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 Brief History of U.S. Stock Market Crashes

(Causes, Costs, and Results)

The Crash of 2000

A total of 8 trillion dollars of wealth was lost in the crash of 2000.

Causes of the Crash:

1. Corporate Corruption. Many companies fraudulently inflated their profits and used accounting loopholes to hide debt. Corporate officers enjoyed outrageous stock options that diluted company stock;
   
2. Overvalued Stocks. There were numerous examples of companies making significant operating losses with no hope of turning a profit for years to come, yet sporting a market capitalization of over a billion dollars;
   
3. Daytraders and Momentum Investors. The advent of the Internet enabled online trading –a new, quick, and inexpensive way to trade the markets. This revolution led to millions of new investors and traders entering the markets with little or no experience;
   
4. Conflict of Interest between Research Firm Analysts and Investment Bankers. It was common practice for the research arms of investment banks to issue favorable ratings on stocks for which their client companies sought to raise capital. In some cases, companies received highly favorable ratings, even though they were actually in serious financial trouble.

From 1992-2000, the markets and the economy experienced a period of record expansion. On September 1, 2000, the NASDAQ traded at 4234.33. From September 2000 to January 2, 2001, the NASDAQ dropped 45.9%. In October 2002, the NASDAQ dropped to as low as 1,108.49 - a 78.4% decline from its all-time high of 5,132.52, the level it had established in March 2000.

Following the Crash:

1. New Rules for Daytraders. Under the new rules that were introduced, investors need at least $25,000 in their account to actively trade the markets. In addition, new restrictions were also placed on the marketing methods daytrading firms are allowed to use;
   
2. CEO and CFO Accountability. Under the new regulations, CEOs and CFOs are required to sign-off on their statements (balance sheets). In addition, fraud prosecution was stepped up, resulting in significantly higher penalties;
   
3. Accounting Reforms. Reforms include better disclosure of corporate balance sheet information. Items such as stock options and offshore investments are to be disclosed so that investors may better judge if a company is actually profitable;4. Separation between Investment Banking and Brokerage Research. A major reform was introduced to avoid conflicts of interest in the financial services industry. A clear split between the research and investment banking arms of brokerage houses was mandated.

 

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