Karen Blumenthal: As Dire as the Times May Seem, History Isn't About to Repeat Itself
A long streak of speculative lending got out of hand as banks and even staid industrial companies made a stream of risky loans. Consumer spending on cars and clothes was slipping, but no one was paying attention. The stock market grew shaky in September, and then in October, the bottom fell out.
Suddenly, everyone seemed to want to sell. But there were few buyers, and over six bleak trading days, the Dow Jones Industrial Average lost a third of its value. It was a panic, said a senior New York Stock Exchange official, "where all at once, the inconceivable terrors of the unknown and the unfamiliar are thrust upon the public mind; confidence is paralyzed, and until it is restored, chaos reigns."
The year, of course, was 1929, though it sounds just enough like today to make us wonder if we should stock up the pantry, take the cash out of the bank and hunker down for a 21st-century Great Depression. No doubt, the parallels are stark and frightening. But the differences between now and then are even greater.
Let's start with lending. In the late 1920s, as the stock market took off, banks expanded their loans for those most unpredictable of assets: stocks. Investors could easily borrow up to 75% of the value of a stock purchase. By 1929, almost $4 of every $10 in bank loans went to buy shares. In addition, Chrysler, General Motors and Standard Oil of New Jersey all made tens of millions of dollars available for stock loans. In one of the most egregious examples, an energy company called Cities Service sold stock and then used the cash to make loans for people to buy more shares.
When the market started to fall, however, brokers had to call clients for more cash to secure their loans -- a so-called margin call. Because they had seen short downturns before, customers weren't eager to bail out. The entertainer Groucho Marx borrowed from the bank, against his life-insurance policy and against his house to come up with cash to meet his margin calls. But it wasn't enough. During that dark week in October, his broker sold all his stocks, wiping out his life savings of $240,000 and leaving him deeply in debt.
"I would have lost more," he said later, "but that was all the money I had."
When those stock assets evaporated, an already weak banking system was crushed. In the first half of 1929, well before the crash, more than 300 banks had closed. More than 1,000 banks closed in 1930. Without a Federal Deposit Insurance Corp., depositors lost everything.
Initially, the Federal Reserve did nothing. To try to keep speculative borrowing on stocks from continuing, it declined to reduce interest rates, choking off credit. Unemployment climbed toward 25% at a time when there was no unemployment compensation. In the Prohibition era, those without jobs couldn't even legally drown their sorrows in beer.
Most striking was the long reluctance to acknowledge a serious problem....
Read entire article at WSJ
Suddenly, everyone seemed to want to sell. But there were few buyers, and over six bleak trading days, the Dow Jones Industrial Average lost a third of its value. It was a panic, said a senior New York Stock Exchange official, "where all at once, the inconceivable terrors of the unknown and the unfamiliar are thrust upon the public mind; confidence is paralyzed, and until it is restored, chaos reigns."
The year, of course, was 1929, though it sounds just enough like today to make us wonder if we should stock up the pantry, take the cash out of the bank and hunker down for a 21st-century Great Depression. No doubt, the parallels are stark and frightening. But the differences between now and then are even greater.
Let's start with lending. In the late 1920s, as the stock market took off, banks expanded their loans for those most unpredictable of assets: stocks. Investors could easily borrow up to 75% of the value of a stock purchase. By 1929, almost $4 of every $10 in bank loans went to buy shares. In addition, Chrysler, General Motors and Standard Oil of New Jersey all made tens of millions of dollars available for stock loans. In one of the most egregious examples, an energy company called Cities Service sold stock and then used the cash to make loans for people to buy more shares.
When the market started to fall, however, brokers had to call clients for more cash to secure their loans -- a so-called margin call. Because they had seen short downturns before, customers weren't eager to bail out. The entertainer Groucho Marx borrowed from the bank, against his life-insurance policy and against his house to come up with cash to meet his margin calls. But it wasn't enough. During that dark week in October, his broker sold all his stocks, wiping out his life savings of $240,000 and leaving him deeply in debt.
"I would have lost more," he said later, "but that was all the money I had."
When those stock assets evaporated, an already weak banking system was crushed. In the first half of 1929, well before the crash, more than 300 banks had closed. More than 1,000 banks closed in 1930. Without a Federal Deposit Insurance Corp., depositors lost everything.
Initially, the Federal Reserve did nothing. To try to keep speculative borrowing on stocks from continuing, it declined to reduce interest rates, choking off credit. Unemployment climbed toward 25% at a time when there was no unemployment compensation. In the Prohibition era, those without jobs couldn't even legally drown their sorrows in beer.
Most striking was the long reluctance to acknowledge a serious problem....