Harold Bierman, Jr., Cornell University
The 1929 stock market crash is conventionally said to have occurred on Thursday the 24th and Tuesday the 29th of October. These two dates have been dubbed “Black Thursday” and “Black Tuesday,” respectively. On September 3, 1929, the Dow Jones Industrial Average reached a record high of 381.2. At the end of the market day on Thursday, October 24, the market was at 299.5 — a 21 percent decline from the high. On this day the market fell 33 points — a drop of 9 percent — on trading that was approximately three times the normal daily volume for the first nine months of the year. By all accounts, there was a selling panic. By November 13, 1929, the market had fallen to 199. By the time the crash was completed in 1932, following an unprecedentedly large economic depression, stocks had lost nearly 90 percent of their value.
The events of Black Thursday are normally defined to be the start of the stock market crash of 1929-1932, but the series of events leading to the crash started before that date. This article examines the causes of the 1929 stock market crash. While no consensus exists about its precise causes, the article will critique some arguments and support a preferred set of conclusions. It argues that one of the primary causes was the attempt by important people and the media to stop market speculators. A second probable cause was the great expansion of investment trusts, public utility holding companies, and the amount of margin buying, all of which fueled the purchase of public utility stocks, and drove up their prices. Public utilities, utility holding companies, and investment trusts were all highly levered using large amounts of debt and preferred stock. These factors seem to have set the stage for the triggering event. This sector was vulnerable to the arrival of bad news regarding utility regulation. In October 1929, the bad news arrived and utility stocks fell dramatically. After the utilities decreased in price, margin buyers had to sell and there was then panic selling of all stocks.
The Conventional View
The crash helped bring on the depression of the thirties and the depression helped to extend the period of low stock prices, thus “proving” to many that the prices had been too high.
Laying the blame for the “boom” on speculators was common in 1929. Thus, immediately upon learning of the crash of October 24 John Maynard Keynes (Moggridge, 1981, p. 2 of Vol. XX) wrote in the New York Evening Post (25 October 1929) that “The extraordinary speculation on Wall Street in past months has driven up the rate of interest to an unprecedented level.” And the Economist when stock prices reached their low for the year repeated the theme that the U.S. stock market had been too high (November 2, 1929, p. 806): “there is warrant for hoping that the deflation of the exaggerated balloon of American stock values will be for the good of the world.” The key phrases in these quotations are “exaggerated balloon of American stock values” and “extraordinary speculation on Wall Street.” Likewise, President Herbert Hoover saw increasing stock market prices leading up to the crash as a speculative bubble manufactured by the mistakes of the Federal Reserve Board. “One of these clouds was an American wave of optimism, born of continued progress over the decade, which the Federal Reserve Board transformed into the stock-exchange Mississippi Bubble” (Hoover, 1952). Thus, the common viewpoint was that stock prices were too high.
There is much to criticize in conventional interpretations of the 1929 stock market crash, however. (Even the name is inexact. The largest losses to the market did not come in October 1929 but rather in the following two years.) In December 1929, many expert economists, including Keynes and Irving Fisher, felt that the financial crisis had ended and by April 1930 the Standard and Poor 500 composite index was at 25.92, compared to a 1929 close of 21.45. There are good reasons for thinking that the stock market was not obviously overvalued in 1929 and that it was sensible to hold most stocks in the fall of 1929 and to buy stocks in December 1929 (admittedly this investment strategy would have been terribly unsuccessful).
Were Stocks Obviously Overpriced in October 1929?
Debatable — Economic Indicators Were Strong
From 1925 to the third quarter of 1929, common stocks increased in value by 120 percent in four years, a compound annual growth of 21.8%. While this is a large rate of appreciation, it is not obvious proof of an “orgy of speculation.” The decade of the 1920s was extremely prosperous and the stock market with its rising prices reflected this prosperity as well as the expectation that the prosperity would continue.
The fact that the stock market lost 90 percent of its value from 1929 to 1932 indicates that the market, at least using one criterion (actual performance of the market), was overvalued in 1929. John Kenneth Galbraith (1961) implies that there was a speculative orgy and that the crash was predictable: “Early in 1928, the nature of the boom changed. The mass escape into make-believe, so much a part of the true speculative orgy, started in earnest.” Galbraith had no difficulty in 1961 identifying the end of the boom in 1929: “On the first of January of 1929, as a matter of probability, it was most likely that the boom would end before the year was out.”
Compare this position with the fact that Irving Fisher, one of the leading economists in the U.S. at the time, was heavily invested in stocks and was bullish before and after the October sell offs; he lost his entire wealth (including his house) before stocks started to recover. In England, John Maynard Keynes, possibly the world’s leading economist during the first half of the twentieth century, and an acknowledged master of practical finance, also lost heavily. Paul Samuelson (1979) quotes P. Sergeant Florence (another leading economist): “Keynes may have made his own fortune and that of King’s College, but the investment trust of Keynes and Dennis Robertson managed to lose my fortune in 1929.”
Galbraith’s ability to ‘forecast’ the market turn is not shared by all. Samuelson (1979) admits that: “playing as I often do the experiment of studying price profiles with their dates concealed, I discovered that I would have been caught by the 1929 debacle.” For many, the collapse from 1929 to 1933 was neither foreseeable nor inevitable.
The stock price increases leading to October 1929, were not driven solely by fools or speculators. There were also intelligent, knowledgeable investors who were buying or holding stocks in September and October 1929. Also, leading economists, both then and now, could neither anticipate nor explain the October 1929 decline of the market. Thus, the conviction that stocks were obviously overpriced is somewhat of a myth.
