What are the mechanics behind a market crash?

[Groty]

Charles Kindleberger's "Manias, Panics, and Crashes" documents the history and causes of manias, panics and crashes beginning with the Dutch tulip mania. It's a good read. I'll try to summarize his theory:

According to Kindleberger, manias are always a function of a prolonged period of loose credit conditions. Loose credit leads to speculation. Towards the end of a stock market mania, people are generally not buying securities because they believe they represent good value. They are buying because they see stocks only going up and they believe they can sell to someone else at a higher price (kind of a greater fool theory). The underlying reason for the mania is usually a combination of an extended period of loose credit together with a belief a "new era" has emerged (examples: industrial revolution in the '20s, tech revolution in the late '90s; potentially the emerging market industrialization today). Everyone is excited by the prospects of the "new era". And the easy credit makes it easy to buy. So buying begets buying with little regard to risk or value.

It ultimately leads to a final, speculative, blowoff phase in which margin debt is often very high (interestingly, I'd note it's currently at record levels).

Then some catalyst causes an intial wave of selling. Often its a perception that credit conditions will tighten and restrict liquidity. Because many market participants are leveraged, the initial selling wave triggers margin calls. The margin calls result in more selling. So the selling feeds on itself as people attempt to preserve gains and front run the guys who will be forced to sell to make margin calls.