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$ Introduction. $ The Cause of the Crash. $ The U.S. Government’s Reaction. $ Did the Stock Market Crash Cause the Depression? $ Why Many People in the U.S. Invested in the Stock Market during 1929. $ Regulations Enforced After the Crash to Protect Investors.
$ Introduction The Dow Jones Industrial Average (DJIA) went from a low of 191 points in early 1928 to a high of 300 points in December 1928 and peaked at 381 in September 1929. Many observers believed that stock market prices in the first six months of 1929 were overpriced, while some perceived that stocks were cheap. This is very common most of the time no matter what the market is doing! On October 3, the Dow began to drop declining throughout the next 2 weeks. The night of October 21, 1929, *margin calls were heavy and numerous Dutch and German sell calls came overnight for the Tuesday morning stock market opening. On Tuesday morning, banks and corporations called in $150 million of call loans and Wall Street was in panic before the New York Stock Exchange (NYSE) opened. On October 24, 1929, people began selling their stocks as fast as they could. Sell orders flooded the market. On a normal day, only 750 – 800 members of the NYSE started the Exchange. However, there were 1100 members for the morning opening that day. Furthermore, the Exchange directed all employees to be present since there were numerous margin calls and sell orders placed overnight and extra telephone staff were arranged. The DJIA closed at 299 that day. October 29 was the beginning of the crash. Within the first few hours the stock market was open, prices fell so far as to wipe out all the gains that had been made in the previous year. The DJIA closed at 230 points. Since the DJIA was - and still is – viewed as the chief indicator of the American economy, public confidence was shattered. Between October 29 and November 13 (when stock prices hit their lowest point) over $30 billion disappeared from the American economy. It took 25 years – until 1954 – for the markets to totally recover. A new high was reached after303 months with an overall gain of 803%.
$ The Causes of the 1929 Crash. While there have been many explanations for the crash, no one can fully account for it. Here are some of the explanations proposed: 1. Stocks were Overpriced Many people believed that stocks were overpriced and the crash brought share prices back to a normal level. However, some studies using standard measures of stock value, such as *Price/Earnings ratios, argued that share prices were not too high. 2. Massive Fraud and Illegal Activities A number of people believed that fraud and illegal activities was one of the causes of the crash. However, evidence revealed that there was probably very little actual insider trading or illegal manipulation. 3. Margin Buying Margin buying was another scapegoat for the cause of the crash. However, it wasn’t the main reason because there was little margin outstanding relative to the value of the market. Margins averaged less than 5 % of the market value. 4. Federal Reserve Policy The new president of the *Federal Reserve Board, Adolph Mille, tightened the monetary policy and set out to lower stock prices since he perceived that speculation led stocks to be overpriced, causing damage to the economy. Also, at the beginning of 1929, the interest rate charged on broker loans rose tremendously. This policy reduced the amount of broker loans that originated from banks and lowered the liquidity of non-financial and other corporations that financed brokers and dealers. 5. Public Officials’ Repeated Statements Many public officials commented that stock prices were too high. For example, the newly elected President of the United States, Herbert Hoover, publicly stated that stocks were overvalued and that speculation hurt the economy. Hoover’s statement suggested to the public the lengths he was willing to go to control the stock market. These kind of statements discouraged investors to believe that the market would continue to be strong and encouraged them to sell their stocks, which could be one of the causes of the crash.
There was criticism of Federal Reserve policy after the crash, even though the Federal Reserve initial reaction to the crash seemed to have been fully appropriate. Between October 1929 and February 1930 the interest rate was lowered from 6 to 4 percent, and the money supply increased immediately after the crash. Commercial banks in New York made loans to securities brokers and dealers, which in turn provided liquidity to the non-financial and other corporations that financed brokers and dealers prior to the crash. However, government securities purchases in the open market continued to decline until 1932, thus reducing market liquidity. Furthermore, although the interest rate was reduced between March 1930 and September 1931, it was raised twice later in 1931. This raise made loans more expensive and deterred people and corporations from borrowing money. Even worse was, that the money supply dropped by 31% between 1929 and 1933 depressing economic development further during the Depression.
After the stock market crash, production fell by nearly 50 percent from the business cycle peak in August 1929 to the trough in March 1933. At the same time, the overall price level dropped by about one-third. Since the Great Depression happened after the 1929 stock market crash, many people blamed it for the economic collapse. Some held President Hoover responsible; others targeted the brokers, bankers and businessmen. But the cause of the Great Depression could not be attributed to one individual or even group of people. Also, it seems unlikely that a crash in stock prices would have been sufficient to lead the U.S. economy into depression and to sustain the downward spiral in business activity. So it can be said with certainty that the stock market crash alone did not cause the Great Depression.
The stock market was propped up by new investors entering the market, who viewed it as an easy way to get rich quickly. However, economic historians estimated that the relatively small number of Americans – about 4 million – had invested in the market at any one time. The constant influx of new investors coming in and old investors moving out ensured that new money was always flowing around and that there was a constant upward movement in the market. This again attracted investors giving the market more liquidity. 2. Increase in Personal Savings Higher wages meant that even the average Americans now had surplus money to put into savings or invest in the stock market. 3. Relatively Easy Money Policy At this time, banks made money more readily available at lower interest rates to more and more people. Loans were taken not only to buy new cars and houses etc, but also to buy stock which is still a common and risky practice nowadays. 4. Over-Production Profits were Invested in New Production From 1925 on, the industry was over-producing. In anticipation of eventually selling the surplus, business leaders funnelled their profits right back into the industry, investing in factories, new machinery and more workers, which led to even greater over-production. This increased production gave the companies an aura of financial soundness, which encouraged Americans to buy more stocks. 5. Investors’ High Expectations At this time there were no effective legal guidelines on the buying and selling of stocks. Free from legal guidelines, corporations began printing up more and more stocks. Many investors in the stock market practiced “buying on margin” which - as I explained above - is buying stocks on credit. Confident that a given stock would rise, an investor put a down payment on the stock, expecting in a few months to pay back the balance of the initial costs plus receive a hefty profit. This turned the stock market into a speculative game in which most of the money invested in the market wasn’t actually there. Now you can imagine why thousands of investors went bankrupt during the crash. They invested money that didn’t actually belong to them. And if there’s one thing banks want, that is getting their money back! So investors suddenly sat on a huge pile of debt which wiped them out financially.
Before the 1929 crash, few regulations were enforced. Investors were not protected from fraud, hype and shoddy stocks. Individuals didn’t know whether companies were doing as well as they claimed and whether companies’ financial reports were reliable. It was after the crash that an agency known as the Securities and Exchange Commission (SEC) was established to lay down laws against dishonest trading practices and punish violators. During the stock market crash of 1929, 4000 banks failed because depositors fought to reach teller windows before the money ran out and their savings disappeared forever. Four years later, Congress passed the Glass-Steagall Act which banned any connection between commercial banks and investment banking, to ensure that such a tragedy would never be repeated in the belief that the banks’ collapse was due to their stock market speculation. However, over the past decades, the Federal Reserve and other banking regulators have softened some of Glass-Steagall’s separations of securities and banking functions by letting banks sell certain securities.
May 10, 2003
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