Definition
The stock market crash of 1929 was a massive crash in stock prices on the New York Stock Exchange, and was the largest financial crash in the United States.
Details
The stock market crash came in multiple parts: the initial crash on October 28 (a 12.87% drop) that continued into October 29 (a 11.73% drop), however prices continued to decline until 1932, with a total loss of 89%.
The crash marked the start, and is one of the major causes of, the Great Depression.
Initially, some of the most wealthy bankers and industrialists tried to halt the crash by buying up millions of dollars in stocks themselves to try to boost prices. On the first day of the crash, the heads of several of the biggest banks in New York pooled their resources to buy huge amounts of US Steel (X) and other Blue Chip stocks. After this gesture, the panic began to subside and prices stopped dropping for the day.
However, the next morning prices resumed their fall, and further huge purchases by the Rockefeller family, and many others, were unable to restore investor confidence. Many people had been using stocks as collateral for loans they had taken out at banks. When the stock value dropped, the banks would often ask people and businesses to repay their loans, causing a massive wave of bankruptcies. This is how the crash in stock prices spread to the economy as a whole.
Causes Of The Stock Market Crash
There are several main causes of the 1929 stock market crash, ranging from wheat farmers through investment bankers and all points in between.
Millions Of New Investors Entering The Market
After World War One, millions of Americans began moving to the cities looking for work, and a new middle class began to emerge from the prosperity that followed the end of the war. This new group of people wanted effective ways to save their money and secure a more profitable return than simply keeping it in a savings account. Generally speaking, they chose to invest in stocks.
Today, this would not be much of an issue, but before the 20th century most investing was in bonds. The transition to stock trading came about because of railroad companies and new industrial companies. This new middle class was also buying cars and houses, which was good for steel businesses and construction companies. This made stock price rise.
This was the first time that small investors were buying stocks at a large scale. Before the 1920’s, it was usually only the wealthy who purchased stocks. In general, they would invest in companies where they saw the prices were already rising to secure the highest return. The average P/E ratio (the stock’s price divided by its earnings – per – share) of the most popular stocks was extremely high compared to what is normally seen today.
When the stock market crash started, it knocked most of these new investors out of the market completely. They were forced to sell their shares and lost all of their savings. This meant there were fewer investors available to buy stocks and help start a recovery.
Crash In Wheat Prices
The year before the stock market crash, American farmers produced record amounts of wheat, so much that it was not all sold by the end of the year. In 1929, wheat prices started to fall as the suppliers were struggling to sell off their reserves as the new harvests came in. Countries like France and Italy were also having huge harvests, so it was not possible to get rid of the extra supply by exporting it, but in 1929 the American harvest was also lower than the previous year.
This meant that farmers who were already facing very low prices now also had less wheat to sell, which caused many farms to fail. Back at this time, a large amount of the US economy was still based on agriculture – from industrial companies selling tractors and farm equipment, to railroads shipping grain from the farms to the cities and ports, to investors trading futures in wheat. When the farms started to fail, it caused a ripple effect through many other sectors through the Summer of 1929, which made investors already very nervous by the time of the October stock market crash.
Trading On Margin
In the 1920’s leading up to the stock crash, there was also a huge amount of margin trading. This is when investors borrow money using stock as collateral, and use the loan to buy even more stock. Since stock prices were rising constantly, banks were happy to provide the loans while investors, both new and old, were turning them into huge profits. So long as the profit made on the stock was greater than the interest paid on the loan, it seemed like a good idea to keep borrowing money.
However, if the stock prices start to fall when you are trading on margin, you end up losing both your investment and having to pay back the loan – with interest. Once stocks started to lose value at the start of the crash, many lenders feared that borrowers would lose too much value and not pay back their loans, so they called the loans. This is called a margin call.
In other words, the banks made investors pay back the loan amount immediately. This meant that many investors who had traded on margin were forced to sell off their stocks to pay back their loans. When millions of people were trying to sell stocks at the same time with very few buyers, it caused the prices to fall even more, leading to a bigger stock market crash.
When investors’ stocks lost more than 50% of their value, they were required to pay back more than the initial investment amount. This led to a devastating outcome for many individuals and lenders, who lost their entire investment plus additional funds. Since the borrowed money was secured by the stocks, investors couldn’t even hold onto the stocks in the hopes that their value would recover. Instead, the lenders took ownership of the stocks when borrowers defaulted on their payments. The lenders then attempted to sell the stocks immediately to recoup some of their losses.
Speculation
The biggest cause of the stock market crash was speculation.
As stock prices began to rise, more investors wanted to buy in to avoid missing out on potential gains. New and experienced investors alike saw impressive returns of 20% or more throughout the 1920s, drawing in many new investors who poured all their savings into the stock market. Meanwhile, more people were using margin trading to take advantage of rising prices and maximize their profits.
As the stock prices continued to rise, demand for stocks increased, causing prices to rise even further. This phenomenon is known as a speculative bubble. As more people traded with borrowed money, the situation became increasingly unstable.
Industrial production began to slow down in 1929, with slightly fewer steel, cars, and houses being built than in previous years. The shock caused by the decline in wheat prices finally led to some stocks losing value. When investors started to lose money, many others tried to sell their stocks as quickly as possible to minimize their losses, exacerbating the problem.
Lack of Information
One of the primary reasons the crisis escalated to such a severe extent and panic spread so rapidly was the lack of information. New investors were unaware of the risks they were taking when they started investing, as they lacked experience and guidance, (they didn’t have HowTheMarketWorks back then!). Meanwhile, even professional investors struggled to understand whether the rising prices were due to a genuine increase in value or part of a speculative bubble.
This uncertainty created an environment of confusion and fear.
During the crash, trading volumes were extremely high, causing stock tickers to fall behind by 3 hours or more. Investors were unaware of the extent of their losses, but they knew things were dire. This uncertainty sparked even more panic, as investors rushed to sell their stocks as quickly as possible.
One unexpected consequence of the stock crash was a significant improvement to the ticker system, allowing for faster dissemination of information to investors.
