Major Stock Market Crashes

Why This Matters

Stock market crashes aren't just dramatic headlines—they're windows into capitalism's fundamental tensions between speculation and stability, innovation and risk, individual profit-seeking and systemic fragility. When you study these crashes, you're being tested on your understanding of how market psychology, regulatory frameworks, and economic interconnectedness shape capitalist systems. Each crash reveals something different about how markets fail and how institutions respond.

Don't just memorize dates and percentage drops. Know what caused each crash, how it spread, and what systemic changes followed. AP questions often ask you to compare crashes by their underlying mechanisms or analyze how government responses reflect evolving attitudes toward market regulation. The pattern you'll see: capitalism's creative destruction sometimes destroys more than intended, and each crisis reshapes the rules of the game.

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Speculative Bubbles and Overvaluation

These crashes share a common origin: prices became disconnected from underlying value as investors chased rising markets, assuming growth would continue indefinitely. When the gap between price and reality becomes unsustainable, corrections are swift and brutal.

The Wall Street Crash of 1929

• Speculative excess and margin buying—investors borrowed heavily to buy stocks, creating artificial demand that pushed prices far beyond company fundamentals
• Confidence collapse triggered a self-reinforcing spiral as margin calls forced selling, which drove prices lower, triggering more margin calls
• 90% peak-to-trough decline over three years, causing 9,000 bank failures and unemployment reaching 25%—the crash exposed the Depression, it didn't cause it alone

Dot-com Bubble Burst (2000-2002)

• Irrational exuberance for internet stocks—companies with no profits and questionable business models attracted billions based purely on growth potential
• NASDAQ lost 78% of its value as investors realized many dot-coms would never generate sustainable revenue
• Exposed the "greater fool" dynamic—investors bought overpriced stocks assuming someone else would pay even more, until no one would

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Systemic Risk and Financial Contagion

These crashes originated in specific sectors but spread throughout the economy because of interconnectedness—when major financial institutions fail, they take others down with them. The problem isn't just bad bets; it's that everyone made the same bad bets.

Global Financial Crisis (2008)

• Subprime mortgage collapse at the core—banks packaged risky home loans into complex securities, spreading toxic assets throughout the global financial system
• "Too big to fail" institutions like Lehman Brothers, AIG, and major banks faced simultaneous crises, freezing credit markets worldwide
• Massive government intervention including $700 billion TARP bailouts and near-zero interest rates—represented the largest state intervention in markets since the New Deal

Black Monday (1987)

• 22.6% single-day drop—the largest percentage decline in Dow Jones history, erasing $500 billion in market value in hours
• Program trading amplified the crash as computerized selling triggered more selling in a feedback loop humans couldn't control
• Regulatory response introduced circuit breakers—automatic trading halts when markets drop sharply, acknowledging that speed itself had become a systemic risk

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External Shocks and Market Fragility

Not all crashes come from within the financial system. External events can expose how fragile market confidence really is—and how quickly fear spreads when uncertainty spikes.

COVID-19 Market Crash (2020)

• Fastest 30% decline in history—the S&P 500 fell from record highs to bear market territory in just 22 trading days as pandemic lockdowns began
• Real economy shock rather than financial system failure—businesses physically couldn't operate, making this fundamentally different from speculation-driven crashes
• Unprecedented fiscal and monetary response including $2.2 trillion CARES Act and Federal Reserve interventions; markets recovered to new highs within months, raising questions about disconnect between markets and economic reality

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Quick Reference Table

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Self-Check Questions

1. Which two crashes best illustrate how speculative bubbles form, and what distinguishes the type of speculation in each case?

2. Explain how program trading in 1987 and mortgage-backed securities in 2008 both represent systemic risks—what do they have in common structurally?

3. If an FRQ asks you to analyze government responses to market failures, which crash would you choose to argue that intervention stabilized capitalism, and which might you use to argue it distorted market signals?

4. Compare the recovery timelines of Black Monday (1987) and the Global Financial Crisis (2008). What does this difference reveal about the nature of each crash?

5. The COVID-19 crash saw markets recover while unemployment remained high. What does this suggest about the relationship between stock markets and the real economy under modern capitalism?