The nation’s total real income rose from 1921 to 1923 by 10.5% per year, and from 1923 to 1929, it rose 3.4% per year. The 1920s were, in fact, a period of real growth and prosperity. For the period of 1923-1929, wholesale prices went down 0.9% per year, reflecting moderate stable growth in the money supply during a period of healthy real growth.
Examining the manufacturing situation in the United States prior to the crash is also informative. Irving Fisher’s Stock Market Crash and After (1930) offers much data indicating that there was real growth in the manufacturing sector. The evidence presented goes a long way to explain Fisher’s optimism regarding the level of stock prices. What Fisher saw was manufacturing efficiency rapidly increasing (output per worker) as was manufacturing output and the use of electricity.
The financial fundamentals of the markets were also strong. During 1928, the price-earnings ratio for 45 industrial stocks increased from approximately 12 to approximately 14. It was over 15 in 1929 for industrials and then decreased to approximately 10 by the end of 1929. While not low, these price-earnings (P/E) ratios were by no means out of line historically. Values in this range would be considered reasonable by most market analysts today. For example, the P/E ratio of the S & P 500 in July 2003 reached a high of 33 and in May 2004 the high was 23.
The rise in stock prices was not uniform across all industries. The stocks that went up the most were in industries where the economic fundamentals indicated there was cause for large amounts of optimism. They included airplanes, agricultural implements, chemicals, department stores, steel, utilities, telephone and telegraph, electrical equipment, oil, paper, and radio. These were reasonable choices for expectations of growth.
To put the P/E ratios of 10 to 15 in perspective, note that government bonds in 1929 yielded 3.4%. Industrial bonds of investment grade were yielding 5.1%. Consider that an interest rate of 5.1% represents a 1/(0.051) = 19.6 price-earnings ratio for debt.
In 1930, the Federal Reserve Bulletin reported production in 1920 at an index of 87.1 The index went down to 67 in 1921, then climbed steadily (except for 1924) until it reached 125 in 1929. This is an annual growth rate in production of 3.1%. During the period commodity prices actually decreased. The production record for the ten-year period was exceptionally good.
Factory payrolls in September were at an index of 111 (an all-time high). In October the index dropped to 110, which beat all previous months and years except for September 1929. The factory employment measures were consistent with the payroll index.
The September unadjusted measure of freight car loadings was at 121 — also an all-time record.2 In October the loadings dropped to 118, which was a performance second only to September’s record measure.
J.W. Kendrick (1961) shows that the period 1919-1929 had an unusually high rate of change in total factor productivity. The annual rate of change of 5.3% for 1919-1929 for the manufacturing sector was more than twice the 2.5% rate of the second best period (1948-1953). Farming productivity change for 1919-1929 was second only to the period 1929-1937. Overall, the period 1919-1929 easily took first place for productivity increases, handily beating the six other time periods studied by Kendrick (all the periods studies were prior to 1961) with an annual productivity change measure of 3.7%. This was outstanding economic performance — performance which normally would justify stock market optimism.
In the first nine months of 1929, 1,436 firms announced increased dividends. In 1928, the number was only 955 and in 1927, it was 755. In September 1929 dividend increased were announced by 193 firms compared with 135 the year before. The financial news from corporations was very positive in September and October 1929.
The May issue of the National City Bank of New York Newsletter indicated the earnings statements for the first quarter of surveyed firms showed a 31% increase compared to the first quarter of 1928. The August issue showed that for 650 firms the increase for the first six months of 1929 compared to 1928 was 24.4%. In September, the results were expanded to 916 firms with a 27.4% increase. The earnings for the third quarter for 638 firms were calculated to be 14.1% larger than for 1928. This is evidence that the general level of business activity and reported profits were excellent at the end of September 1929 and the middle of October 1929.
Barrie Wigmore (1985) researched 1929 financial data for 135 firms. The market price as a percentage of year-end book value was 420% using the high prices and 181% using the low prices. However, the return on equity for the firms (using the year-end book value) was a high 16.5%. The dividend yield was 2.96% using the high stock prices and 5.9% using the low stock prices.
Article after article from January to October in business magazines carried news of outstanding economic performance. E.K. Berger and A.M. Leinbach, two staff writers of the Magazine of Wall Street, wrote in June 1929: “Business so far this year has astonished even the perennial optimists.”
To summarize: There was little hint of a severe weakness in the real economy in the months prior to October 1929. There is a great deal of evidence that in 1929 stock prices were not out of line with the real economics of the firms that had issued the stock. Leading economists were betting that common stocks in the fall of 1929 were a good buy. Conventional financial reports of corporations gave cause for optimism relative to the 1929 earnings of corporations. Price-earnings ratios, dividend amounts and changes in dividends, and earnings and changes in earnings all gave cause for stock price optimism.
Table 1 shows the average of the highs and lows of the Dow Jones Industrial Index for 1922 to 1932.
Dow-Jones Industrials Index Average
of Lows and Highs for the Year
Sources: 1922-1929 measures are from the Stock Market Study, U.S. Senate, 1955, pp. 40, 49, 110, and 111; 1930-1932 Wigmore, 1985, pp. 637-639.
Using the information of Table 1, from 1922 to 1929 stocks rose in value by 218.7%. This is equivalent to an 18% annual growth rate in value for the seven years. From 1929 to 1932 stocks lost 73% of their value (different indices measured at different time would give different measures of the increase and decrease). The price increases were large, but not beyond comprehension. The price decreases taken to 1932 were consistent with the fact that by 1932 there was a worldwide depression.
