What causes the stock market to crash? The 2008 Financial Crisis

crash-landed-you-have_1xRecent Stock Market Crashes – What Happened?

Stock market crashes are brutal. Some people lose their entire life savings, some people go even further and take their own lives. Stock market crashes, bubbles, whatever you wish to call them, date back as far as 1637. In 1637, in the Netherlands, trading for bulbs of tulips went wild. For a period of four years tulip contracts were the talk of the market and reached unsustainable prices. In 1637, it all came to an abrupt end. A collapse; this was called the Tulip Mania Bubble.

The 2008 Financial Crisis

Each market crash has its own unique characteristics for how and why it happened. The one thing all crashes have in common are quick and painful price drops. As stock markets around the world evolve and become more interconnected, so does the vulnerability of economic conditions of one country affecting another. This is partially what happened in 2008, when the financial crisis in the U.S. had rippling effects around the world.

“The U.S. Senate’s Levin–Coburn Report concluded that the crisis was the result of “high risk, complex financial products; undisclosed conflicts of interest; the failure of regulators, the credit rating agencies, and the market itself to rein in the excesses of Wall Street.”[14] The Financial Crisis Inquiry Commission concluded that the financial crisis was avoidable and was caused by “widespread failures in financial regulation and supervision,” “dramatic failures of corporate governance and risk management at many systemically important financial institutions,” “a combination of excessive borrowing, risky investments, and lack of transparency” by financial institutions, ill preparation and inconsistent action by government that “added to the uncertainty and panic,” a “systemic breakdown in accountability and ethics,” “collapsing mortgage-lending standards and the mortgage securitization pipeline,” deregulation of over-the-counter derivatives, especially credit default swaps, and “the failures of credit rating agencies” to correctly price risk.”

In the early 2000’s, the Federal Reserve was printing money like it was going out of style. Interest rates were falling and at the time, President George W. Bush had a dream for all Americans “everyone should participate in home ownership.” Banks, Fannie May, Freddie Mac, independent lenders, and any other lending institution that wanted in on the game had access to more money than they could lend out. People making $10.00 per hour were buying $400,000 homes, but how were they qualifying?

No doc loans were part of the problem. People were encouraged to exaggerate their incomes to help qualify for a more expensive home. The banks would accept these figures under the guidelines of the “no doc loan policies.” The prospective homeowner would pay a little higher interest rate for their mortgage, but what the heck, homes were appreciating at 30 percent a year – who cared. Then the bubble burst.

In 2008, the roof fell in. Signs of the collapse had reared its ugly head in 2007, but politicians and other big players tried to keep the game going a little longer, knowing that the end was near. This gave insiders time to salvage more profits before the stock market crash occurred.

Subprime Loans, Credit Default Swaps Spread to Global Markets

In modern times, Wall Street has created all sorts of securities that are sold around the world. The lure of juicy returns and the intention of backing these securities with “no loss” insurance policies made countries feel safe in investing in these subprime packages. Iceland was one of the first countries to feel the effects of the housing collapse. Failure of Icelandic banks threatened the government with bankruptcy. An emergency loan from the International Monetary Fund saved Iceland from having to go bankrupt.

Another casualty of this financial crisis was Lehman Brothers. A long standing institution, Lehman Brothers was on the verge of going under if the U.S. government couldn’t find someone to bail them out. No one stepped forward, and Lehman Brothers went bankrupt, causing panic in the stock market. A panic on Wall Street sometimes spills over to the banks, and President Bush, with he urging of Secretary of the Treasury, Paulson, passed the Troubled Asset Relief Program (TARP).


Large corporations like Citi Bank, Bank of America, AIG and  the auto industry were bailed out by the government.

There’s a lot of blame to go around for the stock market crash of 2008. Greed and politics reared its ugly head in events leading to the crash of 2008, just as it did 400 years earlier in the Tulip Mania bubble.

Dodd–Frank to the rescue

This law was passed in response to the financial crisis and made sweeping changes to the financial regulation in the US. The last time something like this passed was after the Great Depression. The official name of this bill is The Dodd–Frank Wall Street Reform and Consumer Protection Act.

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