What caused the Sock Market Crash of 2008?

Answer 1

The cause isn't George Bush, real estate, consumers, etc. Those are the easy scapegoats.

Expensive stocks cause crashes, and cheap stocks halt declines.

Read "Market Wizards" to get an idea of the caliber of the world's greatest money managers. Then, consider that stocks had reached a great price extreme in 2000 that was actually a run-of-the-mill price target that technicians could readily compute. As the decline unfolded, more almost-traditional analysis forecast the low of July, 2002. Sadly, even though the Daily charts had their price targets realized, the Weekly and Monthly charts had experienced a breakdown that forecast that another decline of 50% was still in the offing.

Compute the decline of the S&P 500 from 2000 to 2002. Note that the entire rally off the low of 2002 was a "corrective" one, that on a long-term chart appears as a "snap-back" or "test" of the failure point. Once the test was completed, and do know that smart-money was DE-leveraging during this time, prices were ready to decline. Also know that once prices begin to decline, and even well-seasoned guys like me realize that finally the second half of the decline of 2000 is underway, then price targets are computed, and bids are pulled. Restated, when a few guys at the blackjack table the dealer is holding 21 before the hand is dealt, they're not going to even put up an initial bet.

Once the October '08 target was reached on the broad indices, the market began a nice basing pattern. This resolved the negative WEEKLY charts left over from 2000-2002, but the monthly ones still have lower targets.

Many people claim that this is George Bush's problem, but the breakdown on the weekly/monthly charts happened as he was coming into office. You can't pin him with this. The market had been rallying for 19 years without a bear market of the magnitude seen in '73-'74 or '29-'32. People over leverage during the good times, and when the pros (back to Market Wizards) see that upside targets are being reached on the Wilshire 5000, they have no reason to hold on for more.

The only thing that kept the "snapback" rally of '03-'07 intact was the unfolding of the Asian bull market. Do note that concurrent with Asia (sans Japan) markets reaching THEIR target prices, global money managers (hedgies) threw in the towel. They took their profits and ran, knowing that the 50% decline forecast by the 2000-2002 decline was still on the table... I know, because this is exactly what I did over the last decade, and while I manage a small amount of money and I teach math and computer programming, I'm still not found in Market Wizards.

Even oil had a target between $140 and $170 in my work from YEARS earlier, and I fully expected a crash after reaching it --- all because so many people get caught long, and the hedgies know the target has been reached - "game over". The selling is relentless because there is NO upside target. And the money flows to another asset class (Treasuries, this time).

This isn't new. I've studied the Dow from 1901 to 1929, and you can see that the percent change from the low to the highs PRIOR to the breakout from the trading range of 20 years is EXACTLY the same percent change from the point of the breakout to the high of 1929. It's no accident that prices peaked there, nor that they cascaded lower, clear back to the LOWS of that 30-year period. Amazing. Pays *not* to buy-and-hold, when you realize that people far smarter than me have been using rules like these for a century.

Another opinion of what caused the Stock Market crash of 2008 goes back to the creating of cheap credit by the Federal Reserve. By the inflationary practice that was most strongly exercised by Greenspan through 2001-2007 there was an artificially low lending rate maintained by the banks. This allowed a large expansion of the money supply for the banks to lend out.

The availability of money, all things being equal, lowers the interest rates regardless of the actual natural interest rate that would exist if there was no centralized banking manipulations. This natural interest rate is an expression of the time-preference of money. Higher time preference indicate a higher desire to spend money and therefore raise the natural interest rates. Since the lower interests rates therefore imply a higher savings rate, there is more money available for long term investments in production - which is where you purchase stock, build new homes, and start new projects.

As the natural interest rates lower and more money is saved rather then spent on consumer goods, a fixed money supply, like gold, would result in a lowering of prices or increasing the purchasing power of the dollar. This creates an increase in the time-value of money and causes consumers to shift their preferences from saving to spending. As this shift occurs, the increase in consumer activity would normally coincide with the completion of these new projects allowing the investment return on the credit given.

However, a continuing artificial pressure on increasing the time-value creates a false impression of their being real money to invest, rather the money invested is a fiat money with implied value but reduced to well below it's required return on the investment because of the inflation presented by the Federal Reserves ability to create credit by creating money out of thin air.

If there is a solution to why the bubble was created in the first place, it will require that the natural interest rate be allowed to express itself in the market over the manipulations of the Federal Reserve system.