financial express __ financial newspaper of bangladesh

Saturday, 20 April 2013

Share market crashes: Lessons from the past

Md Toufique Hossain

In the financial world the years 1929 and 2010 are both identical. On the Black Tuesday on October 29, 1929 the US stockmarket collapsed completely. And in Bangladesh it was the Black Wednesday on December 08, 2010 when the marketheaded for the biggest fall in its history. The similarity between the two crashes is that in both the cases there was a stockmarket bubble and then the inevitable crash happened.

The Wall Street crash: The US stock market collapse, popularly known as the Wall Street Crash, was the most devastating.It was on Thursday when the initial crash began and it ended on the Black Tuesday with the market collapsing completely.

In early 1920 it was easier to get loans from banks and the people felt the stock market was the best option to put moneyin. Many investors were tempted by this idea of investing in shares. So they borrowed heavily and invested more in the UScapital market. Many investors thought that the fabulous boom would continue forever. In the fall of 1929, economist IrvingFisher announced: "Stock prices have reached what looks like a permanent plateau."

The boom didn't last forever and burst so badly that it led to a major economic crisis known as the Great Depression.Millions lost their lifelong savings, companies went out of business and all faith in banks was lost. Depositors' money to thetune of $ 140 billion disappeared and 10,000 banks failed.

After the 1929 crash, policy makers went for official investigation into it. The U.S. Congress approved the Glass-Steagall Actin 1933, which was a crucial mechanism aimed at barring banks from investing depositors' money in stocks.

Causes of the crash: Basically a speculative boom happened in the late 1920s and the rising share prices encouragedmillions of Americans to invest heavily in the stock market. They expected that the share prices would rise further.Speculations thus led to creation of the bubble.

The central bank failed to contain the bubble. In 1928, the USA central bank was very much worried about the alarmingprice rise in the stock market. They took a lot of initiatives to avert overheating of the economy and the stock market. In1929 the central bank raised interest rates several times to cool the overheated economy and the stock market. At thesame time it reduced the government securities holding rate and increased the open market rate with alteration of the callloan rate. All these failed to stop the continued speculation that led to the bubble, which ultimately burst.

Margin investors: Many investors became millionaire by buying on the margin. But when the market crashed on October 28and 29, the millionaire margin investors went bankrupt almost instantly. Many banks that had invested their depositors'money in the stocks lost it as the stocks plunged.

Dhaka share market crash: The Dhaka stock market suffered two big blows. The first one was in 1996 and the second onebegan at the fag end of 2010. On November 5, 1996 the market lost 233 points in a single day. It was blamed then on theunlawful kerb market trading and the extreme manipulation resorted to by many dishonest broker houses.

As time went by, the market saw a sluggish but sound trend during the period between 2002 and 2008. The year of 2009and the last quarter of 2010 were the golden periods of the market when a lot of people jumped headlong into the marketto invest in shares. In 2010 the market reached its peak and market regulators predicted something would go wrong

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because of the strange growth of stock market. For instance, the DSE General Index (DGEN) which was the main index ofthe Dhaka Stock Exchange (DSE) reached its peak at 8,918 points on December 5, 2010. Ultimately, the inevitablehappened. The DGEN lost 6.0 per cent or 547 points within half an hour on the Black Wednesday in December 2010. It farexceeded the momentum of the crash that happened on November 5, 1996. (The Table 1 shows the movement of the DSEGeneral Index from November 2010 to May 2011.)

*Source: International Journal of Economics and Finance; Title: Catastrophe in

Stock Market in Bangladesh, Page 120 (Data based on www.bloomberg.com)

The Graph 1 shows the DSE price movement on the main index during the period of December 8-20, 2010 while the Graph2 shows the movement of three Chittagong Stock Exchange (CSE) indexes, namely CSE 30, CSCX and CASPI, during thesame period.Causes of the market crash: Basically during the period of December 3-19, 2010, Bangladesh's capital market wasovervalued and overheated. Two decisions triggered some sort of panic in the capital market. Firstly, clients of brokeragehouses and merchant banks were barred from buying shares until their cheques were cashed. And secondly, it was thenetting facility. For instance, no brokerage house provided advance finance to their clients for investment in shares.Corrupt practices: The market crash in 2010-11 also occurred due to a number of corrupt practices. These corrupt practicesincluded window-dressing of balance sheets, book building method, direct listing, private placement, share split, inflateddividend declarations, issuance of preference shares and price manipulations in the secondary market. Some big playersmanipulated the stock market through omnibus accounts during the market swings. They chose those omnibus accounts togamble in the market. It is not possible to find out issue-wise or client-wise transactions or the actual number of sharesunder omnibus accounts. There was


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*Source: Data gathered and prepared by the writer *Source: Data gathered

