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BEATING THE BEAR

Lessons from the 1929 Crash Applied to Today’s World

Harold Bierman, Jr.

Beating the Bear

BEATING THE BEAR Lessons from the 1929 Crash Applied to Today’s World Harold Bierman. Jr. .

electronic. 1929.abc-clio. stored in a retrieval system. Investments. Title. Box 1911 Santa Barbara. ISBN 978-0-313-38214-7 (alk. Library of Congress Cataloging-in-Publication Data Bierman.973'0916·dc22 2010014496 ISBN: 978-0-313-38214-7 EISBN: 978-0-313-38215-4 14 13 12 11 10 1 2 3 4 5 This book is also available on the World Wide Web as an eBook. Jr. except for the inclusion of brief quotations in a review. paper) · ISBN 978-0-313-38215-4 (ebook) 1.com for details. Beating the bear : lessons from the 1929 crash applied to todayÊs world / Harold Bierman. without prior permission in writing from the publisher. 4.B387 2010 330. or transmitted. California 93116-1911 This book is printed on acid-free paper Manufactured in the United States of America .Copyright 2010 by Harold Bierman. in any form or by any means. P. Praeger An Imprint of ABC-CLIO. Jr. Includes bibliographical references and index. Stock Market Crash. LLC 130 Cremona Drive. or otherwise.O. I. LLC ABC-CLIO. photocopying. 2008–2009 3. mechanical. Harold. Bear markets·History. No part of this publication may be reproduced. 2. All rights reserved. Visit www. cm. recording. Global Financial Crisis. p. HB37171929.

I still think keeping that memory green a useful service. John Kenneth Galbraith . if only for the minority so saved.

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Market Myths in 1929 and 2008–2009 4. Stopping the Speculators: Margin Buying. . The Events Prior to the 1929 and 2008 Crashes 3.S. and the 1929 Crash 9. Practice for the October Crash: The Week of March 25. The U. Dispelling the Myths of 1929 11. The Senate Hearings of 1931 Concerning 1929 10. The Great Crash of 2008: The 2008–2009 Market in Depth 8. . Trusts. The FedÊs Role in Good Times and Bad 5. Government Accuses .CONTENTS Acknowledgments Introduction 1. Short Selling. 1929 6. 12. The 1929 Market in Depth: The Ups and Downs of the 1929 Stock Market 7. The Prime Cause of the 1929 Crash: The Public Utility Sector ix xi 1 9 19 29 55 63 77 95 109 115 141 153 . Pools. How High Is High? The Stock Markets in 1929 and 2008 2.

viii CONTENTS 13. Post-Crash Investment Strategies: Beating the Bear Market Notes Bibliography Index 167 179 185 193 199 . Lessons to Be Learned 14.

their helpfulness is well remembered. Christopher Pratt. Sandra Dawson. Above all. I also want to thank Burton Malkiel. The leave and the research were financed by the Arthur Andersen Foundation and CornellÊs Johnson Graduate School of Management. At Cornell. Among those who were especially helpful were: Betsy Ann Olive and Don Schedeker of CornellÊs Johnson Graduate School of ManagementÊs library staff. Sheri Hastings kept my faxes flowing. Sections of this book were written during a study leave spent at the Judge Institute of Management.ACKNOWLEDGMENTS Many people contributed to this project. especially Ann Toseland. and did not complain of my repetitive requests. Jerome Hass. Ann kept me supplied with film of the newspapers of 1929 to 1950. I want to thank the people at the University of Cambridge Library. Seymour Smidt. Lazenby of the archives division of the Federal Reserve Bank of New York. Richard Barker. Geoff Meeks. Dick Conway called my attention to the article that motivated my initial research efforts. University of Cambridge. While the others are unnamed by me (unfortunately). faculty colleagues at Cornell made useful suggestions. Gishan Dissanaike. . and Maureen OÊHara. who offered a friendly intellectual challenge that led to my initial interest in the events of 1929. Rosemary A. and Geoff Wittington all facilitated my visit and made it a very pleasant experience. Barb Drake typed untold revisions.

