The Stock Market Crash

The first blow was the break in the stock market during the last week in October 1929. Declines in the stock market, even substantial ones, do not inevitably cause declines in business. The 1987 crash is an example of one that did not. The 1929 break, however,

Wall Street on Black Thursday, October 24, 1929. Investors and the curious milled around in confusion in the planked street (subway construction was going on) as the extent of the disaster inside the New York Stock Exchange (at right) became clear.

Significantly accelerated the mild downturn then under way because of the catastrophic magnitude of the decline and the uncertainty it created about the future course of the economy.

The New York Times index of 25 industrial stocks, which early in 1924 had stood at 110, had climbed by January 1929 to 338, and by September to 452. It was almost impossible to buy a common stock that did not rise rapidly in value, and investors quickly accumulated fortunes. The optimism engendered by these gains permeated the business community and led to the conclusion that permanent prosperity had arrived. Some investors and government officials, however, had become uneasy about the dizzying heights to which prices had risen. President Hoover and officials at the Federal Reserve worried about excessive speculation and the danger of a crash. In August, the Federal Reserve raised the discount rate (the rate at which it lent to member banks) to 6 percent in an attempt to stem the flow of credit into the stock market. The Bank of England and other central banks took similar actions for the same reason. For a short time, at least, these actions had no effect: Stock prices continued upward.

On September 5, the well-known investment adviser Roger Babson warned that a crash was coming, and the market staggered through the “Babson break.” Prices declined through September, but as yet, there was no sign of panic. Then a sharp break occurred on October 23 and October 24 (“Black Thursday”), when a record of 13 million shares traded (3 million was normal). Massive organized buying by banks and investment houses prevented a complete rout, but on October 28 (“Black Monday”) and October 29 (“Black Tuesday”), the panic resumed. The slide continued until mid-November. By that time, stock prices had fallen to about one-half of what they had been in August.

Newspapers reported the painful details of Wall Street’s collapse.

Well into 1930, however, share prices remained above the levels reached in 1926. If all that was involved had been the loss of the extraordinary capital gains made by stock market investors in 1927 and 1928, it would be hard to blame the depression on the stock market crash—after all, “easy come, easy go.” The unique psychological trauma produced by the crash was more significant than the direct effects of the loss of wealth. In the 1920s many Americans had come to believe that the economy had entered a “new era” of continuous and rapid progress that would carry them to higher and higher standards of living. The spectacular rise in the stock market was taken as proof that this view was widely shared by knowledgeable investors. When the market crashed, this optimistic view of the future crashed with it; almost overnight, uncertainty and pessimism about the future gripped the public. Purchases of consumer durables, in particular, which depended on consumer confidence about the future and which had increasingly been bought on the installment plan, declined drastically (Romer 1990). See New View 23.1 on lessons the stock market crash could teach.

LESSONS FROM HISTORY FOR INVESTING IN THE STOCK MARKET

Figure 23.4 shows the value of stocks on the New York Stock Exchange from 1925 to 1955. If someone had invested at the peak in 1928, they would have had to wait until 1952, 24 years, to see the value of their investment recover. This might have seemed an acceptable wait for a young person, fresh out of

Source: Historical Statistics 2006, Series CJ800.

College, and saving for retirement. But it would have seemed a tragedy for an older person nearing retirement in 1928. The right time to buy, of course, was at trough in 1932. Stocks bought in 1932 had nearly doubled in value by the end of the decade. The trick, of course, was knowing that the stock market had finally bottomed out and having the cash to invest.