If we take the 386 high of September 1929 and the 1929-year end value of 248.5, the market lost 36% of its value during that four-month period. Most of us, if we held stock in September 1929 would not have sold early in October. In fact, if I had money to invest, I would have purchased after the major break on Black Thursday, October 24. (I would have been sorry.)
Events Precipitating the Crash
Although it can be argued that the stock market was not overvalued, there is evidence that many feared that it was overvalued — including the Federal Reserve Board and the United States Senate. By 1929, there were many who felt the market price of equity securities had increased too much, and this feeling was reinforced daily by the media and statements by influential government officials.
What precipitated the October 1929 crash?
My research minimizes several candidates that are frequently cited by others (see Bierman 1991, 1998, 1999, and 2001).
- The market did not fall just because it was too high — as argued above it is not obvious that it was too high.
- The actions of the Federal Reserve, while not always wise, cannot be directly identified with the October stock market crashes in an important way.
- The Smoot-Hawley tariff, while looming on the horizon, was not cited by the news sources in 1929 as a factor, and was probably not important to the October 1929 market.
- The Hatry Affair in England was not material for the New York Stock Exchange and the timing did not coincide with the October crashes.
- Business activity news in October was generally good and there were very few hints of a coming depression.
- Short selling and bear raids were not large enough to move the entire market.
- Fraud and other illegal or immoral acts were not material, despite the attention they have received.
Barsky and DeLong (1990, p. 280) stress the importance of fundamentals rather than fads or fashions. “Our conclusion is that major decade-to-decade stock market movements arise predominantly from careful re-evaluation of fundamentals and less so from fads or fashions.” The argument below is consistent with their conclusion, but there will be one major exception. In September 1929, the market value of one segment of the market, the public utility sector, should be based on existing fundamentals, and fundamentals seem to have changed considerably in October 1929.
A Look at the Financial Press
Thursday, October 3, 1929, the Washington Post with a page 1 headline exclaimed “Stock Prices Crash in Frantic Selling.” the New York Times of October 4 headed a page 1 article with “Year’s Worst Break Hits Stock Market.” The article on the first page of the Times cited three contributing factors:
- A large broker loan increase was expected (the article stated that the loans increased, but the increase was not as large as expected).
- The statement by Philip Snowden, England’s Chancellor of the Exchequer that described America’s stock market as a “speculative orgy.”
- Weakening of margin accounts making it necessary to sell, which further depressed prices.
While the 1928 and 1929 financial press focused extensively and excessively on broker loans and margin account activity, the statement by Snowden is the only unique relevant news event on October 3. The October 4 (p. 20) issue of the Wall Street Journal also reported the remark by Snowden that there was “a perfect orgy of speculation.” Also, on October 4, the New York Times made another editorial reference to Snowden’s American speculation orgy. It added that “Wall Street had come to recognize its truth.” The editorial also quoted Secretary of the Treasury Mellon that investors “acted as if the price of securities would infinitely advance.” The Times editor obviously thought there was excessive speculation, and agreed with Snowden.
The stock market went down on October 3 and October 4, but almost all reported business news was very optimistic. The primary negative news item was the statement by Snowden regarding the amount of speculation in the American stock market. The market had been subjected to a barrage of statements throughout the year that there was excessive speculation and that the level of stock prices was too high. There is a possibility that the Snowden comment reported on October 3 was the push that started the boulder down the hill, but there were other events that also jeopardized the level of the market.
On August 8, the Federal Reserve Bank of New York had increased the rediscount rate from 5 to 6%. On September 26 the Bank of England raised its discount rate from 5.5 to 6.5%. England was losing gold as a result of investment in the New York Stock Exchange and wanted to decrease this investment. The Hatry Case also happened in September. It was first reported on September 29, 1929. Both the collapse of the Hatry industrial empire and the increase in the investment returns available in England resulted in shrinkage of English investment (especially the financing of broker loans) in the United States, adding to the market instability in the beginning of October.
Wednesday, October 16, 1929
On Wednesday, October 16, stock prices again declined. the Washington Post (October 17, p. 1) reported “Crushing Blow Again Dealt Stock Market.” Remember, the start of the stock market crash is conventionally identified with Black Thursday, October 24, but there were price declines on October 3, 4, and 16.
The news reports of the Post on October 17 and subsequent days are important since they were Associated Press (AP) releases, thus broadly read throughout the country. The Associated Press reported (p. 1) “The index of 20 leading public utilities computed for the Associated Press by the Standard Statistics Co. dropped 19.7 points to 302.4 which contrasts with the year’s high established less than a month ago.” This index had also dropped 18.7 points on October 3 and 4.3 points on October 4. The Times (October 17, p. 38) reported, “The utility stocks suffered most as a group in the day’s break.”
The economic news after the price drops of October 3 and October 4 had been good. But the deluge of bad news regarding public utility regulation seems to have truly upset the market. On Saturday, October 19, the Washington Post headlined (p. 13) “20 Utility Stocks Hit New Low Mark” and (Associated Press) “The utility shares again broke wide open and the general list came tumbling down almost half as far.” The October 20 issue of the Post had another relevant AP article (p. 12) “The selling again concentrated today on the utilities, which were in general depressed to the lowest levels since early July.”
