The Great Crash 1929, and current financial crisis

I read "The Great Crash 1929" and I have compiled my thoughts on the book as it relates to the .com bust and the current financial crisis.

What caused the Crash in 1929?
1) Low Interest Rates. One conventional explanation is that the US Federal reserve cut interest rates too low and it enabled speculators. Winston Churchhill was largely blamed because he returned to the gold standard. Eventually, this caused Britian to beg the US to cut interest rates. When the US obliged credit was cheap. Cheap credit alone doesn't explain the crash. There have been other periods of cheap credit without a stock market crash. Although I think it is considered a factor in the 1929 crash as well as the 2008 crash.

2) Speculation. Another cause of the 1929 bubble was too much leverage. Individual investors did large buying on margin. Furthermore, holding companies and investment trusts indirectly added leverage to the markets.

3) Optimism. One of the biggest causes of any bubble is optimism. In 1929 there were several emerging technologies that brought great optimism about the future, namely the auto, radio, and airline industries. Lindenbergh had accomplished the first solo, transatlantic flight. People had trust in leaders due to hearing them over radio. Irving fisher even argued that prohibition of alcohol would increase worker productivity. Similarly, the optimism about the potential of the internet fueled the .com bust. The idea that everyone should own a house and that house prices never go down helped fuel the 2008 crash.  In 28 and 29 there was the term "new era", a term nearly directly reflected in the .com bubble with the "new economy."

In 1929 Irving Fisher was the poster boy for optimism. He famously said "Stock prices have reached what looks like a permanently high plateau." only a few days before the crash. On the flip side, shortly before the crash, Roger Babson said "Sooner or later a crash is coming, and it may be terrific."

Irving Fisher shortly after the crash

Another similarity after the 1929 crash and the 2008 crash is the assertion by Presidents and economic luminaries that the "fundamentals are sound."  In 1929, it was Irving Fisher and President Hoover, among others. In 2008 President Bush, John McCain and Hank Paulson have repeatedly stated that the fundamentals are sound when in fact, it's obvious they don't know.

During the .com bubble Alan Greenspan famously warned of irrational exuberance on December 5th, 1996. It would be over four years before the stock market crashed. The genius of the book the great crash is that it explains the psychology and paradox of investing during a bubble. "Temporary breaks were serious trials for those who declined fantasy. People who knew there was a bubble were fooled by small dips and eventually began to give up."

The 20s are characterized as the run up to the crash, but 28 and 29 were the years where it really went off the charts. I had always heard the stock market lost 90% of it's value during the crash, what I didn't realize was it took nearly three years.
September 3, 1929, the times industrials hits a peak 452
October 24, 1929 - black thursday - the market crashed and largely rebounded the same day.
October 29, 1929 - black tuesday - worst day in market. times industrial down 43 to 275
July 8, 1932 - the times industrials bottomed at 58. It took nearly 3 years to find a bottom.

Just as the computers get backlogged currently on days of high volume, the tickers couldn't keep up with falling prices. This induces panic because people don't know how much they have lost until later or after the fact when they may not be able to sell because the markets are closed.
In some cases stocks gapped huge. Often mondays saw huge losses because people reflected over the weekend. (Similar to Monday March 10, 2000 during the .com bubble)

John D. Rockafeller, the richest man in America at the time, wrote letter assuring the public the fundamentals were sound and he was buying common stock on October 30, 1929. Similarly, Warren Buffet, the current richest man in America, wrote an op-ed piece in the New York Times on October 17, 2008. Bill Gates, the richest man in America at the end of the .com bubble was probably relieved because the bubble was causing high rates of attrition at Microsoft.

"The Great Crash" asserts that the common belief in large increases in suicide is largely a myth. There was the high profile suicide of Ivar Kreuger. In the 2008 crash there have been 2 high profile suicides, namely English financier Ross Stephenson, and De La Villehuchet due to Bernie Madoff scandal.

Scandals are often uncovered during crashes and depressions because people become concerned and suspicious, whereas they are more lax in times of prosperity. This was true of the crash in 1929, there were numerous embezellments, the worst of which was the union industrial bank of flint michigan. The executives embezzled about 4 million (which is a lot inflation adjusted). The .com bust saw a slew of embezzlements: Enron, WorldCom, Adelphia, HealthSouth, Cendant, Global Crossings, Tyco, and the demise of Arthur Anderson. The 2008 crash has exposed Bernie Madoff.

Hoover enacted tax cuts after the crash, but enacted large tax increases in 1932. There was a strong perception that the budget had to be balanced to restore confidence, but that seemed to only worsen the crisis.

The depression from 1873 till 1896 was known as "the great depression" before the great depression of 1929 - around 1940. There is an article about how that depression is more similar to the 2008 crisis.

The book claims the crash of 1929 started as a simple recession due to high inventory. The book is largely about the crash, not the depression. The long term depression is harder to explain, but there are four contributing factors.
1) Unequal distribution of wealth. The top 5% of the population received 1/3 of the personal income
2) bad corporate structures, namely holding companies and investment trusts. these companies depended on dividend, so there was pressure to maintain the dividends rather than invest in capital expenditures.
3) bad banking structure. In the first six months of 1929 346 banks failed with deposits of $115 million.
4) the dubious state of foreign trade. At the time the US was mainly an exporter and Hoover raised tarrifs to protect that status.

The big question is can or will it happen again. Or is it happening again? There were a lot of government regulations passed that have helped preventing the problems. The Glass Steagal Act created the FDIC, which was crucial to restoring confidence and stability to the banking system. It also separated commercial banks from other financial institutions, most notably brokerage firms. The Fed was given control of how much speculators could buy on margin. The SEC was created. Insider trading was outlawed. Also outlawed was mass coordination to manipulate the markets (I was surprised to learn they were at one point legal). There were numerous pump and dump scams preceding the crash, just as there were during the .com bubble largely thanks to email providing an easy way to pump up small stocks.

2008 Crisis and Deregulation
Many of these safeguards have been removed, namely, the repeal of Glass Steagal (Gramm-Biley-Leach Act) which enable the merger of banks and brokerages. In addition, the uptick rule was eliminated in 2007, that was designed to prevent bear raids. Deregulation of banking is a peculiar position in light of the fact that the goverment is an insurer of the banks through the FDIC and an ad hoc insurer to other financial institutions that are "too big to fail" through TARP. No reasonable insurer would encourage their clients to take on more risk. The irony is that senators like Phil Gramm that espoused free market capitalism have forced the fed to the verge of nationalizing the financial system.

The current financial crisis can be traced back to deregulation of even older laws. Credit default swaps, which are side bets and unregulated insurance on securities, were made illegal after the Panic of 1907, as is discussed in these two 60 minutes segments, but were legalized in 2000 by the Commodities Future Modernization Act. Sub-prime mortgages, CDOs, mortgage backed securities, and most importantly credit default swaps are what brought down the likes of Bear Stearns, Leahman Brothers, and AIG. As Warren Buffet said "Wall Street drank their own Kool-Aid." There is the cliche that those who don't remember the past are doomed to repeat it... I suspect people knew their history, but were too idealogical or greedy to act on it.

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