STOCK MARKET CRASH (1929)

The great bull market of the 1920s and the spectacular collapse of the New York Stock Exchange (NYSE) in late 1929 occupy a pivotal position in popular explanations of the cause of the Great Depression. Professional historians, however, are more circumspect in assessing the impact of the Wall Street crash.

MARKET GROWTH DURING THE 1920s

The U.S. economy staged a rapid recovery from the postwar Depression of 1920 and 1921, and between 1922 and 1929 real gross national product (GNP) grew by 22 percent. This period was an era of stable prices, full employment, high levels of investment and high company profits. The United States exuded great confidence in the economy. The nation seemed blessed with business talent, which could skilfully employ the riches at its disposal. Big business in particular flourished, building on the technological advances that had been adopted during World War I. National prosperity encouraged stock market growth. Securities had been relatively undervalued at the start of the expansion but soon began to rise as corporate profits grew.

Everyone involved in the market seemed to benefit. Investors could look forward to a dividend and also to a rise in the value of their stock, which could easily be converted into cash if necessary. The small investor who could not afford to develop a diversified portfolio found especially attractive investment trusts, which grew spectacularly in the twenties. Business looked first to retained profits to fund investment on which future profits were based but did so in the clear knowledge that any shortfall could easily be addressed by approaching the market. Commercial banks, no longer approached by companies anxious to borrow, reacted to the loss of business lending opportunities by moving into the investment banking and brokerage business themselves. In doing so they encouraged greater participation in the market.

THE BOOM GATHERS PACE

It is difficult to be certain when the market was transformed from vigorous expansion to unsustainable growth, but this change probably occurred in early 1928. Between early 1928 and the middle of 1929 the economy grew very rapidly, and the confidence that many investors had in the market increased also. Indeed, some scholars believe that those who bought stock at progressively higher prices were acting rationally as they would expect earning on their investments to justify the price paid. However, during this period stock prices were rising far more rapidly than dividends, and it is reasonable to assume that the judgement of a number of investors was clouded by the prospect of an inexorable increase in stock prices.

As Eugene White (1990) notes, when the market was at its most vigorous some of the stock which investors found most attractive was in companies that paid no dividends and did not expect to pay any in the near future. In other words the advantage of owning such stock was solely that its price would continue to rise. For example, investors were attracted to stock in public utilities, which had come to the fore in the 1920s with the expansion of electricity, and also in companies employing the latest technology, for example the movie-making industry. Both groups contained large numbers of firms that paid no dividends.

Moreover, many share deals were financed by credit. The investor made a deposit and borrowed the remainder of the purchase price from the broker using the stock as collateral. This transaction was called "buying on the margin" and seemed a sensible option, as the capital gain from the stock would easily cover the cost, including the interest charge on the broker's loan. The brokers, who supported this system of trading as more stock could be sold and more commission earned, borrowed from banks to advance loans to their clients. As long as stock prices continued to improve, the relationship between borrowers and lenders was relatively risk free. However, if securities failed to appreciate as expected, some purchasers would have difficulty in repaying their brokers' loans. If the price falls were very steep, the broker would be in difficulty as the shares accepted as collateral would have to be sold on a declining market. The majority of investors, however, did not consider the prospect of a collapse in prices as a realistic possibility.

Nevertheless, there was some unease as prices soared. A few major investors began to withdraw from the market, and some leading executives even volunteered that their own company stock was overvalued. Most significant, the Federal Reserve (Fed) became concerned that the mounting speculation was potentially destabilizing. The Fed decided to gently deflate the speculative bubble instead of running the risk that it might eventually burst and result in an economic collapse.

The Fed exhorted its member banks not to lend for speculative purposes. More positively, in early 1928 it began to pursue a tight money policy by raising interest rates and selling government bonds. The Fed believed that its action would make borrowing for speculation more expensive and that gradually it would cease and the market would return to normal. The monetary authorities were confident that their actions would only affect the stock market and would not impair the performance of the economy.

To the chagrin of the Fed, the funding of brokers' loans increased by 50 percent between June 1928 and June 1929. The source of the money flowing into the market was not member banks, but foreign banking houses and U.S. businesses and private individuals attracted by the high rate of interest which borrowers were prepared to pay. Idle balances and funds that had been earmarked for foreign investment were switched to the home market, causing consternation in those countries that had come to rely on U.S. international capital flows. Indeed, there was a plentiful supply of credit for brokers' loans even though the Fed had pursued a restrictive monetary policy. Investors were prepared to pay higher rates to lenders because they believed that the rising market made it worthwhile. But the availability of credit was not the cause of continuing speculation. Speculators were not forced to borrow.