An evaluation of the October 16 break in the New York Times on Sunday, October 20 (pp. 1 and 29) gave the following favorable factors:
- stable business condition
- low money rates (5%)
- good retail trade
- revival of the bond market
- buying power of investment trusts
- largest short interest in history (this is the total dollar value of stock sold where the investors do not own the stock they sold)
The following negative factors were described:
- undigested investment trusts and new common stock shares
- increase in broker loans
- some high stock prices
- agricultural prices lower
- nervous market
The negative factors were not very upsetting to an investor if one was optimistic that the real economic boom (business prosperity) would continue. The Times failed to consider the impact on the market of the news concerning the regulation of public utilities.
Monday, October 21, 1929
On Monday, October 21, the market went down again. The Times (October 22) identified the causes to be
- margin sellers (buyers on margin being forced to sell)
- foreign money liquidating
- skillful short selling
The same newspaper carried an article about a talk by Irving Fisher (p. 24) “Fisher says prices of stocks are low.” Fisher also defended investment trusts as offering investors diversification, thus reduced risk. He was reminded by a person attending the talk that in May he had “pointed out that predicting the human behavior of the market was quite different from analyzing its economic soundness.” Fisher was better with fundamentals than market psychology.
Wednesday, October 23, 1929
On Wednesday, October 23 the market tumbled. The Times headlines (October 24, p.1) said “Prices of Stocks Crash in Heavy Liquidation.” The Washington Post (p. 1) had “Huge Selling Wave Creates Near-Panic as Stocks Collapse.” In a total market value of $87 billion the market declined $4 billion — a 4.6% drop. If the events of the next day (Black Thursday) had not occurred, October 23 would have gone down in history as a major stock market event. But October 24 was to make the “Crash” of October 23 become merely a “Dip.”
The Times lamented October 24, (p. 38) “There was hardly a single item of news which might be construed as bearish.”
Thursday, October 24, 1929
Thursday, October 24 (Black Thursday) was a 12,894,650 share day (the previous record was 8,246,742 shares on March 26, 1929) on the NYSE. The headline on page one of the Times (October 25) was “Treasury Officials Blame Speculation.”
The Times (p. 41) moaned that the cost of call money had been 20% in March and the price break in March was understandable. (A call loan is a loan payable on demand of the lender.) Call money on October 24 cost only 5%. There should not have been a crash. The Friday Wall Street Journal (October 25) gave New York bankers credit for stopping the price decline with $1 billion of support.
the Washington Post (October 26, p. 1) reported “Market Drop Fails to Alarm Officials.” The “officials” were all in Washington. The rest of the country seemed alarmed. On October 25, the market gained. President Hoover made a statement on Friday regarding the excellent state of business, but then added how building and construction had been adversely “affected by the high interest rates induced by stock speculation” (New York Times, October 26, p. 1). A Times editorial (p. 16) quoted Snowden’s “orgy of speculation” again.
Tuesday, October 29, 1929
The Sunday, October 27 edition of the Times had a two-column article “Bay State Utilities Face Investigation.” It implied that regulation in Massachusetts was going to be less friendly towards utilities. Stocks again went down on Monday, October 28. There were 9,212,800 shares traded (3,000,000 in the final hour). The Times on Tuesday, October 29 again carried an article on the New York public utility investigating committee being critical of the rate making process. October 29 was “Black Tuesday.” The headline the next day was “Stocks Collapse in 16,410,030 Share Day” (October 30, p. 1). Stocks lost nearly $16 billion in the month of October or 18% of the beginning of the month value. Twenty-nine public utilities (tabulated by the New York Times) lost $5.1 billion in the month, by far the largest loss of any of the industries listed by the Times. The value of the stocks of all public utilities went down by more than $5.1 billion.
An Interpretive Overview of Events and Issues
My interpretation of these events is that the statement by Snowden, Chancellor of the Exchequer, indicating the presence of a speculative orgy in America is likely to have triggered the October 3 break. Public utility stocks had been driven up by an explosion of investment trust formation and investing. The trusts, to a large extent, bought stock on margin with funds loaned not by banks but by “others.” These funds were very sensitive to any market weakness. Public utility regulation was being reviewed by the Federal Trade Commission, New York City, New York State, and Massachusetts, and these reviews were watched by the other regulatory commissions and by investors. The sell-off of utility stocks from October 16 to October 23 weakened prices and created “margin selling” and withdrawal of capital by the nervous “other” money. Then on October 24, the selling panic happened.
There are three topics that require expansion. First, there is the setting of the climate concerning speculation that may have led to the possibility of relatively specific issues being able to trigger a general market decline. Second, there are investment trusts, utility holding companies, and margin buying that seem to have resulted in one sector being very over-levered and overvalued. Third, there are the public utility stocks that appear to be the best candidate as the actual trigger of the crash.
Contemporary Worries of Excessive Speculation
During 1929, the public was bombarded with statements of outrage by public officials regarding the speculative orgy taking place on the New York Stock Exchange. If the media say something often enough, a large percentage of the public may come to believe it. By October 29 the overall opinion was that there had been excessive speculation and the market had been too high. Galbraith (1961), Kindleberger (1978), and Malkiel (1996) all clearly accept this assumption. the Federal Reserve Bulletin of February 1929 states that the Federal Reserve would restrain the use of “credit facilities in aid of the growth of speculative credit.”
In the spring of 1929, the U.S. Senate adopted a resolution stating that the Senate would support legislation “necessary to correct the evil complained of and prevent illegitimate and harmful speculation” (Bierman, 1991).
The President of the Investment Bankers Association of America, Trowbridge Callaway, gave a talk in which he spoke of “the orgy of speculation which clouded the country’s vision.”