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the beginning of the Great Depression. In 1955.INTRODUCTION Senator Glass: „Mr. Senate Committee on Banking and Currency on stock exchange practices Admittedly. . I know that there is more skill to stock speculation. Whitney.. In the minds of most people. John Kenneth Galbraith published his very readable and enjoyable classic The Great Crash. And it would be. but I will follow a different path and arrive at a different set of conclusions. Where Are the CustomersÊ Yachts? The year 1929 stands out as the most significant year of the decade of the 1920s. What I have never been able to determine is·how much more? ·Fred Schwed. the year 1929 marks the crash of the stock market. right on that point may I ask you a question: What percentage of the public is [sic] speculating in stocks of the stock exchange understand the real intrinsic value of the stocks in which they deal?‰ Hearings before the U. and the end of a 10-year period of prosperity that exceeded anything the United States had ever known.S. 1929. Jr. A reader of that popular book might well conclude that it would be foolhardy for someone to retrace the same path. it is preposterous to suggest that stock speculation is like coin flipping.

This book considers the economic situation in 1929 and the events leading up to the stock price declines in October of that year. and we should try to understand it. public utilities. The myth that is most relevant to this book is „Stocks were obviously overpriced (the evidence suggests stocks were reasonably priced. Sloan are inspirational. and it is equally important to understand that event. Likewise. Young. and that in 1929 it was far from obvious that the stock market was in trouble. saw increasing stock market prices as a speculative bubble manufactured by the mistakes of the Federal Reserve Board: „One of these clouds was an American wave of optimism. This book is an attempt to refute unjustified myths and to define the causes of the 1929 stock market crash. It is important that the causes be properly understood. readers can better grasp the present market situation and more wisely make financial decisions. todayÊs news is filled with stories about what is happening and why. I take a fresh look at the Crash of 1929 and then compare that period to the stock crash of 2008 – 2009. and the causes that led to the decline of 2008 – 2009.)‰ While stocks were not obviously overpriced in general.xii INTRODUCTION What actually was the economic situation in 1929? How does it compare to the economic situation in 2008 – 2009? To better illuminate the current dark financial picture. It concludes that the 1920s were a wondrous period of economic prosperity for the United States. much of what has happened could have been foreseen and even avoided · just as it could have been in 1929. There were several factors that combined in October 1929 to bring about the crash. While itÊs still too soon to come to rock-solid conclusions about the financial market meltdown of 2008 – 2009. There are many myths about 1929 that are incorrect. Owen D. I challenge the facts „everyone knows‰ and overturn previously held assumptions concerning the catastrophic events that led to 10 years of economic depression. During the 1920s. What went wrong and caused the stock market to crash in October 1929? What did happen in 1929? Herbert Hoover. there was one sector of the market. By accurately assessing the causes behind the 1929 stock market crash that led to the Great Depression. that can be shown to have been overpriced. born of continued progress . But something very serious happened in 1929 to stock prices. the president of the United States. The stories and achievements of such business people as Benjamin Strong. commerce in the United States attracted truly outstanding individuals who achieved successes of an international nature. The 2008 – 2009 stock market crash was actually more severe than the 1929 – 1930 crash. and Alfred P. because the 1929 stock market was not that much different from the market today or different from what the market could be at any time in the future.

