[I wonder if anyone decided that video games were a fad.]
The video game crash of 1983 was the sudden crash of the video game business and the bankruptcy of a number of companies producing home computers and video game consoles in North America in late 1983 and early 1984. It brought an end to what is considered the second generation of console video gaming.
The crash was followed by a gap of three years, during which there was a much smaller market in games for home computers in North America, and no significant development for video game consoles. That gap ended with the success of the Nintendo Entertainment System (NES) that was first introduced in Japan in 1983 (as Famicom) and then in the United states in 1985 and would break out in popularity in 1987.
This period is sometimes referred to as the "video game crash of 1984," because that was the year the full effects of the crash became obvious to consumers. Hundreds of games were in development for 1983 release, most of which ended up in bargain bins. But few games were developed in 1983 for release the following year, resulting in a drought of new video games in 1984....
The world wide video game crash of 1983 was caused by a combination of factors, though with different factors in several markets:
- In Europe, the boom years of personal computing [1981–1985] were trumpeted by very aggressive marketing of inexpensive home computers, especially the Commodore 64, with the theme “Why buy your child a video game and distract them from school when you can buy them a home computer that will prepare them for college?” Marketing research for both sides tracked the change as millions of consumers shifted their intention to buy choices from game consoles to low-end computers that retailed for similar prices. A similar campaign occured in the U.S. without the same effect, where instead the personal computer industry grew because of the crash and is not seen as directly causing it.
- A flood of consoles on the market giving consumers too many choices. At the time of the U.S. crash, there was a plethora of consoles on the market: Atari 2600, Atari 5200, Bally Astrocade, Colecovision, Coleco Gemini, Emerson Arcadia 2001, Fairchild Channel F System II, Magnavox Odyssey2, Mattel Intellivision (and its just released update with slew of peripherals, Intellivision II), Sears Tele-Games systems (which included 2600 and Intellivision clones), Tandyvision, and Vectrex. Each one of these had their own library of games, and many had (in some cases large) 3rd party libraries. Likewise, you had many of these same companies announcing yet another generation of consoles for 1984, such as the Odyssey3, and Atari 7800. 
- A flood of poor titles from hastily financed startups, combined with weak high-profile Atari 2600 games based on the hit movie E.T. and the red-hot arcade game Pac-Man.
- The news media sensationalized both the boom days of 1980 and the problems of 1982–83. In particular, the story of Atari burying thousands of E.T. cartridges in a New Mexico landfill shifted the outlook of the video game market in the eyes of many media outlets....
A second, highly visible result of the crash was the institution of measures to control third-party development of software. Secrecy against industrial espionage had failed to stop rival companies from reverse engineering the Mattel and Atari systems, and hiring away their trained game programmers. Nintendo—and all the manufacturers who followed—controlled game distribution by implementing licensing restrictions and the implementation of a security lockout system. Would-be renegade publishers could not publish for each others’ lines—as Atari, Coleco and Mattel had done—because in order for the cartridge to work in the console, the cartridge must contain the appropriate key chip for the lock inside the console and the publisher must acknowledge their license to Nintendo in the copyright notices. If no key chip was present or if the key chip did not match the lock inside the console, the game would not work. Although Accolade achieved a technical victory in one court case against Sega, challenging this control, even it ultimately yielded and signed the Sega licensing agreement. Several publishers—notably Tengen (Atari), Color Dreams, and Camerica—challenged Nintendo’s control system during the 8-bit era. The concepts of such a control system remain in use on every major video game console produced today.
Nintendo reserved the lion’s share of NES game revenue for itself by limiting most third-party publishers to only five games per year on its systems. It also required all cartridges to be manufactured by Nintendo, and to be paid for in full before they were manufactured. Cartridges could not be returned to Nintendo, so publishers assumed all the risk. Nintendo portrayed these measures as intended to protect the public against poor-quality games, and placed a golden seal of approval on all games released for the system. Although most of the Nintendo platform-control measures were adopted by later manufacturers like Sega, Sony and Microsoft, the others never used such strong measures to hold a larger share of the games market for themselves, which later forced Nintendo to follow suit.
The hardware manufacturers of 2005 routinely receive $9 U.S. or more for every licensed software product sold by authorised third party publishers, and defend their legal rights aggressively. This allows console manufacturers to cash in on the success of third-party publishers, and it also gives the console manufacturers control over shoddily produced, pornographic, or otherwise controversial third-party games such as Custer’s Revenge that could taint the console’s reputation.
A lesser effect of the crash that lasted through the end of the 1980s until a new generation of console hardware had arrived: Surviving game development and publishing companies began targeting home computer platforms in the absence of a strong console to target. Electronic Arts, for example, was founded in 1982 and began shipping titles in 1983; it avoided being caught in the crash because of its business plan to develop only to computers. The computer game market was worldwide, but proved to be particularly strong in the United Kingdom....