Adolph Casper Miller, an outspoken member of the Federal Reserve Board from its beginning described 1929 as “this period of optimism gone wild and cupidity gone drunk.”
Myron C. Taylor, head of U.S. Steel described “the folly of the speculative frenzy that lifted securities to levels far beyond any warrant of supporting profits.”
Herbert Hoover becoming president in March 1929 was a very significant event. He was a good friend and neighbor of Adolph Miller (see above) and Miller reinforced Hoover’s fears. Hoover was an aggressive foe of speculation. For example, he wrote, “I sent individually for the editors and publishers of major newspapers and magazine and requested them systematically to warn the country against speculation and the unduly high price of stocks.” Hoover then pressured Secretary of the Treasury Andrew Mellon and Governor of the Federal Reserve Board Roy Young “to strangle the speculative movement.” In his memoirs (1952) he titled his Chapter 2 “We Attempt to Stop the Orgy of Speculation” reflecting Snowden’s influence.
Buying on Margin
Margin buying during the 1920’s was not controlled by the government. It was controlled by brokers interested in their own well-being. The average margin requirement was 50% of the stock price prior to October 1929. On selected stocks, it was as high as 75%. When the crash came, no major brokerage firm was bankrupted, because the brokers managed their finances in a conservative manner. At the end of October, margins were lowered to 25%.
Brokers’ loans received a lot of attention in England, as they did in the United States. The Financial Times reported the level and the changes in the amount regularly. For example, the October 4 issue indicated that on October 3 broker loans reached a record high as money rates dropped from 7.5% to 6%. By October 9, money rates had dropped further to below .06. Thus, investors prior to October 24 had relatively easy access to funds at the lowest rate since July 1928.
The Financial Times (October 7, 1929, p. 3) reported that the President of the American Bankers Association was concerned about the level of credit for securities and had given a talk in which he stated, “Bankers are gravely alarmed over the mounting volume of credit being employed in carrying security loans, both by brokers and by individuals.” The Financial Times was also concerned with the buying of investment trusts on margin and the lack of credit to support the bull market.
My conclusion is that the margin buying was a likely factor in causing stock prices to go up, but there is no reason to conclude that margin buying triggered the October crash. Once the selling rush began, however, the calling of margin loans probably exacerbated the price declines. (A calling of margin loans requires the stock buyer to contribute more cash to the broker or the broker sells the stock to get the cash.)
By 1929, investment trusts were very popular with investors. These trusts were the 1929 version of closed-end mutual funds. In recent years seasoned closed-end mutual funds sell at a discount to their fundamental value. The fundamental value is the sum of the market values of the fund’s components (securities in the portfolio). In 1929, the investment trusts sold at a premium — i.e. higher than the value of the underlying stocks. Malkiel concludes (p. 51) that this “provides clinching evidence of wide-scale stock-market irrationality during the 1920s.” However, Malkiel also notes (p. 442) “as of the mid-1990’s, Berkshire Hathaway shares were selling at a hefty premium over the value of assets it owned.” Warren Buffett is the guiding force behind Berkshire Hathaway’s great success as an investor. If we were to conclude that rational investors would currently pay a premium for Warren Buffet’s expertise, then we should reject a conclusion that the 1929 market was obviously irrational. We have current evidence that rational investors will pay a premium for what they consider to be superior money management skills.
There were $1 billion of investment trusts sold to investors in the first eight months of 1929 compared to $400 million in the entire 1928. the Economist reported that this was important (October 12, 1929, p. 665). “Much of the recent increase is to be accounted for by the extraordinary burst of investment trust financing.” In September alone $643 million was invested in investment trusts (Financial Times, October 21, p. 3). While the two sets of numbers (from the Economist and the Financial Times) are not exactly comparable, both sets of numbers indicate that investment trusts had become very popular by October 1929.
The common stocks of trusts that had used debt or preferred stock leverage were particularly vulnerable to the stock price declines. For example, the Goldman Sachs Trading Corporation was highly levered with preferred stock and the value of its common stock fell from $104 a share to less than $3 in 1933. Many of the trusts were levered, but the leverage of choice was not debt but rather preferred stock.
In concept, investment trusts were sensible. They offered expert management and diversification. Unfortunately, in 1929 a diversification of stocks was not going to be a big help given the universal price declines. Irving Fisher on September 6, 1929 was quoted in the New York Herald Tribune as stating: “The present high levels of stock prices and corresponding low levels of dividend returns are due largely to two factors. One, the anticipation of large dividend returns in the immediate future; and two, reduction of risk to investors largely brought about through investment diversification made possible for the investor by investment trusts.”
If a researcher could find out the composition of the portfolio of a couple of dozen of the largest investment trusts as of September-October 1929 this would be extremely helpful. Seven important types of information that are not readily available but would be of interest are:
- The percentage of the portfolio that was public utilities.
- The extent of diversification.
- The percentage of the portfolios that was NYSE firms.
- The investment turnover.
- The ratio of market price to net asset value at various points in time.
- The amount of debt and preferred stock leverage used.
- Who bought the trusts and how long they held.
The ideal information to establish whether market prices are excessively high compared to intrinsic values is to have both the prices and well-defined intrinsic values at the same moment in time. For the normal financial security, this is impossible since the intrinsic values are not objectively well defined. There are two exceptions. DeLong and Schleifer (1991) followed one path, very cleverly choosing to study closed-end mutual funds. Some of these funds were traded on the stock market and the market values of the securities in the funds’ portfolios are a very reasonable estimate of the intrinsic value. DeLong and Schleifer state (1991, p. 675):
“We use the difference between prices and net asset values of closed-end mutual funds at the end of the 1920s to estimate the degree to which the stock market was overvalued on the eve of the 1929 crash. We conclude that the stocks making up the S&P composite were priced at least 30 percent above fundamentals in late summer, 1929.”