as the following conversation suggests: Investor: „I am developing a feel for the market.‰1 But the optimism was justified. You are probably just catching a cold. The Federal Reserve Board did not create the bubble. but it may have contributed to the destruction of stock market values. Diversify! . with any degree of confidence. The „bubble‰ did not have to burst. but it is not clear how much more skill we have to pick stocks or to determine when the market is too high (when it becomes necessary to make the sell decision) or too low (when it becomes necessary to make the buy decision).INTRODUCTION xiii over the decade. the determination of stock value still remains a challenge). in hearings before the Senate Committee on Banking and Currency.‰ Many financial decisions made today are heavily influenced by what we understand to have happened in the past. the real intrinsic value of stocks (in fact. During 1928. The 2008–2009 crash was actually more severe than the 1929–1930 crash. which the Federal Reserve Board transformed into the stock-exchange Mississipi Bubble. Senator Glass asked Whitney to reveal the percentage of investors who were speculators and who understood the real intrinsic value of the stocks they bought. We should look to the events of 1929 in order to better understand the events of 2008–2009. the stock market again crashed. It is important that we try to understand what the actual economic situation was in 1929 and what happened to the stock market. The first lesson for an investor is that even in a normal year. no one in 1929 knew how to determine. The stock market is volatile and always will be. Stock picking requires more skill than coin flipping. as Fred Schwed maintains. Whitney (and others) could not distinguish between a speculator and an investor. Also. the stock market can fall 50 percent in a matter of months. In 2008. The investor who does not recognize that fact is vulnerable to unnecessarily large losses.‰ Friend: „Take an aspirin. Overconfidence on the part of investors who „know‰ that the market is too high or too low is very dangerous.

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. p. But the series of events leading to the crash actually started before that date. ·Rappoport and White (1993.0 measure for 1929. but using the 290. from 1922 to 1929 stocks rose in value by 218. The trading volume was approximately three times the normal daily volume for the first nine months of the year. THE STOCK MARKET 1922–1932 Table 1. the increase for 1929 was only 15 percent. a 9 percent drop for the day. Using the information of Table 1. stocks lost 73 percent of their value (different indices measured at different times would give different measures of the increases and decreases).7 percent. The price increases were large but not beyond comprehension.1. October 24. 1929. From the low of 245.1 shows the average of the highs and lows of the Dow Jones Industrial Stock Index for 1922 to 1932. let alone a culprit. 570) On Black Thursday. the stock market (New York Stock Exchange) fell 34 points.6 in 1928 to the high of 386 in 1929. This is equivalent to an 18 percent annual growth rate in value for the seven years. There was a selling panic. The price decreases from 1929 to 1932 were consistent with the fact that by 1932. contemporary and historical accounts have failed to find even a smoking gun.Chapter 1 HOW HIGH IS HIGH? THE STOCK MARKETS IN 1929 AND 2008 However. From 1929 to 1932. given the real prosperity taking place in the United States. there was a 57 percent growth.

Samuelson. U. and 111. October 24. as a matter of probability.S. Paul A. accelerating as it went. I would have been sorry. 40. In fact.1 79. since Black Thursday was not the end of the decline.6 245.2 BEATING THE BEAR Table 1. I discovered that I would have been caught by the 1929 debacle‰ (1979.6 290.0 95. for many reasons. 637–39. and stock price expectations were not optimistic. the market lost 36 percent of its value during that four-month period.6 104. 29). p. on the other hand.8 134.0 225. John Kenneth Galbraith apparently would have had no difficulty forecasting the crash: „On the first of January of 1929. I would have purchased stocks after the major break on Black Thursday. would not have sold early in October. 1930 –1932 average of the lows and highs for the years. .* Average of the Highs and Lows Index 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 91. pp. the boulder would roll down the hill. 1985. if I had liquidity.1 Dow-Jones Industrials Index. there was a worldwide depression. We will find that there were many contributing factors leading up to the crash. Each of them is small taken individually. If we take the 386 high of September 1929 and the 1929 year-end value of 248. 49. pp. was like a large boulder on top of a hill.4 137. 9). The 1929 stock market. Wigmore. it was most likely that the boom would end before the year was out‰ (1961. Most of us. Given enough pushes to get it started.4 *1922 –1929 measures are from the Stock Market Study. Senate.48. but together they helped create the right situation for the debacle. if we held stock in September 1929. 110.9 177. For the next 10 years. p. 1955.2 150. admits that „playing as I often do the experiment of studying price profiles with their dates concealed. We want to consider why the market was in such a sensitive position and what factors acted to start its downward fall.

