The Federal Reserve Act of 1913 fostered the illusion that sharp downturns were a thing of the past, and in September 1929 Professor Irving Fisher confidently proclaimed that share prices had reached a "permanently high plateau". He would soon eat his words.
It’s a racket. Those stock market guys are crooked.
From 1924 there was a widespread belief that the US had entered a new era of capitalism, in which productivity and prosperity would be greater than ever before. This belief was based on the more scientiﬁc management styles now being employed, the more sophisticated state of investment theory, Prohibition, and the economies of scale that had been achieved in the banking, railroad and utilities sectors.
It was also thought that the establishment of the Federal Reserve in 1913 had put an end to business cycles. Consequently, as was the case during the 1990s, many investors saw stock market investments as essentially riskless and believed that stocks would now consistently outperform bonds.
Stock valuations became increasingly optimistic and were based on new valuation methods which emphasised discounting estimated future cash ﬂows at the expense of fundamentals.
The election of the laissez-faire President Coolidge in 1924 was also a boon for stock market investing. Coolidge approved drastic cuts in income tax, corporation tax and capital gains tax, which allowed people to retain more of their incomes for speculation.
When the Federal Reserve reduced interest rates and lowered reserve requirements in 1925 to help Britain get back on the gold standard, a stock market boom began, centring on new consumer goods such as automobiles, refrigerators and the wireless.
One of the most remarkable features of the boom was the number of new speculators involved. The stock market was no longer the preserve of "hard-boiled knights" but was open to "great new hordes of small investors who were never in this game before and have come out of it with six-passenger coupes or whitened hair".
Signs of Wall Street were everywhere: stock tickers were not conﬁned to brokers’ ofﬁces alone but could be found in beauty salons, restaurants and ocean liners.
Wall Street’s inﬂuence even broke into the hallowed precincts of America’s churches. One New York church offered contributors to its building fund "engraved certiﬁcate of investment in preferred capital stock in the Kingdom of God" whilst several religious magazines advised their readers to invest in "Bible Annuity Bonds".
The two most prominent groups of speculators during the 1920s were the "Detroit Crowd" and the Irish-Americans. The former included Walter Chrysler and William Crapo Durant, the founder of General Motors. Ironically, after making big losses on the stock market in 1920, Durant’s response was to give up the day job and become a full-time stock operator; by 1929 he controlled over $4bn dollars of stocks ($38bn in today’s money).
The Irish-Americans included Charles Mitchell, Mike Meehan and Joseph Kennedy, the father of J. F. Kennedy. Mitchell, president of the National City Bank, pioneered many of the aggressive sales tactics used in the 1920s for ofﬂoading second-rate securities – a practice that became known as Mitchellism. This involved ‘manufacturing’ securities which were then distributed by pouncing on "prospects" (potential clients) at train stations and bars. Even the day before the crash, he remained bullish: there was "nothing fundamentally wrong with the stock market or the underlying business or credit structure". Unfortunately, he believed his own sales patter and lost millions of dollars in the crash.
Less holy concerns also gave way to the overriding stock market obsession, with one psychologist remarking: "Sex has become so free and abundant that it no longer provides the thrill it once did... gambling on Wall Street is about the only thrill we have left."
At the height of the boom, market developments competed with sex and romance in women’s conversations, and women’s magazines observed that their readers found stockbrokers sexier than movie stars.
Another curious feature of the boom years was the public fascination with esoteric trading systems, which were, according to their creators, "guaranteed to beat Wall Street".
These included systems based on sunspot sightings, solar ﬂare activity and planetary positions, and a stock picking method that used secret codes contained within comic books. There was even a system that predicted there would be no downturns in months containing the letter "r".
Yet, for all its glamour, the 1920s boom was built on very shaky foundations. Sustained consumer demand relied on speculative forms of credit such as instalment payment plans.
In their demand for instant gratiﬁcation, consumers bought more and more goods on credit in anticipation of future earnings that they (mistakenly) assumed would grow. Speculators extensively used margin loans to fund investments, allowing huge leverage to be built up.
Such loans were initially very attractive due to the low discount rates, which were reduced even further in 1927.
Although the Fed changed tack from February 1928, raising rates and warning US banks against making these loans, demand from speculators remained high. Supply also remained high, even in the absence of banks, since companies could make big proﬁts by lending capital to the call loans market.
The use of leverage was not restricted to individuals. Utility and railway companies were consolidated into huge holding companies called systems, with cross-shareholdings in numerous utilities and railways, each of which was highly leveraged.
This arrangement magniﬁed proﬁts for the holding company, but it also increased the risks, should things turn sour.
By 1929, the stock market had become seriously overvalued and was said to be "discounting not only the future, but the hereafter". From the beginning of 1925 to the market peak in September 1929, share prices outgrew earnings threefold.
By this stage the whole economy was ailing. Interest rates were now at 6% – not high enough to dampen demand for margin loans but sufﬁcient to damage the rest of the economy. These high interest rates also resulted in gold ﬂows from Europe to New York, weakening US export markets.