Unfortunately (p. 682) “portfolios were rarely published and net asset values rarely calculated.” It was only after the crash that investment trusts started to reveal routinely their net asset value. In the third quarter of 1929 (p. 682), “three types of event seemed to trigger a closed-end fund’s publication of its portfolio.” The three events were (1) listing on the New York Stock Exchange (most of the trusts were not listed), (2) start up of a new closed-end fund (this stock price reflects selling pressure), and (3) shares selling at a discount from net asset value (in September 1929 most trusts were not selling at a discount, the inclusion of any that were introduces a bias). After 1929, some trusts revealed 1929 net asset values. Thus, DeLong and Schleifer lacked the amount and quality of information that would have allowed definite conclusions. In fact, if investors also lacked the information regarding the portfolio composition we would have to place investment trusts in a unique investment category where investment decisions were made without reliable financial statements. If investors in the third quarter of 1929 did not know the current net asset value of investment trusts, this fact is significant.
The closed-end funds were an attractive vehicle to study since the market for investment trusts in 1929 was large and growing rapidly. In August and September alone over $1 billion of new funds were launched. DeLong and Schleifer found the premiums of price over value to be large — the median was about 50% in the third quarter of 1929) (p. 678). But they worried about the validity of their study because funds were not selected randomly.
DeLong and Schleifer had limited data (pp. 698-699). For example, for September 1929 there were two observations, for August 1929 there were five, and for July there were nine. The nine funds observed in July 1929 had the following premia: 277%, 152%, 48%, 22%, 18% (2 times), 8% (3 times). Given that closed-end funds tend to sell at a discount, the positive premiums are interesting. Given the conventional perspective in 1929 that financial experts could manager money better than the person not plugged into the street, it is not surprising that some investors were willing to pay for expertise and to buy shares in investment trusts. Thus, a premium for investment trusts does not imply the same premium for other stocks.
The Public Utility Sector
In addition to investment trusts, intrinsic values are usually well defined for regulated public utilities. The general rule applied by regulatory authorities is to allow utilities to earn a “fair return” on an allowed rate base. The fair return is defined to be equal to a utility’s weighted average cost of capital. There are several reasons why a public utility can earn more or less than a fair return, but the target set by the regulatory authority is the weighted average cost of capital.
Thus, if a utility has an allowed rate equity base of $X and is allowed to earn a return of r, (rX in terms of dollars) after one year the firm’s equity will be worth X + rX or (1 + r)X with a present value of X. (This assumes that r is the return required by the market as well as the return allowed by regulators.) Thus, the present value of the equity is equal to the present rate base, and the stock price should be equal to the rate base per share. Given the nature of public utility accounting, the book value of a utility’s stock is approximately equal to the rate base.
There can be time periods where the utility can earn more (or less) than the allowed return. The reasons for this include regulatory lag, changes in efficiency, changes in the weather, and changes in the mix and number of customers. Also, the cost of equity may be different than the allowed return because of inaccurate (or incorrect) or changing capital market conditions. Thus, the stock price may differ from the book value, but one would not expect the stock price to be very much different than the book value per share for very long. There should be a tendency for the stock price to revert to the book value for a public utility supplying an essential service where there is no effective competition, and the rate commission is effectively allowing a fair return to be earned.
In 1929, public utility stock prices were in excess of three times their book values. Consider, for example, the following measures (Wigmore, 1985, p. 39) for five operating utilities.
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1929 Price-earnings Ratio
High Price for Year
Market Price/Book Value
Consolidated Gas of New York
Pacific Gas & Electric
Public Service of New Jersey
Sooner or later this price bubble had to break unless the regulatory authorities were to decide to allow the utilities to earn more than a fair return, or an infinite stream of greater fools existed. The decision made by the Massachusetts Public Utility Commission in October 1929 applicable to the Edison Electric Illuminating Company of Boston made clear that neither of these improbable events were going to happen (see below).
The utilities bubble did burst. Between the end of September and the end of November 1929, industrial stocks fell by 48%, railroads by 32% and utilities by 55% — thus utilities dropped the furthest from the highs. A comparison of the beginning of the year prices and the highest prices is also of interest: industrials rose by 20%, railroads by 19%, and utilities by 48%. The growth in value for utilities during the first nine months of 1929 was more than twice that of the other two groups.
The following high and low prices for 1929 for a typical set of public utilities and holding companies illustrate how severely public utility prices were hit by the crash (New York Times, 1 January 1930 quotations.)
|Firm||High Price||Low Price||Low Price DividedBy High Price|
|American Power & Light||1753/8||641/4||.37|
|Buffalo, Niagara & Eastern Power||128||611/8||.48|
|Consolidated Gas Co. of N.Y.||1831/4||801/8||.44|
|Electric Bond and Share||189||50||.26|
|Long Island Lighting||91||40||.44|
|Niagara Hudson Power||303/4||111/4||.37|
Picking on one segment of the market as the cause of a general break in the market is not obviously correct. But the combination of an overpriced utility segment and investment trusts with a portion of the market that had purchased on margin appears to be a viable explanation. In addition, as of September 1, 1929 utilities industry represented $14.8 billion of value or 18% of the value of the outstanding shares on the NYSE. Thus, they were a large sector, capable of exerting a powerful influence on the overall market. Moreover, many contemporaries pointed to the utility sector as an important force in triggering the market decline.