or the world changed.‰ This conclusion. the November prices are too low. p. 1929). „Wall Street did have a go yesterday . Treasuries in August of 1929 yielded 3.55 times as large as the 1925 prices). 271). more impressively. Dividend yield on the average stock was 3. using only stock prices. Reasons will be given to justify the level of prices.14. the increase was 15 percent. Assume that . . In evaluating the P/EÊs of firms in 1929. The second popular method of „proving‰ that the market was too high is to compare the September 1929 prices with those in November 1929 or. the expected growth rate is g = rb = 0.36) = 0. 480). to be described later. either the September prices are too high.‰ Before the events played out. They conclude ( p. with those of September 1929. In 1932. Thus John Maynard Keynes (Moggridge 1981. I conclude that the market was not too high in 1929. Balke and Gordon (1986) show a 155 percent increase (the third-quarter 1929 stock prices are 2.2) to illustrate the excessive heights that stocks reached in September 1929. They went down. „The sharp rise in implied volatility coincident with the stock-market boom suggests the fear of a crash.14(. 1929.S. Lydia (October 25.36 and a return on new investment of r = 0. U. . in a letter to his wife.05. that there was fear of a market crash. thus a crash was inevitable. One is to compare the stock market prices for some prior period. During the first nine months of 1929. Malkiel (1996. There is a plausible explanation for the high prices of September 3. p. prices were 32 percent of the year-end 1929 prices. One position is that the stock market was too high. There is evidence that the stone on the hill is an apt description of the market in 1929. with prices in 1932. p. Senate. wrote. . There are two basic but naïve and incorrect methods of „proving‰ that the stock market was too high in September–October 1929. .19 percent in August. it is useful to estimate the costs of capital. 50) uses the following stock prices (Table 1. Rappoport and White (1994) treat brokersÊ loans as options written by the lender and bought by the borrowers.HOW HIGH IS HIGH? 3 Observers were not pleased with the severity of the crash. In a recent study. Long-term debt was yielding approximately 5 percent and preferred stock 6 percent. I have been in a thoroughly financial and disgusting state of mind all day.S. Obviously. But comparing stock prices merely shows that changes took place. is easily acceptable given the statements and positions of the Federal Reserve Board and the U. say 1925. and 1992. 1. The market did go up dramatically from 1925 to October 1929. For comparison. The stock price increases for this time period are impressive. The biggest crash ever recorded .64. and the dividend payout rate was 0. many others would share KeynesÊs despondency. With a retention rate of b = 0.7 percent.

but the range of estimates seems to be from 12.3 being a reasonable estimate. Let us consider (Table 1. we have very reasonable P/ E ratios ranging from 7 to 18.2 Selected Stock Prices in 1929 High Price September 3. based on statistics from MoodyÊs) is an average P/ E of 16. 572) found a P/ E of 29. these P/ EÊs are too low.3. October 26. Adding growth from the use of debt and from issuing new equity capital. 1929 American Telephone & Telegraph Bethlehem Steel General Electric Montgomery Ward National Cash Register Radio Corporation of America 304 140 3931Î4¼ 137 Î8 1271Î2 101 7 Low Price November 12. using the high and low prices of 1929 (numbers from Wigmore. Using the high prices in the numerators.8. Using the low 1929 prices for all the stocks.06. 1985. With these assumptions and facts. given the low cost of equity and high expected growth rate. 34 – 87). . p. If anything. a P/ E of 20 is justified for the average firm.4 using the low prices of 1929.64 = = 20 = E k − g 0.4 BEATING THE BEAR Table 1.05 With a growth rate of 0. with an indicated P/ E of 73. 59. One estimate in Bierman (1991.8 using the high stock prices and 12. which is low compared with the 20 computed above. pp. a larger P/ E than 20 would be justified. the ratios are somewhat high.2 percent. Wigmore (1985.082 − 0. 1929) The use of different companies and data from different times results in different measures of the P/ E ratio in 1929. P (1 − b ) 0. 1929 1971Î4¼ 781Î4¼ 1681Î8 491Î4¼ 59 28 the cost of equity is approximately 8. These P/ EÊs are based on the data of 135 companies.4 to 29. Irving Fisher estimated the P/ E ratio to be 13 for the market as of August 1929 (Commercial and Financial Chronicle.3) the price – earnings ratios of the same six companies that were included by Malkiel. with 16. a P/ E of 29 would be justified. There is a wide range of calculations of actual average P/ EÊs for 1929. p. especially RCA.

