Cheap and easy credit. That’s what the crash was really all about. Greed. And a big, bad bear market nobody could have imagined happening. Non-professional, retail investors were allowed to borrow some 90% of their investment portfolio to go buy new stocks beyond the stocks they already owned.
So...quick math: if someone invested $1,000 of their own hard-earned savings, and the stock tripled, like it did in the mid-’20s for a lot of easy money stocks, then that $1,000 would have become $3,000 in a short period of time. Duh. Great. But, in fact, margin rules were almost non-existent in the era. It was common to allow investors to have 3, 4, or 5 times their invested equity as borrowed margin. Or, said another way, on an initial $1,000 invested, many investors were stupidly allowed to buy $5,000 worth of stocks.
But let’s take a simpler approach. If an investor had been allowed to margin their account up to 90% of its value, then that investor, on $1,000 of their own capital, could have purchased $1,900 worth of that stock that tripled. Doing the math, 3 times $1,900 gets you $5,700. You pay back the $900 of margin that you borrowed against yourself, and you will have netted something like $4,800, albeit a little bit less, because you will have paid interest to the brokerage that allowed you to borrow money in this manner.
So, in the margin case, the $1,000 of your invested capital made you 4.8 times your money, rather than 3 times your money. And that’s way more dough to crow about. In those days, the extra $1,800 would have bought you, like...a house. So everything was great in 1926, 1927, 1928...when the market mostly, generally went up and provided easy money for the well-heeled investors who could play the game. And everyone was incentivized to keep the party rolling. Brokerages could charge fat commissions on transactions and nobody complained, because the market’s rise more than paid for those commissions. Brokerages could also charge big interest rates on borrowed margin, because the market’s rise masked all those costs. And everything ended up sweet and beautiful, as the prince married the princess, and they went off to their castle in the clouds.
Oh, but wait...then reality struck. One day, a not-so-kindly old woman offered Snow White the apple. She bit…and the market went down. And down. And down. Such that panic selling ensued, and more or less everyone who was on the hook to pay back borrowed money in the form of margin had their loans called immediately by the brokerages, as they lost more than everything...meaning that not only did the investors lose their investments, but the brokerages who had underwritten those loans themselves went bankrupt, because the stocks went down so far that even the margin limit covenants were violated.
On the stock purchased for $1,000 with the $900 of margin, that $1,000 worth of stock ended up being worth $500 or less, so even if the brokerage sold every share of that original $1,000 investment, now worth only $500, the $500 in original value remaining didn’t even come close to covering the $900 in margin the brokerage’s client took out in loans in the first place.
Yes, it sounds like the crazy, maddening crowds at work…and the crowds back then were mad. Everyone was buying on margin...and if you weren’t, well then you were just another sucker hauling bricks or ice or railroad ties for a living. Life was way easier when you could just phone in a stop order and play golf all day. So this was bad. And a half. And as part of the process of investors panicking, they lost trust in the financial system of America. Many investors then wanted to sleep on a pile of their hard-earned, saved $20 bills. They ran to the banks en masse, and asked for withdrawal money, which the banks didn’t have.
So the frame, then...was a failed stock market. Lack of trust in the banking system in America. No credit offered to pretty much anyone. And no adult supervision to get this country out of the deep financial hole it had dug. Well, along came FDR with the New Deal. He primed the pump in creating federal guarantees for banking deposits up to a certain amount. He also enforced vastly stricter regulations on banks, brokerages, and pretty much anything financial, such that, going forward, this country ran a dramatically more conservative balance sheet.
The result? Gradually, greed came to overtake fear, and the market slowly trundled northward.