THE GREAT CRASH

The New York Stock Exchange (NYSE) hit its peak in early September 1929 and then declined, even though that month saw a record volume on new issues. During the first three weeks of October the market performed erratically, but on October 23 prices fell sharply to levels reached at the beginning of the year. On the following day, "Black Thursday," panic set in and 12.9 million shares were traded. The urge to sell became so overwhelming that the tickertape on which stockholders relied for the most up-to-date information ran several hours late, thus adding to the confusion. Brokerage firms were inundated. Good stock was liquidated along with the indifferent. A group of prominent bankers made a public move to rally the market by purchasing $125 million worth of stock, which for a while had a positive effect. However, on October 29, 16.4 million securities, a record volume, were traded on the NYSE. That day became known as "'Black Tuesday," and it symbolized the panic, helplessness, confusion, and fear that had taken a firm grip on the market. Confident statements from leading financiers, such as the Rockefellers, were seized upon by the few remaining optimists who attacked the gloomy for "talking down the market." However, nothing could arrest the fall, and the market continued to decline until November 14. The collapse had lasted three weeks during which time the average value of stocks had declined by over 50 percent. The market then seemed to revive coincident with the decision of the Fed to reduce interest rates, but those who thought the worst was now over were sadly mistaken.

Why did the stock market crash? There is no doubt that the price of some stocks had reached levels that could not be justified by a rational assessment of future earnings. Elements of the market were therefore potentially unstable. But the collapse embraced virtually all stock, not just the out-rageously overpriced. Why did panic replace confidence so comprehensively?

The stock market crash followed the peak of economic activity, which was reached in the middle of 1929. As the prospects for the economy declined sharply, it was increasingly clear to investors that they would have to revise downward their estimates of future business profitability and do so quickly. Once the certainty of high company profits evaporated, so did confidence in rising stock prices. Buying "on the margin" had boosted sales in prosperous times, but the system worked sharply in reverse when conditions changed.

One significant factor acting as a brake on economic activity was the tight money policy pursued by the Fed to erase speculation. High interest rates and a slowdown in the growth of the money supply were sufficient to tilt the economy into a steep recession. The Fed's monetary initiative failed to halt stock market speculation, but unfortunately it did affect the economy. However, the Wall Street crash did not cause the Great Depression. It was an early and violent reaction to changing economic circumstances.

The crash did have some adverse effects. It markedly reduced the wealth of investors and adversely affected their ability and willingness to purchase goods and services. Public confidence was shaken as one of the most potent symbols of national prosperity tumbled. However, in early 1930 there was a note of optimism. The fortunes of the economy and the market were in the ascendant. Perhaps the speculative boil had been lanced, and the worst was over.

WALL STREET 1930–1933

Confidence in the market evident in early 1930 proved sadly misplaced, and in the second half of the year a steep decline in stock prices commenced. During 1931 the economy continued to deteriorate, and problems were compounded by domestic bank failures and by the international financial crisis that culminated in the devaluation of sterling in September. The consumer durable sector, which had been so vigorous during the boom, now faced declining sales. Few consumers purchased automobiles or other goods whose purchase was not considered essential. All these factors helped to increase unemployment, lower confidence, and erode corporate profits. The stock of some food manufacturers, some retailers, and most tobacco companies was relatively sound, but stock in heavy industry and investment trusts fell precipitously. The year 1932, during which aggregate business profits were negative, was the worst year of the Depression for most stocks. On average prices had fallen to a mere 12 percent of their 1929 levels and only five stocks exceeded by one-third their 1929 prices. The worst affected stock could be found in the automobile, steel, railroad, and farm equipment sectors.

Amid the gloom some individual companies performed relatively well. Wigmore identifies J. C. Penney, General Electric, IBM, and Woolworth as examples, in which cases exceptional management resulted in a financial performance far ahead of their rivals. Gold mining and tobacco companies had the best stock results between 1929 and 1933. The worst performances were in the financial sector and the entertainment industry where many major movie companies flirted with ruin. The downward slide of the market mirrored that of the depressed economy, though some stocks, which had been driven high by the unrestrained enthusiasm of the pre-Depression boom, fell a long way and became worthless. It is important to remember that this was a time of massive general deflation when all prices declined, so it is not surprising that the market also shared this phenomenon. It is also clear that the decline in stock prices after mid-1930 was even more dramatic than the falls during the Wall Street crash. However, at this time the falling market was just one of a number of shocks forcing public and business confidence to ever lower levels.

THE STOCK MARKET AND THE NEW DEAL

During the first few months of the Roosevelt presidency the economy began a vigorous recovery and dragged the securities market along in its wake. However, even in 1937, the best year for the economy during the 1930s, an index of total stock prices, using 1929 = 100 as its base, had only reached 59. A disaggregation of this index shows that the figure for railroad stock was 34 while public utilities stock, which had played such a vigorous role in the boom of the 1920s, had reached 44. The performance of industrial stock was relatively good but, at 69, was still a long way below the level achieved in 1929. The depressed stock market as a whole was substantially below even 1928 price levels. Since both business profits and investment were very depressed during the 1930s compared to the levels that had been achieved during the booming 1920s, it is not surprising that the market as a whole failed to stage a more vigorous recovery.