In October. but it reflected the stock price decreases of September and the first week of October. and the multiple was for 20 representative companies (6 were below 20 times earnings). . For example.HOW HIGH IS HIGH? Table 1. 1) reported that aviation issues were selling at 12 times net after their market value was reduced 56 percent (the P/ E had been 23).2 Using the High Price for 1929 American Telephone & Telegraph Bethlehem Steel General Electric Montgomery Ward National Cash Register Radio Corporation of America (RCA) 20 13 43 60 28 73 Using the Low Price for 1929 13 7 18 16 11 17 5 The Wall Street Journal on October 9. the Dow Jones railroad index dropped from 173 to 159. economy. they had been selling for 35 times earnings. October 5. The P/E measure was for 27 dividend-paying railroads. 1986. 17). The year 1929 was the best year ever for the U. but this level of production was still higher than JulyÊs level.9 Times Earnings. 3) reported „Utilities Sell at 24 Times Net.22 in 1928 to 315.3 Price – Earning Ratios for the Corporations of Table 1. Real income rose 10. 616): „Meanwhile. 1929 (p. the Journal ( p.‰ This multiple was before the October 24 crash. it dropped to 120. 782). THE REAL ECONOMY The 1920s were a period of real growth and prosperity. in August it increased to 121. At the end of July. The above P/EÊs were all before Black Thursday. A day later. business news continues rather good.S.5 percent per year from 1921 to 1923 and 3.69 in 1929 (Balke and Gordon. and in September to 123. p.1 percent.4 percent from 1923 to 1929. During October. a drop of only 8.‰ The net was for the 12 months ending June 30. 1929 ( p. had an article with the heading „Rails Sell 11. The gross national product (GNP) increased in real terms from 296. On October 22 the Journal ( p. The Federal Reserve Bulletin showed production at 119 in July. Railroads were not a bubble on October 1. There was a widespread feeling that real business activity was in good shape. consider the following from the Economist. The earnings used were the estimated 1929 earnings.

This was twice the rate for the entire period studied (the last year studied was 1953 [Kendrick. 1) had a major headline: „Best September in Typewriters. . not necessarily observed in October 1929.000 tons below August. On May 24. 1961]). the Wall Street Journal (p. Balancing these belated negative reports were two front-page headlines in October from the Wall Street Journal (October 2): „Steel Activity in Sharp Rise‰ and (October 7) „Motor Output Above Normal.6 BEATING THE BEAR with exceptionally high rate of production during the summer months. There were warning signs. The Journal editor concluded that there was little chance of a recession. This was an annual growth rate of 3. Steel output in September was 416. 30).6 percent. 1929. The June 15 . .‰ The majority of the economic news reports in October were very favorable. All of the following measures for September – October 1929 were above the 1923 –1926 index measure of 100: Total production Manufacture Building contracts awarded Factory employment Factory payrolls Freight car loadings Commodity prices were less than 100 and the prices of farm products were at 105.3 percent for the manufacturing sector. On October 4. The October 1. They were not likely to be widely known in October. Farming.‰ The article went on to say that sales of typewriters were regarded as a reliable index of business activity. communications. total factory productivity increased at an annual rate of 5.‰ During the period 1919–1929. Excellent autumn and holiday trade is anticipated. issue of Forbes described record-breaking rail earnings. mining.‰ These observations were from the New York Times. p. and „automobile production decline[d] 82. The Federal Reserve Bulletin (1930. transportation. Across all industries the period 1919–1929 was the period of most productivity improvement. 494) showed total industrial production at 83 in 1919 and 118 in 1929 (the maximum was 125 in May and June). that real economic activity was slowing.000 cars practically to level of 1928. 1929 (p. The business news during the summer and fall of 1929 was very good. the Magazine of Wall Street carried an article describing the expansion possibilities for electricity in rural areas. December 31. . and public utilities all did well.

