“Those who cannot remember history are condemned to repeat it,” warned philosopher George Santayana. There is no more glaring example than the 1929 stock market crash, which in some ways was eerily similar to the boom and bust cycle that the stock market went through beginning in March 2000.
It wasn’t the Internet that fascinated the nation and helped usher in the roaring 1920s, it was electricity. At the same time, many people became enamored with the stock market. With very favorable margin rates (you could borrow 9 times the amount of your original investment), it seemed as if everyone was in the stock market.
As more and more people entered the market, the prices of stocks went up. (In a way, it was like a huge Ponzi scheme. People paid off what they owed on their original investment with the paper profits they made on their rising stocks.) The attitude of the Coolidge administration was laissezfaire, a French term meaning “letting things be.” The government wanted to let the forces of capitalism work without interference.
As the stock market got shakier and the economy got worse, the new president, Herbert Hoover, realized that something had to be done. The goal was to increase margin requirements (which many considered the main culprit) without causing panic. Unfortunately, the market panicked.
After a series of frightening stops and starts, the market finally crashed on October 24, 1929. Over $10 billion of investors’money was wiped out before noon. Huge crowds of angry and shocked investors packed the visitor’s gallery of the NYSE to watch the debacle. By noon the market was in a “death spiral.” Investors around the world were horrified at the extent of the financial damage.
By October 29, 1929, all the market’s gains from the past year had been wiped out. Eventually, the market fell 89 percent from its 1929 high of 381.
After the crash, economists tried to figure out what had gone wrong. It was obvious that many people had missed the signs the market was overpriced. For example, the P/Es of many stocks were high, well beyond what was considered the P/E safe zone of 15. In addition, the Fed decided to raise interest rates, which many economists considered to be the wrong move. Congress also had a hand in turning what really was a recession into a fullblown depression. For example, during this period it doubled income taxes and raised tariffs on imports and exports.
Another problem was that banks were allowed to operate with few restrictions on how much they could lend. After the crash, many of the banks’ customers had no way of paying back the money they had borrowed, forcing many banks to close. Finally, many people believed that fraud and insider activity was to blame.
After the initial crash, the United States entered a 3-year bear market; the Dow finally bottomed at 41 in 1932. The new president, Franklin Delano Roosevelt (FDR), took a number of unprecedented steps to bring stability and trust to the market, including creating the SEC in 1932. Wall Street was skeptical about letting the government interfere with the private sector, but the steps FDR took eventually helped turn the economy around. However, it took 25 years for the Dow to make it back to 381.