Consumer demand was ﬂagging as well. The declining agricultural commodity prices in the US had reduced the purchasing power of the farmers, who constituted a large part of the population.
Moreover, with $6bn of instalment loans outstanding, instalment credit could not be expanded any further, given that wages were not increasing.
The following excerpt is taken from Eddie Cantor’s Caught Short! A Saga of Wailing Wall Street (1930):
"My throat is cut from ear to ear. I am bleeding profusely in seven other places. There is a knocking in the back of my head, my hands tremble violently, and I have sharp shooting pains all over my body, and in addition to all that my general health is none too good."
One of the greatest diagnosticians in America thumped me and probed me all over the premises. “You are a very sick man”, he said ﬁnally. “A very sick man. You are suffering from Montgomery Ward of the liver; General Electric of the stomach; Westinghouse of the brain, and besides you have a severe case of Internal Combustion.”
"The joke’s on the doctor. He didn’t notice me as I walked into his ofﬁce or he’d have discovered that I also had a bad limp from taking an unexpected ride on Otis Elevator! They let me in on the top ﬂoor. When I ran out of collateral, the cable snapped and I landed in the basement without a shock-absorber. They sent in a margin-clerk and two other interns to collect the pieces."
President Hoover had been urging caution since 1928, but few investors listened until Roger Babson, an eminent statistician, prognosticated doom on 5 September 1929. Suddenly fear outweighed greed.
On 24 October, or "Black Thursday," a record 12.9m shares were traded, triggering a sell-off on European markets the following day. The New York market continued to tumble when trading resumed after the weekend.
Finally, on 31 October, Treasury Secretary Mellon announced a drop in interest rates to 5%. The economy staggered along for several years before a further signiﬁcant stock market decline during the summer of 1932, bringing the Dow Jones Industrial Average down 89% from its peak on 3 September 1929.
In this period, production declined by 46%, foreign trade by 70%, and wholesale prices by 32%, while unemployment soared by more than 600%. The Great Depression had begun in earnest.
The Crash prompted signiﬁcant regulatory changes. Under the Glass-Steagall Act of 1933, commercial and investment banking were separated and in 1934, stock market pools, insider trading and market manipulation were prohibited. In the same year, the Securities and Exchange Commission was founded to prevent "unnecessary, unwise & destructive speculation", headed by poacher-turned-gamekeeper Joseph Kennedy.
The Fed limited margin loans to 50% of the collateral value of the shares and bear trades were restricted by an "uptick rule" that meant that short sales could not be made unless the stock had risen since the last trade.
Government also assumed a heavier presence in the economy, sweeping away laissez-faire policies and introducing a minimum wage and a welfare system. These ad hoc measures were given intellectual endorsement by Keynes’s General Theory of Employment, Interest and Money in 1936.
Whilst it is difﬁcult to see the bright side of people jumping off buildings, 30% share declines and the century’s worst depression, the Wall Street Crash led to a number of stabilising reforms including the establishment of the SEC and the banning of insider trading.
The preceding boom had also brought "modern" technologies such as the car, the radio and movies within the reach of ordinary people and had resulted in greater freedom for women.
1926 cartoon predicting the stock market crash
"The Long and the Short of it" – the man ruing his losses, the woman celebrating her gains
Inevitably there were hundreds of suicide jokes, such as the one about joint account holders jumping off a bridge holding hands, or guests at New York hotels who are asked, "You wanna room for sleeping or jumping?"
Of most questionable taste, however, was a book called 21 Delightful Ways of Committing Suicide (1930) which describes and illustrates 21 novel means of suicide, ranging from "animal absorption" to "hydraulic excess".
It opens in the following way:
"I have been thinking over the whole subject of Suicide lately – ever since the Wall Street Crash, in fact – and personally I have come to the conclusion that most people have the wrong idea of it entirely.
Say ‘Suicide’ to most people and they will wrinkle up their noses and go ‘Ugh’ and assume an expression of acute disgust, as though you had told them you were an uncle-lover or put maple-syrup on your poached eggs. As far as they are concerned, a Suicide in the family is like discovering that their grandfather is the illegitimate son of Benedict Arnold.
I think this is too bad. I think such a prejudice is distinctly unfair. I am not naturally bloodthirsty or cruel; I give lumps of sugar to truck-horses, and frequently help old ladies or children across the street (this is the best gag for getting through the trafﬁc myself that I have discovered yet); but still I feel that there is a lot to be said for Suicides. The idea, I am convinced, is basically sound."
The following advert was published by Standard Statistics – the forebears of Standard & Poor – in the 14 September 1929 edition of The Saturday Evening Post. The timing could not have been worse.
"History sometimes repeats itself- but not invariably. In 1719 there was practically no way of finding out the facts about the Mississippi venture. How different the position of the investor in 1929!"
"Today, it is inexcusable to buy a 'bubble' - inexcusable because unnecessary. For now every investor - whether his capital consists of a few thousands or mounts into millions - has as his disposal facilities for obtaining the facts. Facts which - as far as is humanly possible - eliminate the hazards of speculation and substitute in their place sound principles of investment."