monopoly position in the mortgage market, especially the mortgage-backed securities market, because of the advantages bestowed upon them by the federal government.

Laws passed by Congress such as the Community Reinvestment Act required banks to make loans to previously underserved segments of their communities, thus forcing banks to lend to people who normally would be rejected as bad credit risks.

These governmental measures, combined with the Federal Reserve’s loose monetary policy, led to an unsustainable housing boom. The key measure by which the Fed caused this boom was through the manipulation of interest rates, and the open market operations that accompany this lowering.

When interest rates are lowered to below what the market rate would normally be, as the Federal Reserve has done numerous times throughout this decade, it becomes much cheaper to borrow money. Longer-term and more capital-intensive projects, projects that would be unprofitable at a high interest rate, suddenly become profitable.

Because the boom comes about from an increase in the supply of money and not from demand from consumers, the result is malinvestment, a misallocation of resources into sectors in which there is insufficient demand.

In this case, this manifested itself in overbuilding in real estate. When builders realize they have overbuilt and have too many houses to sell, too many apartments to rent, or too much commercial real estate to lease, they seek to recoup as much of their money as possible, even if it means lowering prices drastically.

This lowering of prices brings the economy back into balance, equalizing supply and demand. This economic adjustment means, however that there are some winners—in this case, those who can again find affordable housing without the need for creative mortgage products, and some losers—builders and other sectors connected to real estate that suffer setbacks.

The government doesn’t like this, however, and undertakes measures to keep prices artificially inflated. This was why the Great Depression was as long and drawn out in this country as it was.

I am afraid that policymakers today have not learned the lesson that prices must adjust to economic reality. The bailout of Fannie and Freddie, the purchase of AIG, and the latest multi-hundred billion dollar Treasury scheme all have one thing in common: They seek to prevent the liquidation of bad debt and worthless assets at market prices, and instead try to prop up those markets and keep those assets trading at prices far in excess of what any buyer would be willing to pay.

Additionally, the government’s actions encourage moral hazard of the worst sort. Now that the precedent has been set, the likelihood of financial institutions to engage in riskier investment schemes is increased, because they now know that an investment position so overextended as to threaten the stability of the financial system will result in a government bailout and purchase of worthless, illiquid assets.

Using trillions of dollars of taxpayer money to purchase illusory short-term security, the government is actually ensuring even greater instability in the financial system in the long term.

The solution to the problem is to end government meddling in the market. Government intervention leads to distortions in the market, and government reacts to each distortion by enacting new laws and regulations, which create their own distortions, and so on ad infinitum.

It is time this process is put to an end. But the government cannot just sit back idly and let the bust occur. It must actively roll back stifling laws and regulations that allowed the boom to form in the first place.

The government must divorce itself of the albatross of Fannie and Freddie, balance and drastically decrease the size of the federal budget, and reduce onerous regulations on banks and credit unions that lead to structural rigidity in the financial sector.

Until the big-government apologists realize the error of their ways, and until vocal free-market advocates act in a manner which buttresses their rhetoric, I am afraid we are headed for a rough ride.

The opinions expressed in this commentary are solely those of the writer.

tonedef's avatar

@chris, one could argue that this crisis was engendered not simply of too much government intervention, but also the wrong kind of intervention- “artificially propping up” the investment firms, and doing absolutely nothing as millions of homeowners lose their livelihoods to rampant laissez faire policies. why did the government allow these firms to issue absurd, wobbily-backed mortgages to americans who clearly could not afford them?

marinelife's avatar

The best explanation I have heard was the one given by Bill Clinton on the Daily Show the other night. As soon as they post it, watch the Clinton interview.

Basically, he said booms are always followed cyclically by busts. He said in 2001 tech stocks were booking and the inevitable bust came. At that time, all that money sloshing around had nowhere to go except housing. At that point, a bunch of unsound instruments were created (like zero down and other sub prime loans) and all the money flooded into these risky investments. (He points out that government encouragement of alternative energy sources, and other problem-solving programs would have provided competition for the investment dollars and created jobs.) Eventually, the inevitable happened and all of these risky loans started to fail (as ARMs went to sky high rates, for example). And here we are in the early phases of the fall of the dominoes.

Bioplasmic's avatar

There are so may variables the answer has got to be multifactorial, here are some possible solutions:

Don’t allow the under pricing of risk.
Add in the true cost of those not participating in transactions.

Ban “special investment vehicles” that lie outside the Basle Agreements.

Investment banks such as Lehman Brothers must be regulated and brought inside the Basle Agreements.

Don’t allow people to make assets so complicated that nobody understands them.
Fine-tune the existing regulatory structure and the nature of banking, to promote liquidity.

Don’t react to the financial situation with political motivation.
Don’t over regulate the system.

Find a good market-driven solution to deal with speculative attacks on banks.
Avoid sharp contractions of bank balance sheets.
Maintain the availability of credit.

Regulate more, those aspects of the free market, that look to short term profit, as opposed to long term prosperity.

Reassess but accept the necessary role of the state in free markets.

Encourage more ‘old fashioned’ manufacturing.

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