Throughout history, there have been a number of financial events that changed the way we do business – and even how we understand the economy. These sudden downfalls caused companies to collapse, unemployment rates to jump, and taught us a few hard lessons about our financial management system.
Sometimes the economy climbs so high that we turn and look back and realize that a fall from this distance is really going to hurt. Even so, we push ahead and try to climb higher and find out where this path will take us. On occasion, we have fallen. Hard. But we have learned from these experiences and, while the path we were on may not have been the one we expected, we were still able to move forward.
The Panic of 1907
When the stock exchange fell nearly 50% from what it was the previous year, a major panic gripped the nation and banks and trust companies were overwhelmed with people trying to withdraw their deposits. Fears built up, causing bank customers to believe (and it was probably completely warranted) that if they didn’t withdraw their money right now, there wouldn’t be any money left for them later.
Runs on banks tend to spread. When you hear that there are hundreds (or thousands) of people rushing to the bank to pull their cash back out, your first instinct will be to make sure that you get what rightfully belongs to you. Unfortunately, the banks of the time simply weren’t prepared for this kind of fallout. They didn’t have the kind of liquid assets on hand to cover all the withdrawals, so bank after bank began to fail.
This time period sparked a high demand for reform in the U.S. currency and banking systems. The crisis was started after an attempt to corner the market on copper which ultimately failed, and the banks that lent money to the people behind the scheme were the first to suffer runs. It was clear that something had to change.
What We Learned
The first thing we tried to do after this panic was start a centralized banking system, which led to the foundation of the Federal Reserve. Before this time, there were literally thousands of currencies in use around the country, some of them more valuable than others, and some were backed by gold or silver and some were not. The Fed was able to address a lot of the problems that led to the panic by making sure that the banks could handle the withdrawals and control the inflation rate through a unified and elastic currency. Think of it as a developing a cashflow forecast for financial institutions.
The Great Depression
The Great Depression of 1929 was a stark reminder of how closely tied our economic system really is, and if one part starts to struggle, it can have a rippling effect that reaches out to the rest of the country (and beyond). Through the early 1920s there was a big boom in the stock market, and between ’20 and ’29 stock prices quadrupled in value. When the bubble reaches the top, though, it’s bound to burst. And over the next three years the stock values dropped 80% from their previous highs.
When the stock market crashed, the rest of the economy seemed to follow right along with it. Demand for goods and services started to dry up for fear that they wouldn’t have all the money they needed. Companies couldn’t finance new projects because new investors wouldn’t buy stock, and the banks lost their depositors’ money in the stock market and then couldn’t collect from customers who had borrowed specifically to invest in company stocks.
This went on to be the worst economic situation the country has faced. This event was so large it eventually spread out and infected the international scene as well.
What We Learned
There were a lot of things we could do to guard against this sort of thing happening again, and many changes were needed to get the economy working again. Some of the initial changes included regulations to fight the kind of deflationary competition that cause some problems, set minimum prices and wages, as well as many labor standards, and many other reforms.
The Dot Com Bomb
The financial downfall that characterized the end of the 90s and early 2000s may not have been as severe as the Great Depression, but there were some very valuable lessons learned from the experience.
Throughout the late 90s, venture capitalists were pumping money into all the new startup companies that had anything to do with business on the Internet. It was seen as the next “sure thing” and soon the stock prices for these companies were shooting up – in many cases severely overvaluing the businesses.
The biggest problem was that these new companies relied on venture capital and IPOs to fund their growth. The “new business model” required that these companies grow as fast as possible and stake their claim on the new market sector before anyone else could get a foothold.
Unfortunately, this meant that these companies had to run at an expected net loss as they built the company and gathered market share.
What We Learned
Some of the biggest dot com companies shut their doors without ever seeing a net profit. New technologies such as business intelligence software and new market segments do not automatically wealth for everyone involved, and throwing money at something will not ensure its success.
We quickly learned exactly what it would take to really make an online business work and that it usually required a lot of the same business principles we have always used.