The October 19, 1929 issue of the Commercial and Financial Chronicle identified the main depressing influences on the market to be the indications of a recession in steel and the refusal of the Massachusetts Department of Public Utilities to allow Edison Electric Illuminating Company of Boston to split its stock. The explanations offered by the Department — that the stock was not worth its price and the company’s dividend would have to be reduced — made the situation worse.
the Washington Post (October 17, p. 1) in explaining the October 16 market declines (an Associated Press release) reported, “Professional traders also were obviously distressed at the printed remarks regarding inflation of power and light securities by the Massachusetts Public Utility Commission in its recent decision.”
Straws That Broke the Camel’s Back?
Edison Electric of Boston
On August 2, 1929, the New York Times reported that the Directors of the Edison Electric Illuminating Company of Boston had called a meeting of stockholders to obtain authorization for a stock split. The stock went up to a high of $440. Its book value was $164 (the ratio of price to book value was 2.6, which was less than many other utilities).
On Saturday (October 12, p. 27) the Times reported that on Friday the Massachusetts Department of Public Utilities has rejected the stock split. The heading said “Bars Stock Split by Boston Edison. Criticizes Dividend Policy. Holds Rates Should Not Be Raised Until Company Can Reduce Charge for Electricity.” Boston Edison lost 15 points for the day even though the decision was released after the Friday closing. The high for the year was $440 and the stock closed at $360 on Friday.
The Massachusetts Department of Public Utilities (New York Times, October 12, p. 27) did not want to imply to investors that this was the “forerunner of substantial increases in dividends.” They stated that the expectation of increased dividends was not justified, offered “scathing criticisms of the company” (October 16, p. 42) and concluded “the public will take over such utilities as try to gobble up all profits available.”
On October 15, the Boston City Council advised the mayor to initiate legislation for public ownership of Edison, on October 16, the Department announced it would investigate the level of rates being charged by Edison, and on October 19, it set the dates for the inquiry. On Tuesday, October 15 (p. 41), there was a discussion in the Times of the Massachusetts decision in the column “Topic in Wall Street.” It “excited intense interest in public utility circles yesterday and undoubtedly had effect in depressing the issues of this group. The decision is a far-reaching one and Wall Street expressed the greatest interest in what effect it will have, if any, upon commissions in other States.”
Boston Edison had closed at 360 on Friday, October 11, before the announcement was released. It dropped 61 points at its low on Monday, (October 14) but closed at 328, a loss of 32 points.
On October 16 (p. 42), the Times reported that Governor Allen of Massachusetts was launching a full investigation of Boston Edison including “dividends, depreciation, and surplus.”
One major factor that can be identified leading to the price break for public utilities was the ruling by the Massachusetts Public Utility Commission. The only specific action was that it refused to permit Edison Electric Illuminating Company of Boston to split its stock. Standard financial theory predicts that the primary effect of a stock split would be to reduce the stock price by 50% and would leave the total value unchanged, thus the denial of the split was not economically significant, and the stock split should have been easy to grant. But the Commission made it clear it had additional messages to communicate. For example, the Financial Times (October 16, 1929, p. 7) reported that the Commission advised the company to “reduce the selling price to the consumer.” Boston was paying $.085 per kilowatt-hour and Cambridge only $.055. There were also rumors of public ownership and a shifting of control. The next day (October 17), the Times reported (p. 3) “The worst pressure was against Public Utility shares” and the headline read “Electric Issue Hard Hit.”
Public Utility Regulation in New York
Massachusetts was not alone in challenging the profit levels of utilities. The Federal Trade Commission, New York City, and New York State were all challenging the status of public utility regulation. New York Governor (Franklin D. Roosevelt) appointed a committee on October 8 to investigate the regulation of public utilities in the state. The Committee stated, “this inquiry is likely to have far-reaching effects and may lead to similar action in other States.” Both the October 17 and October 19 issues of the Times carried articles regarding the New York investigative committee. Professor Bonbright, a Roosevelt appointee, described the regulatory process as a “vicious system” (October 19, p. 21), which ignored consumers. The Chairman of the Public Service Commission, testifying before the Committee wanted more control over utility holding companies, especially management fees and other transfers.
The New York State Committee also noted the increasing importance of investment trusts: “mention of the influence of the investment trust on utility securities is too important for this committee to ignore” (New York Times, October 17, p. 18). They conjectured that the trusts had $3.5 billion to invest, and “their influence has become very important” (p. 18).
In New York City Mayor Jimmy Walker was fighting the accusation of graft charges with statements that his administration would fight aggressively against rate increases, thus proving that he had not accepted bribes (New York Times, October 23). It is reasonable to conclude that the October 16 break was related to the news from Massachusetts and New York.
On October 17, the New York Times (p. 18) reported that the Committee on Public Service Securities of the Investment Banking Association warned against “speculative and uniformed buying.” The Committee published a report in which it asked for care in buying shares in utilities.
On Black Thursday, October 24, the market panic began. The market dropped from 305.87 to 272.32 (a 34 point drop, or 9%) and closed at 299.47. The declines were led by the motor stocks and public utilities.
The Public Utility Multipliers and Leverage
Public utilities were a very important segment of the stock market, and even more importantly, any change in public utility stock values resulted in larger changes in equity wealth. In 1929, there were three potentially important multipliers that meant that any change in a public utility’s underlying value would result in a larger value change in the market and in the investor’s value.
