Stock Market Decline & Failure
- Stock markets decline when more people sell stocks than purchase them. In this case, the supply of available stocks exceeds the demand. This natural shift in supply and demand causes a decrease in price, thereby resulting in a general decline of the stock market. Stock market failures result when there is a massive sell-off of stocks with few buyers willing to absorb the excessive supply. Failures are often instantaneous, happening in a single day.
- People sell stocks for many reasons: If a large company reports a loss, sellers dump the stock and may choose to purchase a different asset such as government bonds instead. People also sell stocks upon hearing bad economic news, such as an increase in layoffs and weak retail sales. Such declines are not always permanent --- short-term investors may buy stocks again the next day or in the next month if the economy shows signs of improvement.
- Stock markets fail for slightly different reasons: In the case of the Great Depression, institutions mandated holders of marginal loans to pay off the full balance. The consequence is akin to a financial institution asking a graduate to pay her student loans in full in the next month: The result is complete insolvency. A similar problem occurred during the mortgage meltdown. Banks raised the mortgage rate on homeowners, thereby rendering them unable to pay the monthly amount. In this case, the number of defaults caused financial institutions to become insolvent. When financial institutions incur these steep losses, a natural consequence is a crash in the stock market. According Floyd Norris in a New York Times article, the 2008-2009 crash caused the market to lose 50 percent of its value over this two-year period.
- Stock market declines and failures reduce personal wealth, slow economic growth and halt consumer spending. When people cease investing in corporations, businesses have less money to invest into their products, labor pool and general expansion. Layoffs are a common byproduct of crashes and failures. When people have less disposable money, however, they stop buying goods and services which only exacerbates problems of the business cycle. As explained in a "Reuters" article, the lack of liquidity in the market is one reason the Fed tried to solve the problem by infusing $300 billion back into the economy in 2008 through its quantitative easing program.