What it is:
The Great Depression is a severe global economic contraction that began in the United States and spread throughout the rest of the world in the 1930s.
How it works/Example:
The United States stock market crash of 1929 is the most famous market crash of all time. On just one day (October 24, 1929), panicked sellers traded nearly 13 million shares on the New York Stock Exchange (more than three times the normal volume at the time), and investors suffered $5 billion in losses.
The years preceding the stock market crash of 1929 were filled with irrational exuberance. Stock prices had risen across the board, even for companies that posted little profit, and investors were optimistic that the general upward trend of the market and the economy would continue for some time. The Dow Jones Industrial Average nearly doubled, rising from 191 in early 1928 to 381 by September 3, 1929. Prices began falling steadily, however, as investors began to take profits.
Then on October 10, 1929, still known as "Black Friday," the Dow Jones Industrial Average closed above 350 for the first time in ten trading days. This respite sparked profit taking, and the Dow Jones Industrial Average began falling again. From Black Thursday to October 29, 1929 (Black Tuesday), stocks still lost over $26 billion of value and over 30 million shares changed hands.
The situation influenced what became a major turning point for the American economy, because many of these borrowers, who had leveraged themselves considerably in an effort to participate in the bull market, were ruined financially. They had to sell everything to pay back their debts, and many couldn't pay them back at all. Thousands of banks failed as a result; businesses closed, unable to get credit; and the nation's disposable income fell precipitously.
Historians often cite the stock market crash of 1929 as the beginning of the Great Depression because it marked not only the end of one of the nation's greatest bull markets, but the end of widespread optimism and confidence in the U.S. economy.
International trade fell and unemployment in the United States rose to 25%. The Depression quickly spread to Europe and the rest of the world. It became the largest global economic collapse in history. The Great Depression ended in 1941, and the unemployment rate did not drop substantially until World War II created demand for goods and services again.
Homelessness and poverty were widespread, forcing many Americans to build makeshift housing. Areas with these ramshackle dwellings were called Hoovervilles -- a jab at President Herbert Hoover, who was elected in 1928 just before the Depression occurred. At the time, Social Security benefits, Medicare and Medicaid did not exist.
Why it matters:
Besides the dramatic effect on investor psychology, the Great Depression contributed to the creation of a variety of new laws, organizations, and programs designed to improve the country's infrastructure, further social welfare, and prevent corporate fraud and abuses. These included the establishment of the Federal Deposit Insurance Corporation (FDIC) and the passage of the Securities Act of 1933, the Glass-Steagall Act of 1933, the Securities and Exchange Act of 1934, and the Public Utility Holding Act of 1935. The panic caused by information delays also spawned faster ticker systems that could handle heavy trading days.