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August 11 - September 7, 2024
Every modern stock market crash has an external catalyst at its heart. These external catalysts—some are acts of nature, such as 1906’s earthquake; some are geopolitical, as in 1987 and 2010; some are political, as in 2008; and some are criminal, as in 1929—are not sufficient themselves to start a crash, though they are necessary.
as stocks decline in value during a correction, investors begin to recognize value and step in to buy at a discount; greed overcomes fear. During a crash, unique forces align. The decline doesn’t stop as these forces overwhelm the ability to know what value is.
The Federal Reserve System was part of the country’s response to the Panic of 1907, when a single man, J. P. Morgan, with access to only private resources, stepped in to stop the chaos.
The Fed’s raising interest rates to restrain the 1920s’ decade-long stock market spree would have been good medicine if delivered in a moderate dosage years earlier. Delivered all at once after the disease had spread, it nearly killed the patient.
One reason that so many Americans had become investors was that there seemed to be little risk and much reward;
The history of modern stock market crashes invariably includes some theoretically sophisticated yet poorly understood financial contraption that mutates when stressed, pushing an already weakened system closer to the cliff.
Icahn pocketed $2 million in greenmail—the premium above market value paid by entrenched management, with shareholders’ money, so a potential acquirer will go away and leave existing management alone—before
They came into existence only because they could be sold and those sales provided investment bankers with their annual bonuses.
J.P. Morgan, its partner in the BISTRO deal, pulled back from the business because they couldn’t model the risk.
In those twenty years, the mortgage-backed security market had become nearly half the size of the U.S. stock market, which had started in the 1700s.
It was easy to stand behind the false belief that complex and sophisticated meant accurate.
Every other modern stock market crash has been fueled by a new financial contraption that was poorly understood and that metastasized at the worst moment. The 2008 stock market crash was fueled by a half-dozen such contraptions.
A product that hadn’t existed twenty-five years earlier was now half the size of the entire U.S. stock market.
Federal National Mortgage Association, known as Fannie Mae,
Federal Home Loan Mortgage Corporation, known as Freddie Mac,
Fannie and Freddie were astonishingly leveraged. The investment trusts that had collapsed in 1929 were leveraged with eight dollars of debt for each dollar of invested capital. Before Bear Stearns collapsed, it had thirty dollars of debt for each dollar of invested capital. Fannie and Freddie in 2008 had seventy-five dollars of debt for each dollar of invested capital, leaving no room for error.
modern stock market crashes are all instances in which people, some smart, some not so much, forgot the lessons that the market teaches repeatedly. It generates an attractive return but with the risk of loss. It’s most vulnerable when it’s overextended. Liquidity dries up when it’s most desired. New financial products might seem to solve an immediate problem, while creating a much larger one in the future when stressed.
the phenomena that attend each crash: a robust stock market rally that pushes stock prices beyond reason, a financial vehicle that will foster selling at the worst possible time, a catalyst that will start the selling, even a warning that may seem odd but will later seem oddly prescient.