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Finance: What was the Market Crash of 19...1 Views
and finance Allah shmoop What was the market crash of
1929 aren't people while there was cheap and easy credit
and that's what the crash was really about Greed and
a big bad bear market nobody could have imagined happening
at the time right Nonprofessional retail investors were allowed to
borrow some 90% of their investment portfolio to go buy
new stocks beyond the stocks they already owned So quick
Math If someone invested $1000 of their own hard earned
savings and the stock tripled like it did in the
mid twenties for a lot of easy money yeah well
then that $1000 would have become $3000 in a very
short period of time Great but in fact margin rules
were almost non existent in era it was coming to
allow investors to have 334 even five times they're invested
equity as borrowed margin or set another way on an
initial $1000 invested Many investors were stupidly allowed to buy
$5000 worth of stocks So really volatile right If things
go the wrong way it hurts But let's take a
simpler approach If an investor had been allowed to margin
there account up to 90% of its value like 50%
is generally the maximum today that you could borrow Then
that investor on $1000 of their own invested capital could
have purchased $1900 worth of that stock that tripled So
doing the math three times 1900 gets you What is
that $5700 You pay back the $900 of margin that
you borrowed against yourself and you'll have netted something like
$4800 in profits albeit a little bit last because you'll
have paid interest to the brokerage's that allowed you to
borrow money in this manner That's a margin interests So
in the margin case while the $1000 ofyour invested capital
maybe 4.8 times your money rather of any paltry three
times your money had you not been leveraged and that's
way more dough to crow about right And in those
days well that extra $1800 would have bought you like
a house So everything was great 90 50 1926 27
28 when the market mostly generally went up and provided
easy money for the well heeled invest who could play
the game and everyone was incentivized to keep the party
rolling Yes that's a flapper girl Brokerages could charge fat
commissions on transactions and nobody complained Why Well because the
markets rise more than eight for those commissions Brokerages could
also charge big interest rates on borrowed margin because the
markets rise Masked all those costs and everything ended up
sweet and beautiful is the prince married the princess and
they went off to their castle in the clouds Oh
but wait Then reality struck One day a not so
kindly old woman offered Snow White the apple she bit
and the market went down down down Such that panic
selling ensued and more or less Everyone who was on
the hook to pay back borrowed money in the form
of margin had their loans called immediately by the kindly
smiling brokerages as they more or less lost while mohr
than everything meaning that not only did the investors lose
all of their investments but the brokerages who had underwritten
those loans themselves went bankrupt because the stocks went down
so far that even the margin limit covenants were violated
That is on the stock purchased $4000 with the $900
a margin That $1000 worth of stock ended up being
worth well $500 or maybe a lot less so even
if the brokerages sold every share of that original $1000
investment now worth only $500 While the $500 in original
value remaining didn't even come close to covering the $900
in margin the brokerages clients took out in loans in
the first place So yeah it sounds like the crazy
maddening crowds at work and the crowds back then were
mad Everyone was buying on margin and if you weren't
well then sucker you were just yet another sucker hauling
bricks or ice or railroad ties for a living Life
was way easier when you could just phone in a
stop order in you know play golf all day So
this was bad and 1/2 and it's part of the
process of investors panicking They lost trust in the financial
system of America Many investors then wanted to sleep on
a pile of their hard earned saved $20 bills so
they ran to the bank on Mass and asked for
their money back They wanted to withdraw all their money
from the banks And guess what The banks didn't have
the money sitting around because they loaned it out for
mortgages and car loans and horse loans or over the
head back then So the frame then was a failed
stock market Lack of trust in the banking system in
America no credit then offered Teo Well pretty much anyone
You can imagine what America would be like if we
didn't have credit cards alive and well and no adult
supervision to get this country out of the deep financial
hole that I dug well along came FDR With the
New Deal he primed the pump and creating federal guarantees
for banking deposits upto a little certain amount like FBI
see limits of 100 grand and change today He also
enforced vastly stricter regulations on banks brokerages and pretty much
anything financial such that going forward this country ran a
dramatically Mohr conservative balance sheets and investment people had to
disclose well pretty much everything The result Well gradually greed
came to overtake fear again and in mid thirties or
so the market slowly trundled northward again It's what I
look like And then everything gave rise Teo Well this
really beautiful sight Welcome to America