The History of Stock Market Panics

run on banksStock market panics are nothing new and there are lessons to be learned. Words like stock market panic, bank runs, bailouts, greedy bankers, financial contagion, short selling, illiquidity and credit crises are nothing new to the stock market.

Stock market panics come and go, but today they seem to come rather rapidly and can fade just as quickly.




Stock Market Panics and Recessions of the 1800s


The stock market panic of 1819 was caused by, among other things, speculation in land and easy credit. When the boom came to an end commodity prices fell including cotton and land prices. Debtors were then left owing large amounts of money on this land, the government stepped in and tried to help these debtors. Much like today’s mortgage assistance programs [1].

The stock market panic of 1857 was caused once again by over-speculation, this time in railroads causing the collapse of the Ohio Life Insurance and Trust. As the financial problems spread throughout the country, everyone pointed their fingers to blame the New York bankers and Wall Street.

Henry J. Redmond who was the owner and chief editor of the New York Times had this to say about the current (1857) panic, “The bankers seemed to be concerned only about their own welfare and not of the community” [2]. That sure sounds familiar.

The stock market panic of 1873 started when the nations most distinguished investment bank, Jay Cooke and Company, failed. The same phrases we hear today were written about in 1873. Credit disappeared or dried up, business closed and foreclosures and bank failures were common. One in six Americans were out of work. Cooke and Company failed because of heavy speculation and advances to the railroads. This stock market panic took most by surprise since the economy seemed to be doing fine, but an underlying cause was the unregulated growth, no government regulation and overbuilding of the railroads after the Civil War. The recession lasted until 1879.

The stock market panic of 1893 turned into the second worse depression in US history. This panic caused the loss of over 16,000 businesses, hundreds of banks to fail, a severe credit crisis and over 20% unemployment. Some historians say this depression started when the Philadelphia and Reading Railroad filed for bankruptcy. Others say that this financial panic started with a large drop in the US gold reserves. And others blame the Sherman Silver Act of 1890. This depression lasted until 1897.

War on Wealth poster 1896
Broadway show inspired by the panic of 1893

Stock Market Panics and Recessions of the 1900s


The stock market panic of 1907 or the Bankers Panic began with a failed attempt by two men to corner the copper market and then runs on the Knickerbocker Trust Company. That night the president of Knickerbocker committed suicide and the next day there were runs on all of the banks. To stop the spread of the panic, J. P. Morgan used his money and asked other bankers to do the same to shore up banks. Actually, this is not unlike what happened in 2008 when bankers were asked to use their money to try and save banks like Bear Stearns and Lehman Brothers.

Shortly after, the panic had spread to the New York Stock Exchange, which was about to run out of money, and once again the group of bankers led by J. P. Morgan loaned the stock exchange money to keep it operating. J. P. Morgan was hailed as a hero.  The stock market panic of 1907 led to the creation of the Federal Reserve.

The roaring 1920s had everyone talking about stocks and buying stocks. Many of these stocks were bought on margin or borrowed money. The main thought was that stocks would continue to go higher and couldn’t or wouldn’t drop. Banks start offering mortgages at 90% margin (borrowed money).

The First National City Bank (Citibank) had its stock brokerage subsidiary repackaging bad Latin American loans as investment securities and selling them to investors who didn’t even know what was in them. I guess some companies never learn their lessons. This little scheme led to the Glass-Steagall Act of 1933 [3].

The stock market panic of 1929 starts when the stock market plummets on October 28th and 29th for a loss of 24.5%. This was the start of the worst economic depression in history, known as the Great Depression. By July of 1932, the Dow Jones Industrial Average (DJIA) had lost 89% since the high point of September 3, 1929. The DJIA didn’t reach its 1929 high point again for another 25 years. For more on the Great Depression, you can read Facts About The Great Depression.

The stock market panic of 1987 was a panic that had everyone trying to sell their stocks and no buyers. The stock market had gone up 41% during the past two years and some worried the market had gone up too fast. By Mid October 1987, the S&P 500 lost 10% in three days. At the opening bell of Monday October 19, 1987, the DJIA dropped and didn’t stop dropping. By the end of the day the DJIA lost 508 points or 22.6% for the largest single day percentage drop in the history of the DJIA. There doesn’t seem to be a major reason for this panic. One reason given was program trading, too many computerized sell orders. The market steadily climbed back to a pre-crash level 15 months later.

Chart of 1987 stock market crash


The Stock market panic of 2008 started more slowly than an instant panic with the drop of housing prices. By March of 2008, there was the run on the banks, causing the collapse of Bear Stearns and September 2008, the collapse of Lehman Brothers, which led to a credit crisis, no money being lent. There is so much blame to go around it will take many books and years to figure it all out.

Once again the constant theme is greed, over leveraging, over borrowing, repackaging of mortgages and reselling these packages to investors who thought they were getting investment grade securities and a congress that some years ago put unrealistic rules for Freddie Mac and Fannie Mae to follow.

Stock Market Panics and Lessons Learned


Whether it is tulips, copper, railroads or bad mortgages, it is usually greed, overleveraging and rampant speculation which led to these stock market panics. Over the past 200 years, nothing much has changed. Even some of the names are the same like Citibank and their repackaging of questionable securities.

I believe that the “Too big to fail” from the Great recession is true for some businesses like AIG and some of the banks. If AIG would have been let to fail, it could have financially ruined millions of retirement accounts and the economy. The same is true for certain banks and companies. While too big to fail might be true, too big to jail should never be true. If these companies are so important to the economic health of the US, Europe and the world, then I would think they have a fiduciary duty to not be so greedy and reckless with our money.

Lessons for us to learn are that these stock market panics will happen again and the only thing we can do is always be prepared. Never over leverage yourself in any type of purchase and always be well diversified in the stock market. Congress won’t save us from the ineptness and greed on Wall Street, so you have to be ready yourself.

© 2010 Sam Montana

Resources

[1] The Panic of 1918 by Christopher Mayer
[2] The Panic of 1857 and the Coming of the Civil War by James L. Huston
[3] History of the FDIC

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