- The Washington Times - Friday, October 29, 2004

NEW YORK — Nobody seemed to pay much attention to the bad news that cropped up in the stock market throughout the year in 1929. Individual investors were buying stocks on margin, speculators drove up prices and the government had a hands-off policy on the economy.

The resulting crash on Oct. 28-29, 1929, drove the Dow Jones Industrial Average down 23.9 percent, sparking a widespread panic that helped sink the nation into the Great Depression.

Seventy-five years later, although Wall Street recovered not only from that crash but subsequent precipitous declines, the question lingers: Can 1929 happen again?

The crash was preceded by a series of sharp declines. But those drops during October created little fear among investors or the public at large. There had been one other major decline in stock prices — a 24.39 percent drop on Dec. 12, 1914, precipitated by the start of World War I.

And while the war years were hard, the Roaring Twenties were an era of unprecedented economic growth, with the overall stock market increasing in price by 667 percent.

Historians say that as individual wealth increased, stock ownership became a hallmark of the burgeoning middle class, leading to widespread speculation in stocks.

“In the 1800s, people had no idea that they could do these kind of things with their money,” said Michael Bernstein, professor of history and economics at the University of California at San Diego. “The experience of the war bonds — buying pieces of paper and getting a return on them down the road — really got people into this idea of paper assets, and it became a kind of craze.”

The speculation of the 1920s was not just in stocks, but also in bonds, real estate and commodities such as oil and coal. So when investors finally woke up to what was happening on Wall Street, they rushed to pull their money out of those other investments to cover their stock losses, causing the value of all their holdings to tumble as well.

The two days of the 1929 crash rank as the third- and fourth-largest one-day percentage losses for the Dow. The 1914 loss remains the largest, followed by the Oct. 19, 1987, crash, when the Dow fell 508 points, or 22.61 percent. But those two crashes did not result in major economic depressions. Why?

The scramble for cash after the 1929 crash and the subsequent selloffs in other investments occurred because small investors weren’t buying stock with their own money — they were buying on margin. They borrowed money from banks and brokerage houses, then used it to buy stock with the idea that the share prices would rise, and they could sell off the stock, repay the loan and walk away with the profits. And for much of the 1920s, it worked well.

But as the markets started crumbling in 1929, banks and creditors started calling in their margins, forcing investors to repay the loans. To do that, investors had to sell off their stocks and other holdings and, as the markets fell rapidly, some investors started defaulting. Faced with increasing defaults, banks called in more margins. More investors defaulted.

Analysts now say it was a perfect downward spiral.

“You had a large amount of margin that would cascade upon itself, triggering further margin calls. And it was completely unsustainable, with no floor underneath it,” said Richard Driehaus, founder of Driehaus Capital Management Inc.

Today, the federal government plays a major role in the health of the U.S. economy. But in the 1920s, Washington did not meddle in business. Times were good, and the thinking was that government interference would discourage investment.

Years later, as the 1987 crash was under way, “the federal government almost immediately took steps to reassure investors. Trading was suspended and, behind the scenes, we know now that the Fed and other government officials took steps to convince people to start buying the next day,” Mr. Bernstein said.

“In October of 1929, a few steps were taken, but Washington really did nothing. One thing we learned from that is that when investor confidence goes in the tank, the government has to take steps to let people know that they’re going to get things under control.”

Another major factor in the 1929 collapse was the weakness of the Federal Reserve. With the Fed 15 years old at the time, the central bank’s members had no idea not only of what to do, but what they could do.

In that era, the Fed was primarily concerned with protecting the integrity of the nation’s currency in world markets, not the overall health of the economy, according to Joseph McAlinden, chief investment officer for Morgan Stanley Investment Management. Raising interest rates would keep the dollar stronger against other currencies and stave off inflation, the Fed reasoned.

“Instead of lowering interest rates, they tightened up and continued to tighten up for the next several years, resulting in a further decline in stocks that didn’t hit bottom until the summer of ‘32, when the markets were 90 percent off their highs,” he said.

Now, of course, the Fed is quicker to respond to market crashes by cutting rates, moving more money into the economy at bargain borrowing rates.

With rampant speculation, heavy margin borrowing, lack of government regulation and an inexperienced Federal Reserve, the nation spiraled into the Great Depression. Some 10,000 banks — hurt by massive loan defaults — shuttered. Millions of people were put out of work, and their investments were reduced to nothing.

The Dow, after peaking at 381 in September 1929, fell to just 41 by July 1932. It would take a quarter century, until 1954, until the Dow rose above 300 again.

Experts agree that the market has, and will, experience crashes like that of 1929. But the experience of 1929 means another big depression is unlikely.

“Today’s economy is much more vibrant, more mature, more diversified,” Mr. Driehaus said. “Margin calls are far better regulated. The Fed knows what it’s doing.

“It’s a different world.”

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