How did speculative investing weaken the stability of the stock market?

Question

anonymous · Answer

Heavy speculation is just a bad idea in any market since it has a tendency to inflate prices to unrealistic levels. That's basically what many investors prior to the Great Depression did when they thought the market would keep going higher and higher. They borrowed money, sold their houses, etc.. to buy into the stock market thanks to that kind of speculation without even considering the underlying reasons for why the market is there in the first place. When the bubble burst, a lot of people literally lost everything they had. Banks closed because of loans that couldn't be repaid by people that lost everything on a "bad bet" thanks to all of that speculation. That crippled the economy because of the domino effect. As banks began closing, people got scared and started pulling their money from the banking system. More recently, we saw how the housing market bubble burst leading to the current recession in 2007-2008. People speculated that people would need more houses and a building boom ramped up. When bad loans defaulted and people couldn't buy all of those houses that were built or being built, it nearly crashed the economy.