Many investors who had directly experienced the market at its most capricious called for some level of state regulation, especially as there was a lingering suspicion that unfair practices may have been responsible for the debacle. Early in the Depression President Herbert Hoover had asked the Senate Banking and Currency Committee to investigate trading practices on Wall Street. When Ferdinand Pecora was appointed counsel to the committee, he attracted public attention by exposing wrongdoing by senior financiers previously thought to be men of the highest probity. Pecora was a highly effective publicist, and newspapers were able to carry vivid stories of dishonesty or practices so close to it that the people were unable to make the subtle distinction to which the minds of several bankers were carefully attuned. Respect for financiers, which had been high in the 1920s, was eroded. The public expected something to be done, and bankers were in a very weak position to fight any congressional attempts at regulation. Although scandal caught the public attention and provided desirable scapegoats, it would be wrong, nonetheless, to see financial malpractice as other than a very minor contribution to stock market misfortune. Still, it is easy to appreciate the strong view emanating from Congress that investors, especially the small investors, needed strong protection, even if only to prevent them being misled.

The Securities Act (May 1933) and the Securities and Exchange Act (June 1934) provided investors with more accurate information so that they could feel more confident when purchasing stock. Investors were also given a breathing space, time to change their minds over stock purchase rather than having to regret an instant decision. As a result the hard-sell tactics that had been used successfully to boost sales in the 1920s, and which were highly popular while the market boomed, were curtailed. The Fed was given the power to set margin requirements for the purchase of securities, which was seen as an additional tool in any future fight against speculation. An independent agency, the Securities and Stock Exchange Commission (SEC), was established to oversee the implementation of the new legislation. The first chairman of the SEC was Joseph P. Kennedy, in his day a formidable Wall Street operator and the father of President John F. Kennedy.

A separate piece of legislation, the Banking Act (1933), separated commercial from investment banking. This legislation compelled commercial banks to quit securities markets and restricted their authority to underwrite securities to those issued by states and local governments. During the 1920s the growth of commercial bank securities affiliates had led to increased competition in the sales of securities. In the frenzied atmosphere of the time, mass marketing techniques, aggressive advertising, and mail shots had drawn many small investors into the market. We see here a typical piece of New Deal regulation where restrictions on competition were seen as essential for the provision of stability. The Banking Act was an attempt, among other things, to curb activities that were considered contributory factors to the great bull market. Speculative excesses were, indeed, absent from the market for the rest of the 1930s, but neither the performance of the economy nor the mood of investors was likely to create the conditions for a return of them.

The securities market expanded, as did the rest of the economy during the 1950s, and in 1954 the Dow Jones Index exceeded its 1929 peak. During this period the Eisenhower administration reduced the SEC's staffing. The volume of trading on the NYSE reached and overtook its the pre-Depression high in 1963. By the 1960s it was becoming clear that the restrictions on competition that had seemed so sensible thirty years previously were contributing to a growing inefficiency in securities markets. Moreover, the increasing globalization of capital markets, and the growing use of computers that led to a rapid diffusion of knowledge as well as the speedy clearance and settlement of accounts, totally transformed the manner in which business was transacted. Indeed, in 1975 Congress urged the SEC to encourage competition rather than help curb it.

On October 19, 1987, the financial world was shaken by a dramatic stock market collapse when the Dow Jones Index fell 508 points, the largest single day drop in U.S. history. Immediately commentators drew parallels between the booming 1980s and the 1920s. They noted that both collapses followed attempts by the Fed to counter speculation by the use of restrictive monetary policy and wondered if the latest crash would be followed by a new Great Depression. In 1987 the Fed moved promptly and provided ample liquidity for the system by engaging in open market operations. Within a few months it was apparent that the economy had been unaffected by the crash, and as confidence in the market returned the Fed was able to reimpose a restraining monetary influence. The 1987 crash showed that regulation cannot prevent stock market crises, but rapid reaction by the Fed can minimize the effect. It was a pity that this was not part of the received wisdom in 1929.

See Also: CAUSES OF THE GREAT DEPRESSION; FEDERAL RESERVE SYSTEM; GLASS-STEAGALL ACT OF 1933; SECURITIES REGULATION.

BIBLIOGRAPHY

Bierman, Harold. The Great Myths of 1929 and the Lessons to be Learned. 1991.

Galbraith, John Kenneth. The Great Crash: 1929. 1954.

Kindleberger, Charles P. Manias, Panics and Crashes: A History of Financial Crises. 1978.

Parrish, Michael E. Securities Regulation and the New Deal. 1970.

Temin, Peter. Did Monetary Forces Cause the Great Depression? 1976.

Thomas, Gordon. The Day the Bubble Burst: A Social History of the Wall Street Crash of 1929. 1979.

Wigmore, Barrie. The Crash and Its Aftermath. 1985.

White, Eugene N. "The Stock Market Boom and Crash of 1929 Revisited." Journal of Economic Perspectives 4 (1990): 67–83.

White, Eugene N. "Banking and Finance in the Twentieth Century." In The Cambridge Economic History ofthe United States, Vol.111: The Twentieth Century, edited by Stanley L. Engerman and Robert E. Gallman. 2000.

Peter Fearon