AFTER WORLD WAR I, the U.S. government pursued a liberal policy, slashed personal income tax, and implemented a loose monetary policy. The U.S. economy quickly emerged from the wartime depression and entered the “Roaring Twenties.” Large-scale industrial production has enabled the middle class to consume luxuries such as cars and radios, and consumerism has prevailed; infrastructure construction and urbanization have also developed rapidly, with the urbanization rate exceeding 50% for the first time. At the same time as rapid economic development, the stock market was also booming. The Dow Jones Industrial Average rebounded from more than 60 points in June 1921, and rose to 376 points in September 1929, an increase of more than 5 times.
At that time, the U.S. stock market was highly autonomous. The U.S. government implemented a laissez-faire policy on the stock market and lacked special securities regulations and regulatory agencies. With the development of the bull market, there were more and more ugly phenomena such as insider trading and joint ventures. At the same time, many inferior companies entered the stock market. Because of the obvious profit-making effect of the stock market, leveraged trading and credit trading were prevalent at that time. Investors could easily make leveraged stock investments with only a small margin, and the leverage ratio was even as high as 1:10.
However, since 1928, the real economy has shown signs of decline. Steel production, automobile sales, and retail sales have declined. Consumer debt has been high. The Federal Reserve also warned of the risk of excessive stock market speculation in March 1929. The Fed raised the discount rate against the economic situation, raising the discount rate from 3.5% to 5%. The Fed also sold government bonds, tightened credit and liquidity, and asked member banks to reduce credit support for funds going into the stock market.
To reduce leverage, the Fed increased the advance ratio of securities brokers from 20% to 50%, but this did not attract enough attention from the market, and the stock index continued to rise until September. Investors’ optimism was hit hard by the London Stock Exchange, which was the first to tumble due to financial fraud, while the Smoot-Hawley tariff bill being debated in Congress at the same time also sparked investor fears of a trade war.
On October 23, the Dow Jones index fell by 6.3%, and on the 28th and 29th, it fell by 13.5% and 11.7%, respectively. By the end of 1929, the stock index had fallen to 248 points. Although the stock index rebounded sharply in the first three months of 1930, it was difficult to change the general trend, and it fell to a minimum of 42 points in July 1932. The highly leveraged trading exacerbated the decline. The margin call for margin trading and the self-reinforcing avalanche effect brought about by forced liquidation made it difficult to stop the vicious circle of panic selling in the market, causing the market to fall sharply.
🔵 Ineffective government rescue: laissez-faire, failure to release liquidity in time, credit crunch black hole and chain effect
The U.S. government and the Federal Reserve did not intervene substantively when the stock market tumbled, thanks to a liberal economic policy of hands-off.
🔵 Although after the stock market crash, the United States began to reflect on the reasons for the collapse of the stock market and took some measures to stabilize the market
🔵 The effect of the rescue and the situation after the stock market disaster: the stock market disaster quickly spread to the financial crisis, economic crisis and social crisis
Before the stock market crash, banks provided a lot of credit support for securities investment, the stock market plummeted and the collateral shrunk rapidly. Many banks were unable to recover their loans and went bankrupt, which made banks’ review of loans more stringent, resulting in industrial and commercial enterprises, especially small and medium-sized industrial and commercial enterprises.
The demand for loans cannot be satisfied, and the hidden trouble or bankruptcy causes more bad debts of banks, forming a negative cycle of credit contraction, the economy is severely impacted, and the industrial production index declines rapidly. The U.S. GNP growth rate from 1929 Q4 to 1933 Q1 has experienced negative growth for 14 consecutive quarters, accumulating -68.56%. The GNP index reached a trough of 53.2 in 1933 Q1, equivalent to only 50% in 1928, lower than the 59 points in 1921, which means that the US economy has retreated for at least more than 10 years.
In the early 1980s, although the U.S. economy bid farewell to the golden period of the 1950s and 1960s and was in a period of low-speed growth in which the old and new economic models were transformed, the fundamentals were still healthy, and the Great Depression of 1929–1933 did not occur. Thanks to the efforts of then-Fed Chairman Paul Volcker, inflation was brought under control and interest rates fell. At the same time, stimulated by the “New Economic Policy” of the US government, fiscal expenditures have expanded, taxes have been reduced, and foreign capital has been vigorously attracted. In addition, stock investment is exempted from taxation. Global capital has entered the US stock market, and the US stock market has been bullish. By the end of September 1987, the S&P 500 had risen by 215% from its lowest point in 1982, and the cumulative gain for that year was as high as 36.2%.
