The third in our series documenting the most devastating events in stock market crash history…
"We take a buck, we shoot it full of steroids and we call it leverage." – Gordon Gekko, "Wall Street II."
The 2008 stock market crash destroyed $16.4 trillion of American households' net worth from 2007 through 2009. It wiped out more than $2 trillion of Americans' retirement savings.
The Dow Jones Industrial Average fell from its high of 14,164.43 reached on Oct. 9, 2007, to 6,443.27 by March 6, 2009 – a 54% plunge in little under 18 months.
During that time, the Dow hit these gloomy milestones:
- The biggest ever single-day crash in Dow Jones history occurred on Sept. 29, 2008, when the U.S. House of Representatives rejected the government's $700 billion bank bailout The Dow dropped 777.68 points (6.98%) — obliterating $1.2 trillion in market value.
- The index's second biggest single-day loss happened just six days later on Oct. 15, 2008. This time, recession talk fueled the 7.9% decline.
- Subprime financial crisis-related events that triggered the top two largest single-day Dow drops also accounted for the fourth, fifth, and tenth largest single-day crashes in Dow history, all occurring in 2008.
- The Dow crashed 18.1% the week of Monday, Oct. 6, 2008, alone.
Here's a look at the events that caused the stock market crash of 2008…
What Caused the 2008 Stock Market Crash: Housing Bubble Led to Subprime Lending
Just like Parts I and II in our stock market crash history series (covering the stock market crash of 1929 and the dot-com crash of 2000-2002), the 2008 stock market crash, boiled down, was caused by a speculative bubble. In 1929, it was speculation over the railroad industry; in 2000, it was speculation over Internet companies; and in 2008, it was speculation over real estate.
From 1996 to 2006, home prices nearly doubled. Robert Shiller's Home Price Index went from 87.0 to 160.6. About 65% of this growth occurred from 2002 to peak prices in 2006.
When the bubble burst, prices quickly plunged. The index was at 105.7 by 2009. This surge in growth followed by rapid decline is unprecedented in the history of U.S. real housing prices, according to the U.S. Bureau of Labor Statistics.
These factors fueled the run-up in housing prices:
- The aftermath of the dot-com crash. After 2000, investors turned away from tech to real estate as an alternative investment.
- The low interest rates set by the Federal Reserve in the 1990s and 2000s provided further incentive for home buying.
- Relaxed lending standards helped demand continue when prices reached levels that most people could not otherwise have afforded…
You see, building up to the start of the collapse in 2007, the subprime mortgage industry thrived. Historically, less than 8% of home loans given out annually were subprime loans. But from 2004 to 2006, that rate ran up to roughly 20%, with much higher rates in certain parts of the country.
Meanwhile, U.S. households became increasingly indebted. The ratio of debt to disposable personal income almost doubled from 77% in 1990 to 127% by the end of 2007.
In other words, people were given access to loans they could not afford: predatory loans.
But as long as home prices continued to skyrocket, these predatory lending practices continued.
That's because banks could afford to give bad loans, so long as borrowing homeowners' equity outpaced their debt. That's because when a borrower defaulted, the bank could foreclose on the home without taking a loss, since it was an asset with ever-increasing value.