Consider the following hypothetical values for a public utility:
Book value per share for a utility $50
Market price per share 162.502
Market price of investment trust holding stock (assuming a 100% 325.00
premium over market value)
Eliminating the utility’s $112.50 market price premium over book value, the market price of the investment trust would be $50 without a premium. The loss in market value of the stock of the investment trust and the utility would be $387.50 (with no premium). The $387.50 is equal to the $112.50 loss in underlying stock value and the $275 reduction in investment trust stock value. The public utility holding companies, in fact, were even more vulnerable to a stock price change since their ratio of price to book value averaged 4.44 (Wigmore, p. 43). The $387.50 loss in market value implies investments in both the firm’s stock and the investment trust.
For simplicity, this discussion has assumed the trust held all the holding company stock. The effects shown would be reduced if the trust held only a fraction of the stock. However, this discussion has also assumed that no debt or margin was used to finance the investment. Assume the individual investors invested only $162.50 of their money and borrowed $162.50 to buy the investment trust stock costing $325. If the utility stock went down from $162.50 to $50 and the trust still sold at a 100% premium, the trust would sell at $100 and the investors would have lost 100% of their investment since the investors owe $162.50. The vulnerability of the margin investor buying a trust stock that has invested in a utility is obvious.
These highly levered non-operating utilities offered an opportunity for speculation. The holding company typically owned 100% of the operating companies’ stock and both entities were levered (there could be more than two levels of leverage). There were also holding companies that owned holding companies (e.g., Ebasco). Wigmore (p. 43) lists nine of the largest public utility holding companies. The ratio of the low 1929 price to the high price (average) was 33%. These stocks were even more volatile than the publicly owned utilities.
The amount of leverage (both debt and preferred stock) used in the utility sector may have been enormous, but we cannot tell for certain. Assume that a utility purchases an asset that costs $1,000,000 and that asset is financed with 40% stock ($400,000). A utility holding company owns the utility stock and is also financed with 40% stock ($160,000). A second utility holding company owns the first and it is financed with 40% stock ($64,000). An investment trust owns the second holding company’s stock and is financed with 40% stock ($25,600). An investor buys the investment trust’s common stock using 50% margin and investing $12,800 in the stock. Thus, the $1,000,000 utility asset is financed with $12,800 of equity capital.
When the large amount of leverage is combined with the inflated prices of the public utility stock, both holding company stocks, and the investment trust the problem is even more dramatic. Continuing the above example, assume the $1,000,000 asset again financed with $600,000 of debt and $400,000 common stock, but the common stock has a $1,200,000 market value. The first utility holding company has $720,000 of debt and $480,000 of common. The second holding company has $288,000 of debt and $192,000 of stock. The investment trust has $115,200 of debt and $76,800 of stock. The investor uses $38,400 of margin debt. The $1,000,000 asset is supporting $1,761,600 of debt. The investor’s $38,400 of equity is very much in jeopardy.
Conclusions and Lessons
Although no consensus has been reached on the causes of the 1929 stock market crash, the evidence cited above suggests that it may have been that the fear of speculation helped push the stock market to the brink of collapse. It is possible that Hoover’s aggressive campaign against speculation, helped by the overpriced public utilities hit by the Massachusetts Public Utility Commission decision and statements and the vulnerable margin investors, triggered the October selling panic and the consequences that followed.
An important first event may have been Lord Snowden’s reference to the speculative orgy in America. The resulting decline in stock prices weakened margin positions. When several governmental bodies indicated that public utilities in the future were not going to be able to justify their market prices, the decreases in utility stock prices resulted in margin positions being further weakened resulting in general selling. At some stage, the selling panic started and the crash resulted.
What can we learn from the 1929 crash? There are many lessons, but a handful seem to be most applicable to today’s stock market.
- There is a delicate balance between optimism and pessimism regarding the stock market. Statements and actions by government officials can affect the sensitivity of stock prices to events. Call a market overpriced often enough, and investors may begin to believe it.
- The fact that stocks can lose 40% of their value in a month and 90% over three years suggests the desirability of diversification (including assets other than stocks). Remember, some investors lose all of their investment when the market falls 40%.
- A levered investment portfolio amplifies the swings of the stock market. Some investment securities have leverage built into them (e.g., stocks of highly levered firms, options, and stock index futures).
- A series of presumably undramatic events may establish a setting for a wide price decline.
- A segment of the market can experience bad news and a price decline that infects the broader market. In 1929, it seems to have been public utilities. In 2000, high technology firms were candidates.
- Interpreting events and assigning blame is unreliable if there has not been an adequate passage of time and opportunity for reflection and analysis — and is difficult even with decades of hindsight.
- It is difficult to predict a major market turn with any degree of reliability. It is impressive that in September 1929, Roger Babson predicted the collapse of the stock market, but he had been predicting a collapse for many years. Also, even Babson recommended diversification and was against complete liquidation of stock investments (Financial Chronicle, September 7, 1929, p. 1505).
- Even a market that is not excessively high can collapse. Both market psychology and the underlying economics are relevant.
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1 1923-25 average = 100.
2 Based a price to book value ratio of 3.25 (Wigmore, p. 39).
Citation: Bierman, Harold. “The 1929 Stock Market Crash”. EH.Net Encyclopedia, edited by Robert Whaples. March 26, 2008. URL http://eh.net/encyclopedia/the-1929-stock-market-crash/