However, due to the collapse of the Bretton Woods system and the expected depreciation of the dollar, to maintain exchange rate stability, following the Plaza Accord, the G7 countries reached the “Louvre Agreement” in February 1987, Japan, Germany and other countries successively lowered interest rates, while the United States raised interest rates to restrain the dollar from continuing to fall.
However, with the rising domestic inflation in Japan, Germany and other countries, this agreement was difficult to maintain. Germany raised short-term interest rates on October 14 and 15 one after another, and the dollar was bearish again.
On October 18, 1987, the US Treasury Secretary announced that the dollar may depreciate actively, plus the impact of bad news such as the cancellation of tax incentives for mergers and acquisitions of listed companies, rumours of the escalation of the Gulf War, and the impact of the increase in the federal funds rate from March to September, the US stock market began to adjust, with three consecutive transactions from October 14th to October 16th. The S&P 500 index fell one after another, with a cumulative decline of 10.1%.
On October 19, the stock markets in Hong Kong, Europe and other places that preceded the opening of the US stock market plummeted one after another. After the US stock market opened, it plummeted by 20.5% (S&P 500), known as “Black Monday” in history.
Programmatic and leveraged trading exacerbated the decline. When the computer program sees a drop in stock prices, it will sell stocks according to the mechanism set in the program long ago, forming a vicious circle, causing the stock price to fall faster, and the falling stock price, in turn, causes the program to sell more stocks.
Before the slump, the incremental financing funds boosted the index to rise. After the slump, the financing balance dropped rapidly, causing the market to lose blood. After the market stabilizes, investors’ risk appetite declines, the financing balance remains stable, the rapid rise before the crash has never been seen again, and the stock market trend is relatively stable.
🔵 The government vigorously rescues the market promptly: Presidential statement, liquidity provision, interest rate cut, guaranteed loan renewal, company repurchase, circuit breaker mechanism
To fix the market, the U.S. government and regulatory agencies learned the lessons of 1929, acted quickly, and decisively intervened in the market:
🔵 The effect of the rescue and the situation after the stock market disaster: panic was eased, the stock market disaster did not evolve into a financial and economic crisis, new highs were reached, and styles were switched
Because of the effective measures of the US government, the Federal Reserve and the SEC, the market panic has been eased. Although most of the other stock markets that opened before the US stock market still plummeted, on October 20, the US stock market began to rebound after the market opened, and then the stock market began to fluctuate. Years later, back to 1987 high. After the stock market crash in 1987, the rise of the U.S. stock market was more driven by rising earnings, and the valuation did not increase much because the market returned to rationality after the crash.
In 2000 and 2001, the United States suffered the burst of the technology stock bubble and the 9/11 terrorist attacks. To stimulate the economy, the Federal Reserve cut interest rates several times from 2000 to 2003, reducing the federal funds rate from 6.5% to 1.0% and maintaining it until 2004. Rates were raised again in June. In a very loose monetary environment, both the housing market and the stock market rose sharply, and the rapid development of financial derivatives such as MBS and CDO during this period further stimulated the rise in housing prices.
By 2006, the average housing price in the United States had risen by 124% compared to 1988; the Dow Jones Industrial Average had bottomed out from 7,422 in October 2002, and once exceeded 14,000 in October 2007, nearly doubling.
Since 2004, the United States has entered the channel of raising interest rates again. By July 2006, the federal funds rate had been raised to 5.3%. The corresponding rise in floating-rate mortgage interest rates has increased the pressure on households to repay their debts, especially those subprime borrowers whose solvency is already very fragile. The fall in interest rates suppressed asset price bubbles and further exacerbated the situation. Active defaults of insolvency began to emerge. The U.S. housing market has been in trouble since 2006.
With the deepening of the crisis, a large number of financial institutions held subprime debt derivatives The losses were heavy, and the crisis spread to the financial system.
In September 2008, the crisis broke out. The two houses were successively taken over by the government, Lehman Brothers filed for bankruptcy protection, Merrill Lynch was acquired by Bank of America, insurance giant AIG received federal aid, and Morgan Stanley and Goldman Sachs had investment banks turned into bank holding companies to accept stricter regulation by the Federal Reserve. Affected by this, US stocks fell sharply. From September to December, the Dow Jones Industrial Average fell by 31.2%, and it fell below 7,000 points in March 2009.
🔵 The government rescues the market: providing emergency liquidity, taking over two houses
The federal government stepped in to bail out at the beginning of the crisis, taking some measures to calm market sentiment and preserve the market:
🔵 Rescue effect: The crisis spread was lower than expected, and the U.S. economy recovered rapidly
Under the active assistance of the federal government, the market panic began to ease, and US stocks bottomed out in March 2009. After the crisis, the United States once again reformed the regulatory system.