„Business so far this year has astonished even the perennial optimists. it was a period of industrial prosperity that had never been surpassed. He also states. „The final collapse of the Wall Street Boom .‰ Thus the business news immediately prior to October 24 was extremely positive (except for the regulatory news applicable to the utility sector). 824): „The share boom of 1926–29 originated in a period of industrial prosperity which has never been surpassed in the worldÊs history. 576) writes. stock prices went up.‰ The research conducted for this book allows us to agree with and expand on these thoughts. „First.‰ He is correct. As the Economist states. 1929. . has confounded optimists and pessimists alike. If this had not been true.‰ When the stock market price break came on Thursday. there was no reason to believe a priori that stock prices were too high before the crash. Of course.‰ He identifies (p. but there is more to be learned. „We will never know exactly what caused the stock market to fall by nearly 30 percent in late October 1929. p. They went up not because of speculators but primarily because of economic facts. the Economist (p. 805) observed.HOW HIGH IS HIGH? 7 issue of the Magazine of Wall Street stated. together with the public statements of numerous government officials. October 24. the speculators would have sold the market (or more exactly its components) short and put an end to the boom long before October 24.‰ And an important point that is frequently ignored (p. Cecchetti (1992. . 574) as causes the „Federal Reserve behavior. .

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and the stock market. with its rising prices. April. The fact that common stocks increased in value by 120 percent in four years (1925–1929) implies a compound annual growth rate of 0.1 shows an index of all common stock prices and the changes in value from 1925 to 1929. The Senate committee was concerned because total loans secured by stocks and bonds of the member banks of the New York federal reserve . Table 2. The decade of the 1920s was extremely prosperous in real terms. and May 1928 are very helpful in understanding the subsequent actions of the Federal Reserve Board in 1929. ·The Magazine of Wall Street. May 18. the stock market increased dramatically. 1929 From 1925 to the first three quarters of 1929. The hearings held by the Senate Committee on Banking and Currency on broker loans in February and March 1928 and the hearings on stabilization held by the House Committee on Banking and Currency in March.218. if the attitude of the Federal Reserve officials can be properly construed from statements of its friends. it is not obvious proof of an orgy of speculation. there are those who are just as apprehensive that the market may go up as the average small investor is afraid that it might go down.Chapter 2 THE EVENTS PRIOR TO THE 1929 AND 2008 CRASHES However. reflected this prosperity as well as the expectation that the prosperity would continue. But Congress and the Federal Reserve Board worried about the speculation taking place in New York. Although this is a large rate of appreciation.

