The Great Depression tore a hole into the economy of the US and it all started with the stock market crash of 1929. Here are some key lessons learned.
The stock market crash of 1929 was an unprecedented economic event in American history. Not only was it financially devastating for so many, but it also marked the beginning of the Great Depression in the United States.
Fueled by exuberant speculation in the stock market, Americans failed to recognize the many warning signs of an event like this one. They continued to engage in risky behavior and ultimately paid a hefty price.
What was unique to this stock market crash of 1929, and how do we prevent it from happening again? Many of us survived the Great Recession a decade ago, though some remain wary of the same thing happening to their investments again. So, are we right to be hesitant? Could we be on the heels of yet another crash?
How Did 1929’s Crash Come About?
The end of World War I had ushered in a prosperous era in America. Manufacturing boomed, and inventions such as the airplane and the radio made life more enjoyable. With optimism at its height, Americans started to invest in the stock market.
As more people invested, stock prices began to rise. This was first noticeable around 1925. Between 1925 and 1927, stocks rose and fell moderately.
In 1927, the market surged ahead. By 1928, the stock market boom was officially underway. Everyday Americans began to see the stock market as a way to get wealthy. Stories spread of friends and family who had made fortunes from investing, which only further fed the frenzy. The excitement surrounding the purchase of stocks soared.
Unfortunately, not everyone who wanted to invest in the stock market could afford to do so. To alleviate this problem, banks allowed investors to buy “on margin.”
Buying Stock on Margin
Buying stocks on margin means that an investor is only required to put down a portion of the purchase price (in this case, 10% to 20%). The broker covers the remaining amount.
Although buying on margin made it possible for many people to invest, it was very risky. If the price of a stock fell below the loan amount, an investor was likely to receive a “margin call.” This meant he or she would have to pay the loan back immediately.
Americans neglected to recognize the inherent risk of buying stocks on margin and continued making purchases. By 1929, in fact, almost everyone was investing: individuals, companies, and banks.
On March 25, 1929, the stock market experienced a mini-crash. As prices started to drop, brokers made margin calls. Panic began to set in. To stop the market from declining further, Charles Mitchell, a prominent banker from National City Bank, stepped in to reassure market participants that his bank would continue to lend.
This assuaged investors, and the panic subsided.
Black Tuesday
By spring of 1929, certain key economic indicators showed signs of weakening. Knowledgeable people warned of a crash; however, no one listened.
During the summer of 1929, the market gained momentum, reaching its peak on September 3, 1929. Two days later, the market started dropping. Margin calls were issued. The ticker could not keep up.
In the afternoon of that same day, a group of bankers pooled their money and invested in the market, ending the precipitous drop. By the end of the day, investors had sold 12.9 million shares.
Resource: The 9 Best Investment Strategies for Short-Term Savings Goals
A few weeks later, on October 28, 1929, the market fell again. The newspapers speculated about an impending crash, and investors realized they needed to get their money out before it was too late.
Tuesday, October 29, 1929, would go down as the worst day in stock market history, even though investors sold over 16.4 million shares of stock. It’s known as Black Tuesday.
The following day, the stock market was closed. When it reopened, stocks continued to drop. This signified the beginning of the stock market crash.
Over the next two years, the stock market plummeted. It reached its low point on July 8, 1932, when the Dow Jones Industrial Average hit 41.22.
Effects of the Crash
The Stock Market crash of 1929 sent ripples throughout the economy. Unable to pay off debts, many Americans were financially ruined. Demand for consumer goods dropped as people began to live in poverty.
After the crash, credit also became worthless; no one could be trusted to repay their debts.
The economy, individuals, and corporations suffered for several years after the crash. Recovery was due in part to President Roosevelt and his Hundred Day plan, during which time he proposed legislation designed to prop up the banking system, stabilize the economy, and restore confidence in Americans.
Although no one is sure exactly what caused the crash, several indicators might have suggested a crash was imminent. For one: prior to the crash, unemployment was on the rise while construction, steel, and automobile production were all declining.
Most economists subscribe to the theory that the crash was a result of the so-called “Boom-Bust.” This theory explains the disaster by describing the stock market as a bubble. The demand for stocks went unchecked, which caused an increase in stock prices, margin buying, and widespread speculation. All of this then led to a bubble, which eventually burst.
Lessons Learned
There’s plenty that we can learn from the stock market crash of 1929 and the Great Depression that followed. Plus, since that devastating period in our history we’ve also had the Great Recession.
While very different, both were painful. And both offer important lessons.
- Crashes Happen: The first and perhaps most obvious lesson is that stock market crashes are a reality. Every investor has to accept that markets move in cycles. Asset bubbles occur. We may be surprised by the timing, but we should never be surprised that bear markets occur.
- Margin is Dangerous: Buying stocks on margin is a dangerous game. Any form of leverage adds risk. With stocks, however, the risk is multiplied. A mortgage can’t be called because the value of a property declines. With stocks bought on margin, the debt can and will be called if values drop.
- Debt is the Devil’s Playground: Beyond margin, all forms of debt increase risk to your finances. Those with little or no debt are more able to navigate financial turmoil.
- Black Swans Exist: The unexpected can and will happen… eventually. Just because interest rates are low today doesn’t mean they will be low forever. Just because stocks seem overvalued doesn’t mean that they can’t go up. The list goes on.
Related: How to Invest Like Warren Buffett
The crash of 1929 was devastating to so many. The lessons learned were very difficult, unprecedented ones.
However, there are many ways we can prevent such large-scale devastation from happening in the future. While we cannot avoid or even perfectly predict stock market crashes, we can minimize their effect on our own finances. The four lessons above are a great place to start.
Do you have additional thoughts or ideas that would help other readers? Please share them below!
If you want to learn more about why I think you should cheer a stock market crash, here is my podcast on the topic:
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