In January 2010, President Obama announced the “Volcker Rule,” emphasizing the divestiture of self-operated businesses from commercial banks; on June 25, Congress passed the “Dodd-Frank Act,” which is considered to be the most severe and strictest since the Great Depression. The comprehensive financial supervision bill mainly includes the establishment of the Financial Stability Supervision Commission, the establishment of the Consumer Financial Protection Bureau, the introduction of over-the-counter derivatives into supervision, the restriction of proprietary trading of commercial banks, the establishment of a new bankruptcy liquidation mechanism, and the Federal Reserve is given greater authority.
U.S. stocks fell sharply during the 2008 financial crisis and began to bottom out in 2009. During this period, except for the abnormal intraday slump on May 6, 2010, it has been on an upward trend. By the end of 2010, the S&P 500 had risen about 90% from its 2009 low. However, the federal government’s $700 billion plan to bail out Wall Street has also led to a rapid increase in the federal debt of the United States. For this reason, the United States has raised the legal limit of federal debt six times in a row from 2007 to 2010. In just a few years, the legal limit of federal debt has never been insufficient 9 trillion to 14 trillion. This also buys hidden dangers for the subsequent sovereign debt crisis.
In December 2009, Moody’s, Standard & Poor’s and Fitch downgraded Greece’s sovereign rating one after another. The European sovereign debt crisis broke out, and then other European countries also fell into crisis one after another, with Spain, Italy and Portugal being the most serious. Affected by this, U.S. stocks fluctuated in April-June 2010. With the meeting of European finance ministers reaching a total of 750 billion euros of emergency aid plans, troubled European countries have also issued fiscal austerity policies one after another, the market’s worries about the debt crisis have eased, and US stocks rebounded.
But in early August, the U.S. Congress failed to reach an agreement on the debt ceiling at the deadline, and U.S. stocks plummeted one after another. The S&P 500 fell 2.6% and 4.8% on the 2nd of August and the 4th of August, respectively and plummeted even more on the 8th of August which was about 6.7%.
On the 9th of August, the Federal Reserve announced that it would keep the federal funds rate at an all-time low of 0 to 0.25% until at least mid-2013. This is the first time the Fed has specified a policy extension since it cut the federal funds rate to that level in 2008. Boosted by this positive news, U.S. stocks rose sharply on the day, with the S&P 500 closing up 4.7%.
Despite the negative impact of the European sovereign debt crisis, the 500 S&P slumped 4.4% again the next day. The US stock market ended the adjustment period in general and began to bottom out and break through the previous high in February 2012.
By comparing several important stock market disasters and rescue policies and effects in global history, we can draw the following inspirations:
1️⃣ The stock market has its own rules of ups and downs. All stock market crashes occur during periods of high stock prices, and the higher the bubble, the deeper the decline.
2️⃣ Leverage tools will magnify the volatility of the stock market. For example, the stock market crash in the United States in 1929, the stock market crash in 1987, and the stock market crash in Taiwan in 1990.
3️⃣ Emerging economies are prone to stock market disasters in the process of promoting financial liberalization. In the process of opening up the capital account and increasing financial innovation tools, the government supervision system is not perfect, and investors are not familiar with the new environment. For Example, the Japanese stock market crash in 1989, the Taiwan stock market crash in 1990, and the Asian financial crisis in 1997.
4️⃣ If the stock market crash occurs during the rising period of the economic cycle or the rate-cutting cycle, the stock market has a strong recovery ability and adjusts relatively quickly and is supported by fundamentals or policy funds. The U.S. economy is in a period of an upswing in the economic cycle and an era of low-interest rates; however, if the stock market crash occurs during a downturn in the economic cycle or a cycle of interest rate hikes, the stock market will have weaker resilience and deeper adjustments, such as the Great Depression in 1929 and 2008 the loan crisis and Japan’s 1989 stock market crash.
5️⃣ When the stock market crash occurs, the government must rescue the market in a timely and effective manner to prevent the stock market crash from causing excessive damage to the financial system and the real economy. At the inflexion point of the economic cycle, the biggest lesson of the Great Depression in 1929 was that government assistance was not timely allowing the stock market crash to spread into a financial crisis and an economic crisis; while the 2008 subprime mortgage crisis was once known as the “Once-in-a-century” stock market crash had relatively little impact on the real economy, and the U.S. economy recovered quickly after the stock market crash.
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