Author: John Kenneth Galbraith
The crash of 1929 has undoubtedly been studied and written about extensively. This book is the gold standard narrative of the events before, during and after the crash. Rather than write a review of this classic book, I have jotted down my notes to remind me of the key events and lessons to be learnt.
At the close of 1928, the US was enjoying a run of several years of prosperity with strong increases in both production and employment. Business earnings were consistently rising and speculation in the stock market was soaring. In the authors words, “the time had come… when men sought not to be persuaded of the reality of things, but to find excuses for escaping into the new world of fantasy”.
Just like the current crop of Tech Stocks, in the twenties it was Radio that was the new technology revolution. The automobile and steel industry were also symbols of progress and there was boundless hope and optimism among traders and the general population. In an age where people only saw the prices of stocks going up, there was plenty of opportunity for schemes that could profit from this rise.
Borrowing money on margin with a relatively low interest rate, to buy stocks that were growing by leaps and bounds, was a sure-fire investment strategy. Additionally, the business of lending money to investors was considered relatively safe as it was protected by stocks, which in normal circumstances were instantly salable. While the interest rate for margin loads grew in 1928 from 5 to 12 percent over the course of the year, it was still much lower than the returns that stocks would provide and speculators were happily taking advantage of this facility. Banks also were in for the ride as they could borrow money from the Federal Reserve Bank at 5 percent interest and make a tidy profit by lending it out at 12 percent or more.
By all measures, when 1929 rolled by, it was clear that we were in the middle of a roaring boom and like all booms, it was only a matter of time before it ended. Part of the job of the Federal Reserve Bank is to somehow regulate the economic activity in the US so as to dampen its unbridled acceleration and conversely soften its harsh landings. The first lever it pulled was to increase the interest rates, but this was a rather ineffective mechanism to slow down the speculation as share prices were increasing at a much higher clip. An increase in the interest rate didn’t do much to dampen the enthusiasm of investors buying on margin. Furthermore, several large companies were directly lending money to the call market, and by early 1929 these were an almost equal source of funding as the Banks.
The next attempt by the Fed was to prevent it’s funds from being directly or indirectly used by banks to lend money to the call market. The market responded nervously in the March timeframe and several prominent business leaders stepped up to restore confidence in the market. One such person was Charles E. Mitchell, the Chairman of the Board of the National City Bank who became a director of the Federal Reserve Bank of New York in January 1929. When the market turned skittish in March, he proclaimed "the National City Bank would loan money as necessary to prevent liquidation”.
During the twenties there was also an uptick of mergers and acquisitions. The predominant kind of merger brought together firms that were doing the same thing, but in different localities. There was a general consolidation of electric, gas, water, bus and milk companies, with the notion that a central and sophisticated management structure would extract more efficiencies from the combined companies. These mergers gave rise to holding companies that issued securities in order to buy the operating companies. The logical next step in this speculative scheme was the investment trust, whose only purpose was to own stock in other companies and reap the ensuing profits when their prices went up.
A typical trust held securities in upwards of five hundred companies so investors with a few dollars were able to spread their risk across many different companies. This was considered such a sure-fire way of making everybody rich that John J. Raskob, the Chairman of the Democratic National Committee released a plan in the early summer of 1929, that was heralded as “A practical Utopia”. The common theme was to pool together the funds from a large number of investors, borrow money on margin, and invest in the stock market. The inevitable rise in the stock prices would handsomely reward all the investors in a relatively short interval of time. The investment trusts were in such high demand that it was not uncommon for their stock to be worth twice as much as the underlying securities that they owned.
One prominent investment bank that was a little late to the party, was the Goldman Sachs Trading Corporation. They started on Dec 4th, 1928 and launched the Shenandoah Corporation in July, 1929 which was seven-fold oversubscribed. On August 20th they launched Blue Ridge corportation, and a couple of days later they acquired Pacific American Associates, which was a West Coast Investment trust that in turn owned several investment trusts. All of this activity provided fuel to the speculative boom, and towards the autumn of 1929, there was a general foreboding that a bust was on the horizon. Every little piece of bad news fed to this pessimism and there were several days in September and October where more than 5 million shares changed hands on the NY stock exchange.
On Monday October 21st, more than 6 million shares changed hands and the market was having a hard time of keeping the ticker up to date with the prices. It took an hour and forty minutes after the close of the market for it to record the last transaction. By Thursday, October 24th the volume ticked up to 13 million and by the evening the nation's most powerful financiers met to figure out how to stop the panic. Word of this meeting re-assured investors and by late evening investors moved back in so as to not be left out of the anticipated rebound. The respite was short-lived as on Tuesday, October 29th, the market was an unmitigated disaster. Within the first half-hour of opening sales were at a pace of 33 million a day. There were many sell orders that had no buyers at all. The worst beating was inflicted the investment trusts, with some of them going dropping to almost zero in value. There were a few more days of turmoil, but the impressive fact is that despite the widespread losses, the stock market continued to operate in an orderly fashion recording trades and making markets. The stories of hordes of speculators hurling themselves from windows, were mostly the result of imaginative minds putting a human narrative to the market rout.
By mid November, the market stopped its perilous decline and ended December with some moderate gains. January, February and March of 1930 also were positive, but the market lost momentum in April and by June it had crashed again. For the next couple of years, the market continued to trudge downward and many stocks decline a further 50+% in value from their Oct. 1929 lows.
The losses were borne by rich and poor and humbled most of the scholarly market forecasters. Many of the financial pundits lost credibility and were never heard from again. Many of the powerful financiers engaged in questionable strategies to curtail their losses, and were eventually investigated and convicted for their crimes. Galbraith invents the term "bezzle" to refer to the gains created from embezzlement or financial fraud.
