Yes, the famous stock market crash of 1929. Many people speak about it today as it is still the worth stock market crash of all time and lead to the largest recession and subsequent depression in history.
There are a lot of competing opinions for what caused this crash. Maybe historians and universities have given their opinions on the crash. However, in 1929 the stock market crashed because of some of the loose monetary policies at the time (that we still see today).
This article is going to be very much an opinion piece at it is difficult to say exactly what caused the crash back then, however, we are here to say that in 1929 the stock market crashed because of two reasons.
Stock Market Crash of 1929
We all know what happened. The stock market completely tanked and the world economy was thrown into recession almost overnight. Millions were out of a job, the credit system froze up, and many people had to wait in food lines for their next meal.
While it took about 24 hours from the world to go from being in good shape to being in all our depression, it was the policies in the previous years that allowed for this massive rubber band the be continuously stretched until in snapped back overnight.
In our opinion, in 1929 the stock market crashed because of two things; cheap money and unlimited margin.
In 1929 the Stock Market Crashed Because of Years of Cheap Money
Not very different from the monetary policy world we live in today, the years up to 1929 saw incredibly low-interest rates and a massive expansion of the credit system. Again, not much different than today, this allowed asset prices to continuously appreciate with very little downside risk.
When the entire financial system is built off debt (just like today where the US is 20 TRILLION dollar in debt), the system needs a continuous stream of new debt created to keep the system alive. One of the ways to do that is to have incredibly low-interest rates. The group that is most responsible for setting interest rates is the Federal Reserve.
For the years leading up to 1929, the Federal Reserve kept interest rates very low. Now you might be thinking this is not such a bad thing but consider this. Say they are 1,000 companies in the world right now and the Federal Reserve sets their overnight interest rate at 5%. For argument sake, 100 of those companies can borrow money at 5%. These companies that can borrow at 5% are seen at the top companies.
Now if the Fed reduced rates to 3%, all of a sudden, 350 companies are able to borrow money because the 250 new companies who are borrowing money can handle the interest at 3%. These companies are not as strong as the first 100 who were capable of managing a 5% loan but they can handle a 3% loan.
These 150 companies that can handle a 3% loan are borrowing everything they can get their hands on to grow their business. But remember, they were not strong enough companies to handle interest rates at 5%. But then all of a sudden, interest rates go higher and these companies can no longer borrow money. The interest on their original loans go up and they cannot create more debt to continue to grow their business. In effect, reality sets in for those 250 companies and everyone knows it. This is how in 1929 the stock market crashed because of cheap money. At some point, reality set in for these companies and everyone knew.
In 1929 the Stock Market Crashed Because of Years of One Big Fat Margin Call
We all know what a standard margin account is these days. There are rules and regulations on the amount of margin and capital requirements and individual or institution must have. However, back in 1929, the concept of margin was brand new and in most cases, there was unlimited margin available for investors and institutions.
As you can guess by now, this was bad. Individual investors were able to have 100:1 margin for all of their positions. Not much different than excessively cheap money, assets prices rose because people could continue to borrow money to buy stock.
Well on the day of the crash, a handful of the top institutions received massive margin calls from their lenders. In an instant, some of the largest institutions at the time had to liquidate their entire holdings in order to pay back their debts.
Again, this is not much different from companies being able to borrow money for incredibly low-interest rates. The skill of those borrowing money was not high enough and those that should have only been able to receive 2:1 margin were getting 100:1.
Cheap Debt and Leverage Caused the Crash
Unfortunately, in 1929 the stock market crashed because of the same reasons that exist today. Cheap credit and super low-interest rates. This is why everyone is so scared of rising interest rates. If interest rates continue to go up, the payments on our interest will be more money than anyone can imagine. Borrowing massive amounts is never a good thing unless you have collateral to back it up.
In 1929 the stock market crashed because of excessive debt…and let’s hope it doesn’t happen again here soon.