The Great Crash, 1929

Summary

Chapter 1: Vision and Boundless Hope and Optimism

Coolidge's State of the Union 1928

Burgeoning get-rich-quick with no effort mentality

Manifestation: Florida real estate bubble [1]

stock market boom

• steady increases in 1924, 1925
• 1925: Britain returned to pre-WW I gold/dollar/pound exchange rate
  • first of several exchange crises
• collapse and restabilization in 1926
• stock market steadily grew in 1927
• gold leaving Britain/Europe for United States
• easy money policy request
  • Montagu Norman (Governor of Bank of England)
  • Hjalmar Schacht (Governor of the Riechsbank)
  • Charles Rist (Deputy Governor of the Bank of France)
  • asked Fed to urge easy money policy
  • Fed cut rates from 4% to 3.5%
  • government securities purchased in high volume
  • Fed made funds available, and these funds were invested in stocks, or made available to people to help finance their purchase of stocks
  • i.e. cheap credit led to speculation

Early 1928: change in nature of boom

Price increases were not gradual but happened in leaps

June: 5 million shares traded per day

November: Hoover elected

Hoover was former Commerce secretary, growing increasingly concerned with market speculation

His attempts to act on his thoughts about speculation were curbed by Coolidge and the Fed, remained well-kept secret

Increase in amount of trading on margin

Discussion of margin trading

• speculators: when trading instruments, main interest is on price changes; so, desirable to divorce price of instrument from the details of the actual instrument
  • e.g. land boom in Florida - speculators didn't care about benefit of owning land, or the potential use of that land
  • so, instruments were created so that speculators dealt only w/ price
  • "binders" - not the land itself, but the right to but the land at a stated price
  • (similar to options, I think...)
• cyclical system: banks provide funds to brokers, brokers provide funds to customers, and customers put down collateral that goes right back to the bank
• volume of speculation: indexed by the volume of brokers' loans (loans collateralized by securities purchased on margin)
  • 1920s: volume of speculation rose from 1-1.5 billion (early 20s) to 2.5 billion (1926) to 3.5 billion (1927) to 4 billion (June 1928) to 5 billion (November 1928) to 6 billion (end of 1928)
  • people swarmed to buy stocks on margin: gains of price increases, without costs of ownership
• lending came from banks
  • cost of owndership assumed by NY banks (and eventually other lenders around the world)
  • loans underwriting securities speculation are safe: stock investments are salable, liquid, retrievable on demand
  • this outlet for non-risk capital was paying 5% in beginning of 1928
  • by end of 1928, was paying 12%
  • companies: why invest in manufacturing, equipment, factories, etc., if instead you could invest in banks and make a 12% return?
  • NY banks: borrowed money from Fed at 5%, then lent it at 12% for call market

Chapter 2: Something should be done?

Beginning of 1929: crash at some point was inevitable

Problem: speculation was running wild; but taking action would create just as big problems as not taking action

Choice became between an engineered collapse or an uncontrolled collapse

Power was in hands of:

• U.S. President
• Treasury Secretary
• Federal Reserve Board (in Washington; oversaw all Fed. Reserve Banks)
• Governor and Directors of Federal Reserve Bank of NY (most powerful Fed. Reserve Bank)

Coolidge: left responsibility of market regulation in hands of Federal Reserve

Incompetence of Federal Reserve Board

• Prior chairman: Daniel Crissinger, appointed by Harding
• 1927: Crisssinger replaced by Roy Young (8 yrs Governor of Minneapolis Fed. Reserve Bank)
• Most were appointees of Harding-Coolidge
• Hoover: described all as "mediocrities"

Fed. Reserve Bank of NY

• chair: Benjamin Strong
  • highly regarded central banker
  • took lead in 1927 monetary easing for Europe's benefit
• October 1928: Strong died, replaced by George Harrison
• Charles Mitchell: chairman of National City Bank; January 1929, became class A director of Fed. Reserve Bank of NY
  • end of boom would mean end of Mitchell, leading to inaction on part of NY Fed Reserve Bank

Instruments of economic control: open market operations, and manipulation of rediscount rate

Open market operations:

• sale by the Fed of government securities brings cash into Reserve Bank vaults, where it sits (instead of being lent to people who then use it to buy stocks)
• government securities = government debt
• problem: lack of government securities to sell
• early 1928: $617 million in securities
• mid-1928: $228 million remaining, remainder was not sold because Fed believed sale of government securities had slowed the boom/been successful

Manipulation of rediscount rate:

• rediscount rate = interest rate for banks borrowing from Fed. Reserve Bank vaults
• interest rates had to be very high to make it unprofitable to lend Fed-borrowed funds to stock-buyers
• additional difficulty: high interest rates would not just affect speculators, but ordinary citizens
• Feburary 1929: NY FRB proposed raising rate from 5% to 6%; Fed Board thought it meaningless gesture; rate wasn't raised until summer

Fed also saw funds coming into markets from companies (non-banks), leading Fed to believe they had no power

Fed could have e.g. set margin requirements higher (from 45-50% to 75%)

Early February:

Fed addressed individual Reserve banks, expressing that banks were overstepping their responsibility when lending for purpose of speculative security loans

Fed also addressed public, stating that use of Fed facilities to aid speculative growth could not continue

"moral suasion": Fed attempts to control the market with words

Market dropped sharply, but recovered within a month

Fed was basically saying, if the loans were not Fed loans, they would not interfere (way of eliminating their own responsibility)

4 March: Hoover took over as President

End of March: Federal Reserve Board meeting daily in Washington, "tight-lipped silence", no indication of content of meetings

25 March: tension too great, people began to sell, corporations reduced loans to call markets, interest rates on loans lifted

26 March: stocks dropped even more; record 8.2 million shares for the day; ticker fell behind trading due to high volume; brokers asked clients for more margin

NY FRB Director Charles Mitchell: told press that National City would loan money to prevent liquidation, borrow from NY FRB to do so

Response to Mitchell was fast; money rates eased, market rallied

National City went further, said it would guarantee reasonable interest rates, lent $25 million to call markets

Mitchell, Fed Reserve came under criticism

Joseph Stagg Lawrence: Wall Street and Washington; defended Wall Street, attacked Fed

From end of March on, no one in authority took action; either assumed it was someone else's responsibility, or thought there was no problem

NY Governor Franklin Roosevelt: followed laissez-faire policy

Quotes

Foreword

What in 1930 took the dramatic form of runs on the bank - the wiping out of middle-class savings and wealth - in 2008 and 2009 took the form of simultaneous, month-over-month collapse in asset values, followed by the bankruptcy, downsizing, and liquidation of business firms. In this there was often less immediate hardship - the country is not short of food - than the drying up of possibilities - for college, work, and retirement.

Chapter 1

...during the same month (September 1928) reassurance came from still higher authority. Andrew W. Mellon said, "There is no cause for worry. The high tide of prosperity will continue.

Mr. Mellon did not know. Neither did any of the other public figures who then, as since, made similar statements. These are not forecasts; it is not to be supposed that the men who make them are privileged to look farther into the future than the rest. Mr. Mellon was participating in a ritual which, in our society, is thought to be of great value for influencing the course of the business cycle. By affirming solemnly that prosperity will continue, it is believed one can help insure that prosperity will in fact continue. Especially among businessmen the faith in the efficiency of such incantations is very great.

Chapter 2

On the first of January of 1929, as a simple matter of probability, it was most likely that the boom would end before the year was out, with a diminishing chance that it would end in any given year thereafter. When prices stopped rising - when the supply of people who were buying for an increase was exhausted - then ownership on margin would become meaningless and everyone would want to sell. The market wouldn't level out; it would fall precipitately.

One of the oldest puzzles of politics is who is to regulate the regulators. But an equally baffling problem, which has never received the attention it deserves, is who is to make wise those who are required to have wisdom.

Regulation of economic activity is without doubt the most inelegant and unreqarding of public endeavors. Almost everyone is opposed to it in principle; its justification always relies on the unprepossessing case for the lesser evil. Regulation originates in raucous debate in Congress in which the naked interests of pressure groups may at times involve an exposure bordering on the obscene.

Because the meaning of their (the Fed) actions are not understood by the great majority of the people, they can reasonably be assumed to have superior wisdom. Their actions will on occasion be criticized. More often they will be scrutinized for hidden meaning.

Of all the weapons in the Federal Reserve arsenal, words were the most unpredictable in their consequences.

The regulatory concern of the Federal Reserve about Wall Street, Mr. Lawrence said in this remarkable volume, was motivated strictly by bias - a bias "founded upon a clash of interests and a moral and intellectual antipathy between the wealthy, cultured, and conservative settlements on the seacoast and the poverty stricken, illiterate, and radical pioneer communities of the interior."

- quoting Joseph Lawrence's Wall Street and Washington

References

Joseph Stagg Lawrence, Wall Street and Washington

• see Chapter 2 above

Seymour Harris, Twenty Years of Federal Reserve Policy

• "I have made much use of this ultra-conservative but very careful account of Federal Reserve policy."

Earl Sparling, Mystery Men of Wall Street

• "..the author's facts, as distinct from his interpretation, are frequently accurate."