The Stock Market Crash of 2008

The stock market crash of 2008 occurred on September 29, 2008. The Dow Jones Industrial Average fell by 777.68 points in intraday trading. Until the stock market crash of March 2020 at the start of the COVID-19 pandemic, it was the largest point drop in history.

The market crashed, partly, because Congress initially rejected the Emergency Economic Stabilization Act of 2008, popularly known as the bank bailout bill. But the stresses that led to the crash had been building for a long time.  

On October 9, 2007, the Dow hit its pre-recession high and closed at 14,164.53. By March 5, 2009, it had dropped by more than 50% to 6,594.44. Although it wasn't the greatest percentage decline in history, it was vicious.

The chart below ranks the 10 biggest one-day losses in Dow Jones Industrial Average history.

The timeline below explains exactly how the 2008 stock market crash happened.

2007

The Dow opened the year at 12,474.52. It rose despite growing concerns about the subprime mortgage crisis. On December 19, 2006, the U.S. Department of Commerce warned that October's new home permits were 28% fewer than the year before. But economists didn't think the housing slowdown would affect the rest of the economy. In fact, they were relieved that the overheated real estate market appeared to be returning to normal.

But falling home prices triggered defaults on subprime mortgages.

The Fed began adding liquidity by buying banks’ subprime mortgages. In October, economists warned about the widespread use of collateralized debt obligations and other derivatives.

As the year drew to a close, the Bureau of Economic Analysis (BEA) revised its growth estimate higher. It said that the nation’s gross domestic product had increased by 0.5% in the third quarter. Its prior estimate said it had shrunk 0.5%. It seemed the U.S. economy could shrug off a housing downturn and banks’ liquidity constraints. The Dow ended the year just slightly off its October high, at 13,264.82.

2008

At the end of January, the BEA revised its fourth-quarter 2007 GDP growth estimate down. It said growth was only 0.6%. The economy lost 17,000 jobs, the first time since 2004. The Dow shrugged off the news and hovered between 12,000 and 13,000 until March.

On March 17, the Federal Reserve intervened to save the failing investment bank, Bear Stearns. The Dow dropped to an intraday low of 11,650.44 but seemed to recover. In fact, many thought the Bear Stearns rescue would avoid a bear market. By May, the Dow rose above 13,000. It seemed the worst was over.

In July 2008, the crisis threatened government-sponsored agencies Fannie Mae and Freddie Mac. They required a government bailout. The Treasury Department guaranteed an estimated $25 billion of their loans and bought shares of Fannie's and Freddie's stock. The Federal Housing Authority guaranteed $300 billion in new loans. On July 15, the Dow fell to 10,962.54. It rebounded and remained above 11,000 for the rest of the summer.

September 2008

The month started with chilling news. On Monday, September 15, 2008, Lehman Brothers declared bankruptcy. The Dow dropped more than 200 points.

On Tuesday, September 16, 2008, the Fed announced it was bailing out insurance giant American International Group Inc. It made an $85 billion loan in return for 79.9% equity, effectively taking ownership. AIG had run out of cash. It was scrambling to pay off credit default swaps it had issued against now-failing mortgage-backed securities (MBS).

In the days following Lehman's collapse, money market funds lost $196 billion. That's where most businesses park their overnight cash. Companies had panicked, switching to even safer Treasury notes. They did this because Libor rates were high. Banks had driven up rates because they were afraid to lend to each other. On September 17, 2008, the Dow fell 449.36 points.

On Thursday, September 18, 2008, markets rebounded by more than 400 points. Investors learned about a new bank bailout package.

On Friday, September 19, 2008, the Dow ended the week at 11,388.44. It was only slightly below its Monday open of 11,416.37. The Fed established the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility. It lent money to banks to buy commercial paper from money market funds. The Fed's announcement confirmed that credit markets were partially frozen and in panic mode.