3 Young asked the rhetorical question: „Is this volume of credit that is going to the stock market denying commerce and industry credit?‰4 He concluded that he could find „ no evidence of credit being denied to commerce or productive industry. The senators did not define speculation.589 1.01 12.‰1 The desire to control the speculation taking place in the New York Stock Exchange (NYSE) was primary.43 28.‰5 Young concluded by stating.202 1.175 0.1 Common Stock Prices. first quarter 1927.219 1.‰ in The American Business Cycle (Chicago: University of Chicago Press. and „the largest part of this sum is used for speculation in the New York Stock Exchange.‰2 Roy Young. third quarter 1929. I am satisfied they are safely and conservatively made. 1986).24 24. first quarter 1929.554 0.18 0. 1925–1929 Index of All Common Stock (1941– 42 = 10) 11. fourth quarter Growth Rate Source: N. exceeded $3.94 17. Gordon. district on January 11. second quarter 1929.94 13. Senator Robert LaFollette of Wisconsin led off the 1928 hearings by quoting H.15 0. „Now. an ex-secretary of the Federal Reserve Board: „it remains a fact that our reserve system has excited no real remedial influence upon the great American evil of stock-exchange gambling. defended the reserve system and pointed out that the increase in broker loans between January 6. Parker Willis.25 0. the newly appointed governor of the Federal Reserve Board (he had been the governor of the Minneapolis Reserve Bank). S.989 Cumulative Change from 1925 Year 1925. 1928.266 0. 1926. J. „Would you not modify that and say they are safely made?‰7 . first quarter 1928. Balke and R. first quarter 1926. p.22 0. „Historical Data.‰6 Senator Carter Glass responded by asking. 802. and February 29.12 21. but they knew it was evil and had to be controlled. I do not think anybody else can say so.49 24.8 billion. I am not prepared to say whether the brokersÊ loans are too high or too low. first quarter 1929.90 0.01 0. „came about entirely in the advances that were made by corporations and individuals‰ and was not the result of actions taken by the Federal Reserve or by New York banks. 1928.08 0.10 BEATING THE BEAR Table 2.39 0.

‰ He stated. „Yes. etc. . however. with a future prospect perhaps ought to sell on a 5 percent or even a 4½ percent basis.THE EVENTS PRIOR TO THE 1929 AND 2008 CRASHES 11 Young did not object to the elimination of the word „conservatively.‰8 This positive statement is important. Glass then „established‰ the presence of gambling in the market. should not sell on a 5 percent basis. but I think that is pretty generally true with relation to the higher grade ones · such securities. Senator Glass: I have in mind just a single security right now among many others that occupy a similar position. . The five other members of the board concluded that there was excessive speculation and the board had to take action. United States Steel. New York). I have enough confidence in the American banking fraternity to believe they can correct that situation themselves. Edmund Platt. . Senator Glass: Do you think that bets are always made with reference to the soundness of the security? Mr. since it separated Young from the other members of the board. speaking from the Federal Reserve Bank standpoint. I am. maybe there is so much capital seeking investment that securities that appear to be reasonably sound. There is another thing injected into the situation. Now if there is a further expansion of this brokersÊ loan account and it gets to the place where it is dangerous and borders on unwarranted speculation. for instance. He also did not realize that some of the trusts were using large amounts of borrowed funds to leverage the returns on equity investment and thus had large amounts of risk. On the other hand. With all the saving of capital that Professor Sprague has told you about and everything. There has been no change in the management of the corporation. I do not see how anybody can tell positively. I do not think the Federal Reserve should say whether they are too high or too low. vice-governor of the Federal Reserve Board ( Platt was an ex-newspaper editor from Poughkeepsie. Platt: Not always. for instance. Platt failed to realize that investment trusts could not protect the investor from changes in the level of the stock market. His thousand dollars are spread among the whole lot of them so there is not very much risk of loss in the long run. We have had a tremendous growth in investment trusts lately by which the smaller investor can put in a thousand dollars and have his investment scattered among such stock as American Telephone and Telegraph. as the investment trusts all buy. also testified that he did not know that the market was too high. It was quoted in last January at 1081Î4¼. I do not believe anybody can positively and definitely say that a security like United States Steel. Platt: It looks as if it was an inflation in the price of securities.9 Mr. there has been no .