and prepared by the writer

no transparency in transactions conducted through these hidden accounts. The big account holders, although well-knownfigures, traded through omnibus accounts, not beneficiary owner (BO) accounts.Stock splits: Stock splits had been used as a tool to mop up small investors' money. The manipulators played with thepsychological weakness of retail investors and encouraged them to buy smaller denomination shares that had a big impacton the stock market.Banks' involvement in capital market: During the recession of 2009-2010, the banks in Bangladesh had a lot of idle moneyin reserve. Honestly speaking, when the banks had such reserves, acquaintances of the bank officials and other people aswell took bank loans for investment in the share market. It generated an overflow of liquidity in the share market. Theoverflow of floating funds helped the concerned circle to manipulate and control the share prices at will. For example, theprice of a share increased by Tk 40 in a single business session, whereas it wouldn't have increased even by Tk 3-4 in anormal market condition. In addition, some commercial banks' exposure to the capital market seriously contributed tocreation of a bubble.After the crash the government announced a stimulus package to spur the market. But it failed to bring the market back tonormal. It also failed to help restore investor confidence. Then comes the issue of budgetary measures. Firstly, a budgetaryprovision was there allowing investment of black money in the capital market. It created an illusory demand for shares onlyfor a short term, not for a long term. Secondly, minimum corporate tax for listed companies was also a good initiative, butit raised a very pertinent question: How many companies got this benefit and how many merchant banks could cope withtheir profitability in this agile market? It is also important to think that excessive bank borrowing under a budgetary plancreated another liquidity crisis in the money market.Lessons from past experience: If we look at the Wall Street crash in 1929, we can learn five main lessons the policy makersapplied to solve the crisis. Firstly, financial markets, banks and the real economy are connected with each other. So anunsettled problem in one sector can put the other sector in trouble. Secondly, the dynamic and swift government


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interference to relieve pressure on the economy is essential during the time of a real economic crisis. Thirdly, thecommercial banks were affected as they were too daring to go to put depositors' money at risk by investing it in the USstock market. Next, the stock market crash can create a negative impact on an economy and the Wall Street crash is thebest example of it. The sudden fall in stock prices caused bankruptcies. As credit shrank, businesses were closed down,workers dismissed, banks failed and money supply declined alongside other severe economic problems. Finally, investorsshould have a proper investment plan and should not borrow money from financial institutions or even beloved ones. Theyshould just invest their own money that they can put at risk.When it comes to the Dhaka Stock Exchange (DSE), there are also three key lessons we learn.No example of punishment: There is no example of punishment to stock market manipulators. They always go scot-free.The ultimate result is the market crash one after another. The DSE headed for the biggest crash on the Black Wednesday inDecember, 2010 after the 1996 collapse. The funny thing is that in both the cases investigation committees wereformed-the first one headed by a vice chancellor of Jahangirnagar University and the other by Khondoker Ibrahim Khaled. Itis a matter of great concern that we failed to properly examine these two reports and take action against manipulators.Small investors prone to hearsay and herd behaviour: All types of investors entered Bangladesh's capital market,especially the small investors who did not have sound knowledge about the market, acted on hearsay and showed herdbehaviour. That's why Bangladesh capital market saw excessive speculations and rumours as happened to the Wall Streetmarket in 1929. Responsibility of policy makers: The abuse of related rules due to structural blunders, frequent changes in policies regardingstabilisation of the stock market, the expected level of coordination among all like BSEC (Bangladesh Securities andExchange Commission), the MoF (Ministry of Finance), the Bangladesh Bank, financial and non-financial institutions, flimsysurveillance in the stock market and the political mindset are the major causes of what happened on the Black Wednesdayand thereafter in Bangladesh.It is estimated that over three million people - many of them small individual investors - lost money because of the plungein share prices. Educated middle class people of Bangladesh, who invested in shares as it is a popular business, were leftbroke with the sudden loss of their capital. They were groping for ways and means to exit the market and minimise thelosses.Wall Street and Dhaka similarities and dissimilarities: The distinctiveness of all major market debacles, especially the WallStreet crash in 1929 and the Bangladesh stock market crash in 2010 is pretty the same. When the stock markets deviatefrom the fundamentals, the share prices start showing the symptoms: prices of stocks increase rapidly and fall massively,and the market loses buyers and everyone looks for the way-out by selling their holdings in a hurry. There was noexception for these two stock market crashes in the two countries.If we look at the Wall Street crash in 1929, we see how crazy the people were about making investment in the sharemarket. Similarly, investors' mania and panic played their part in sending the share prices downward on the BlackWednesday. Then the role of the banks regarding the stock market crash for both the countries was the same. In both thecases, the central banks concerned failed to tackle the situation.The main dissimilarities: In the US many commercial banks faced bankruptcy whereas in Bangladesh it did not happen. TheUS did really well to introduce the Glass-Steagall Act to separate commercial banks from the stock market involvement,especially in buying stocks from the market. But in Bangladesh it did not happen.Many think there is not much impact of a capital market on the economy. But it is not true. The Wall Street crash is the bestexample of it. The devastating meltdown in 1929 caused the Great Depression in the economy of the US. So, in countrieslike Bangladesh if the stock market crash happens one after another, then we must be ready to see the worst economiccondition.Stock market crashes are recurrent incidents in the world financial market. It is important to bear in mind that markets donot go straight up forever. Crashes happened in the US and also in Bangladesh. Prevention of this type of incidents needsstrong national coordination and straightforward activities of big players like Bangladesh Securities Exchange Commission,Dhaka Stock Exchange, Chittagong Stock Exchange and political leaders.Last but not the least, the main crisis of Bangladesh's stock market is confidence, not liquidity. But in restoring investors'confidence, the liquidity position also plays a big role. If we are able to solve the liquidity problem, then obviouslyday-to-day transactions will increase. If transactions increase, then automatically the investor confidence will get a bigboost.


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Reform is a continuous process. The 1929 stock market crash destroyed the world economic structures. By the trough of thedepression in 1933 the market had lost 85 per cent of its 1929 value. After that, President Franklin D. Roosevelt himselftook a corrective measure regarding reforms and was able to bring normalcy to the market and the economy as well. But inBangladesh we did not see any such move from the top leadership. However, the US enacted the Glass-Steagall Act to keepbanks away from investing in the stock market. In Bangladesh also we need to separate the money market from the stockmarket as both of them are two separate entities. When a bank invests in the stock market, it actually puts the depositors'money at risk. The writer is a stock market analyst and now serving as a young professional at BRAC International [email protected]

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