On Saturday, September 20, 2008, Secretary Henry Paulson and Federal Reserve Chair Ben Bernanke sent the bank bailout bill to Congress. The Dow bounced around 11,000 until September 29, 2008, when the Senate voted against the bailout bill. The Dow lost 777.68 points during intraday trading. Global markets also panicked:

• Brazil's Ibovespa stock exchange was halted after dropping 10%
• The London FTSE dropped 5.3%
• Gold nearly reached $900 an ounce
• Oil dropped to $95 a barrel

To restore financial stability, the Fed doubled its currency swaps with foreign central banks in Europe, England, and Japan to $620 billion. The governments of the world were forced to provide all the liquidity for frozen credit markets. 

October 2008

Congress finally passed the bailout bill in early October, but the damage had already been done. The Labor Department reported that the economy had lost a whopping 159,000 jobs in the prior month. On Monday, October 6, 2008, the Dow dropped by 800 points, closing below 10,000 for the first time since 2004.

The Fed tried to prop up banks by lending $540 billion to money market funds. The funds needed the cash to meet a continuing barrage of redemptions. Since August, about $500 billion had been withdrawn from prime money markets. 

JPMorgan Chase managed the Fed's Money Market Investor Funding Facility (MMIFF). It purchased up to $600 billion of certificates of deposit, banknotes, and commercial paper that would come due in 90 days. The remaining $60 billion came from the money markets themselves. But they were also purchasing the commercial paper from the MMIFF. 

The Fed quickly lowered the fed funds rate to just 1%. But the Libor bank lending rate stayed at a high of 2.58%.  The Fed also coordinated a global central bank bailout.

The Dow responded by plummeting 15% throughout the month. By the end of October, the BEA released more sobering news. The economy had contracted 0.3% in the third quarter. The nation was in recession. 

November 2008

The month began with more bad news. The Labor Department reported that the economy had lost a staggering 240,000 jobs in October. The AIG bailout grew to $150 billion. The Bush administration announced it was using part of the $700 billion bailouts to buy preferred stocks in the nations' banks.

The Big Three automakers asked for a federal bailout. By November 20, 2008, the Dow had plummeted to 7,552.29, a new low. But the stock market crash of 2008 was not over yet.

December 2008

The Fed dropped the fed funds rate to 0%, its lowest level in history. The Dow ended the year at a sickening 8,776.39, down almost 34% for the year.

2009

On January 2, 2009, the Dow climbed to 9,034.69. Investors believed the new Obama administration could tackle the recession with its team of economic advisers. But the bad economic news continued. On March 5, 2009, the Dow plummeted to its bottom of 6,594.44.

Soon afterward, President Barack Obama's economic stimulus plan instilled the confidence needed to stop the panic. On July 24, 2009, the Dow reached a higher plane. It closed at 9,093.24, beating its January high. For most, the stock market crash of 2008 was over.

Aftermath

Investors bore the emotional scars from the crash for the next four years. On June 1, 2012, they panicked over a poor May jobs report and the eurozone debt crisis. The Dow dropped 275 points. The 10-year benchmark Treasury yield dropped to 1.47. This yield was the lowest rate in more than 200 years. It signaled that the confidence that evaporated during 2008 had not quite returned to Wall Street. 

In 2013, the stock market finally recovered. Stock prices rose faster than earnings, creating an asset bubble. The Dow continued setting higher records until February 2018. Fears of inflation and higher interest rates sent the Dow into the longest correction since 1961. Like many other past stock market crashes, it did not lead to a recession.

The correction ended in August 2018, and the Dow ended 2018 at 23,327.46. In 2019, it set a record of 27,359.16 in July. It then began declining due to concerns about trade wars initiated by President Donald Trump.

The Bottom Line

The stock market crash of 2008 was a result of defaults on consolidated mortgage-backed securities. Subprime housing loans comprised most MBS. Banks offered these loans to almost everyone, even those who weren’t creditworthy.

When the housing market fell, many homeowners defaulted on their loans. These defaults resounded all over the financial industry, which heavily invested in MBS. Consequently, companies doing business with these banks were negatively affected, and this pummeled their stocks, in turn.

The scale of the banking crisis led to a failure of confidence in the U.S. stock market as well. As a side effect, the stock market crashed in the fall of 2008.

The U.S. stock market did not sufficiently recover until mid-2013.