EconEdLink:Where DidAlltheMoneyGo?- ClueSheet#3c
The StockMarket Crash of1929
By MichaelBoldin
This articlecourtesy ofTheDismalScientist producedby Economy.com,Inc.
October24,1929.BlackThursday.On thisinfamousday,theNew YorkStockExchange washitwithchaos thatquicklyamounted toa30%declinein thevalueoftheDow Jones Industrial Average.This lossmarked theendofthe RoaringTwenties,whenmany believedthattheonlydirectionforthestockmarket andtheentireeconomywasup.
SoontheU.S.enteredintoitslongestanddeepesteconomicslump, theGreat
Depression,andit took25years for theDowto return to itsprevioushigh.While few believethat thecrashonWall Streetin1929wasthe root causeoftheDepression,it wasanimportantfactor inputting theeconomyonaroadof instabilityandsetting the stage forother problemsand mistakes thatproducedalargeblackmarkonthis country'seconomicandcultural history.
Few havepersonal memoriesofthe1929crash,but theeventstillcolors theplayof cautiousinvestors.Ina matter ofhours,thousandssawtheirfortunessink,turning previouspapermillionairesintodestitutepaupers. Popularlegendsreportnumerous suicides,and therewerea few highlyvisibleanddocumentedcasesonOctober24and theweeksthat followed.When thecarnageendedand themarket reacheditslow point in mid-1932,theDow,astockindexbuiltupon thehighestqualitycorporationsin the world,wasdownalmost90% invalue.
Tofullyappreciatetheimpactofthecrash,it isimportant toalsolookatthebullmarket ofthe1920sandhow WallStreet operatedat the time.Inthe1920s,manyoftheDow stocksrose morethan five-foldinvalue,enticingthosewithlittleknowledgeofthe financialaspectsand risksof stocktrading totrymakeaquick fortuneonWall Street. OnenotoriousexampleoftheexuberancewasanarticleintheAugust1929issueof Ladies'HomeJournal titled"EverybodyOughttobeRich"thatclaimedAmericawas enteringagoldenagewherereturnsofover 20%per yearonstockswouldbecommon.
Numerousindividualsofmodestmeans took interestandboughtstockon marginin the late1920s,puttingupaslittleas10%ofthecashprice,borrowingtheremainderfrom a brokerage firm.Aslongas themarket rose, everythingwasfine. Butwheneverthe market showedasignificantdownwardblip,margincallsweretriggeredthatforced
those thathadhighlyleveragedtheirstockpurchasetosellataloss. Theseforcedsales causedmanytounexpectedlyloseall of theirsavings.Thestockmarket saw several largeswingsinlate1928andearly1929 thatshouldhavewarnedinvestorsof the inherentrisksinstocks, butfewtookheed.
It isestimatedthatthedropinstocks inlate1929wasworth$30billion,whichwasabout
30%of GDP atthe time. Clearly,thishadalargenegativeimpact on theeconomyand contributed tothebankingpanicand Great Depressionthat followed.Therewereafew useful outcomes, however.Before thecrash,securityregulationswereeitherlackingor rarelyenforced, andstockbrokers regularlyhypeddubiousfirms.In1934,after Congressionalhearingson theproblems, theSecuritiesandExchangeCommission (SEC)wasestablishedtopoliceWallStreet behaviorandprotectinvestorsfrom fraud.
Also,after 1929 manymoreeconomistsand financialexpertsbecameinterestedin studyingtechniquesfor properlyvaluingstocksandgivingadviceonhow toavoid financialpanics.Theirresearchhasaddedtoour knowledgeabouttheeconomyandis atleastpartially responsiblefor thegreaterstabilityin manymarkets.
A long-lastingnegativeeffect ofthe1929crashwasthat manywereturnedoff permanently towardstock investing.Few seem toknow,however,thatapurchaseof diversifiedstocksevenattheir peakin1929wouldshow averyhealthyreturn (ifheld to today),especiallycomparedtosupposedlyless riskybondsandbankCDs that historicallyhave troublekeepingpacewithinflation.
Nonetheless,despite thehigh,long-runpositive returnsthat stockscanshow,manyask whetheranothercrashcouldhappen?Inonesense,it alreadyhas. On"BlackMonday," October19,1987,theDow lost 23%invalue.Thedifferencebetweenthiscaseand
1929,however,wasthat the marketsoonstabilizedandayearlaterit washittingnew highs.BlackMondayof 1987hadlittlelastingimpactontheeconomy,saveforthe
adoptionof additionalrulesforhow WallStreet operatesduringasuddendecline.Still,
someseestockpricesasovervaluedin1999;broadstockindexessuchas theS&P 500 show price-earning ratiosof almost35compared tothehistoricalaverageof 15. Therefore, adeclineof30% ormore tomoveclosertohistoricalfundamentalsis conceivable,especiallyif someof thehigh-flyingInternet stocksarehitwith
unexpectedlybad revenueandearningsnews.However,it wouldsurelytakeasecond GreatDepressiontomatchtheproblemssurroundingthe1929crash thatpushedstocks toonetenthof theirprevioushigh.
Answer thefollowingquestions:
1.Whatfactors bidstockpricesupduringthe1920screatingthe"bull market"?
2.How didthe "bull market"unravel?
3.Whatwasthefinancial impactoninvestors andwhat didthis dototheeconomy?