No one is ever going to agree on what caused the New York Stock Exchange to crash in October of 1929. But this Monday morning quarterback with the hindsight of several decades is going to say it was because of a bit of speculation coupled with some hubris.
In August 1929, Dr. Charles Dice published New Levels in the Stock Market, a book explaining how the market had reached its heady heights and, frankly, a title that just begged to be taken down a peg. As he laid out his thesis, he also praised (hu)man's confidence and explained how our belief in ourselves would become a self-fulfilling prophecy to our greatness.
Dr. Dice explained that with the advent of talking pictures and radio in more and more homes, we were able to see and hear the leaders of industry for the first time. And people perceived them as open, frank, friendly and direct: in a word, trustworthy. The CEOs of massive companies like Standard Oil and U.S. Steel were no longer seen as robber barons but as leaders of men working to create a sense of trust - an essential ingredient for a boom. Trust gives people faith, it fills us with belief and purpose and glee - and we buy! And every day Americans, who had learned to buy during World War I, did buy.
As background, prior to World War I most people in the U.S. did not own a security of any kind. But the U.S. government created Liberty Bonds and actively encouraged the public to buy and trade them, giving many their first taste in saving as well as investing. These individual investors (wage earners, middle-class salaried workers, clerks) were people who previously had not been part of the investment system. After the war, banks were setting up bond departments to help new depositors open not only deposit accounts but investment accounts. Of course, all these new investors needed to know how their investments were doing: financial reporting expanded from a few column spaces to several pages in print to financial reporting subscriptions. New York brokerage houses began to open branches outside of New York to help these individual investors. The U.S. markets went from 2% participation before the 1920s to just under 20% by October 1929. The industry that grew up around this participation jump was also significant: there were new media publications, wire-houses, odd-lot traders, regional bond desks, associate brokers and other support businesses popping up to meet the demand. Sources indicate these new branch offices were suggesting that people make purchases without cash on hand, that they speculate. Because in a boom, the price is always going up, right?
How many people had margin accounts during 1929 isn't precisely known, nor is it known how many of the stocks were actually purchased on margin. The idea that a person only needed to put 10% down to purchase a stock is something of a myth at this point - an idea often quoted online but no source material seems to exist. In fact, during the period information on these accounts is only available by way of Broker Loan reports - monthly tabulation reports made by the NYSE and weekly reports by the Federal Reserve System - that showed increases in loans but also had a footnote stating that the data didn't mean anything! It is known that brokerage houses in 1929 required customers to put 45% to 50% down on margin accounts; however, there doesn't appear to have been any cash reserve requirement and loans were made to bridge the gap. In January 1929, broker's loans for stocks purchased on margin were up $260 million. At the time, this was an amazing amount of money to be out on loan and there was a stock market boom happening. Then, on March 25, 1929, the market dropped 9 ½ points. So why didn't the bubble burst then? Because of hubris.
A trend seen throughout the market boom of the late 20s was captains of industry stepping in to support the market. On March 26, 1929, it was Charles E. Mitchell's turn. He wanted (maybe needed) the boom to continue as head of National City Bank and a director of the New York Federal Reserve Bank. He did the equivalent of a media blitz and put his bank's commitment behind it, shoring up the market boom for another day.
As it goes, that hubris didn't stop with the captains of industry maintaining the boom. In an interview for "The American Magazine" in June of 1929, Bernard Baruch stated that there were no bears on Fifth Avenue: that the world's economic condition seemed on the "verge of a great forward movement." Professors at Ivy league universities provided scientific evidence as to why the market would never go down again. Professor Irving Fisher of Yale stated, "Stock prices have reached what looks like a permanently high plateau." Compared to its compatriots, Harvard had been mildly bearish in the first half of 1929, but jumped right on the bandwagon by the summer when no slight correction had occurred.
This hubris led to broker's bulletins, letters and newspapers no longer speculating where a stock would rise by the end of the reporting period or the week - they were speculating where stocks would land by 2 pm on a given day. This, of course, led to greater speculation in stocks, more risk, a bigger price bubble and larger loans and ... pandemonium! All the way until we got to those infamous six days in October.
Editor's note: If you didn't get a chance to read the first installment, you can do so here. The final installment of the series will discuss the repercussions. Stay tuned!
Dice, Charles A, Ph.D., New Levels in The Stock Market, McGraw Hill Book Company, Inc., 1929
Galbraith, John Kenneth, The Great Crash, Houghton Mifflin Company, 1972