reach such proportions as to seriously embarrass the credit requirements of business and commerce. a congressman from Arkansas: Mr. that the rapid increase of the past three years in the use of credit for speculative purposes is a tendency in the wrong direction. Mills. or was yesterday. Platt: It was selling at 108? Senator Glass: It was selling at 108 in January. It was selling on the market yesterday at 69. the amount invested in stock loans will naturally have the effect of limiting credit availability. Mr. I have had this book in my hands only a couple of days. In March.12 BEATING THE BEAR approximate increase or diminution in the supply and sale of the product. at 69. Now. so I cannot tell you all that is contained in the volume. That is his theme.‰ if „long run‰ is defined to be in excess of 20 years. the risk prospects are much different. April. There followed an interesting exchange between Miller and Otis Wingo. and might possibly. The same security is selling on the market. if some measure of control is not provided.12 Wingo later asked a series of questions that anticipated perfectly the misguided actions of the board in 1929. the House Committee on Banking and Currency held hearings on stabilization.‰11 The inability of the board to distinguish between credit being used to finance security purchases and credit used to finance the purchase of real goods and services was to cost the country dearly. Cunningham of the Federal Reserve Board (an ex-Iowa farmer) did offer some comments. These hearings were relative to the consideration of an act that would amend the Federal Reserve Act of 1913 to have the federal reserve system promote the stability of commerce and a more stable purchasing power for the dollar. In the short run. H. Wingo: I think you will find when you read it clear through that he says that the behavior of prices is largely like the behavior of individuals. Charles Hamlin of the board (a lawyer from Boston) declined the invitation to testify. however. He quoted extensively from The Behavior of Prices by Frederick C. what is that but gambling?10 Glass seemed to suggest that buying a stock that decreased in value was gambling. Platt was correct about „not much risk of loss in the long run. Credit used for such purposes is a part of the credit availability of the country. but E. Miller: Well. and in the event that the credit supply should become or limited. Mr. The first person to testify was Adolph Miller of the Federal Reserve Board. and May of 1928. He made clear that he was against the use of credit for speculative purposes: „I do feel. . a former economics professor.

„ I am of the opinion that for the purposes of good administration in the federal reserve system a tight control over the diverting of its credit into any kind of speculative loans is necessary. you would know where the money went to. Mr. Miller: How do you propose to reconcile those two purposes? We have a securities market in this country that generally is ready to take advantage of easy and cheap credit. He was even a fine pragmatic teacher (as evidenced by his questions). then you will meet that need and not be scared off because perchance there is an attendant evil that there may be a lot of speculation in the stock market? Mr.‰15 Miller did not speak directly to that statement but he did finally state.‰ But he also stated „I should always be reluctant to act. but his testimony can be summarized by his statement that „stability is a big question and a big problem. the course of history might well have been changed. The factor that should control in fixing the rediscount rates and in determining whether or not you will put more money in the market or take money out is not what is going on in the stock market · that is not the prime consideration · but what are the necessities of legitimate business? Mr. My point is this. perhaps. Miller was the intellectual leader of the board in 1929 and the most forceful of its members. Wingo was intelligent and knowledgeable.‰19 Young.‰18 Remember. It is one that I am not capable of talking about . Wingo: I donÊt think you caught my point. Hamlin. you cannot always determine when a brokerÊs loan or a stock loan is one for speculative purposes. But it can be sensed.THE EVENTS PRIOR TO THE 1929 AND 2008 CRASHES 13 Mr. The board was in deep trouble. Miller and four other members of the board did not understand the difference between the stock market and the real economy. Wingo: And the fact that in meeting the necessities of legitimate business you happen to stimulate a little bit the amount of speculation in the stock market should not deter you from meeting the major needs of business?13 Miller kept responding and Wingo kept pointing out to Miller that „You still donÊt get my question. Miller: Yes.‰14 If Miller had understood Wingo. wouldnÊt you?‰17 Miller responded „It is not always easy to know it. testified at this hearing and revealed that he thought the board had a right to act when „speculation so threatens business. governor of the Federal Reserve Board. Unfortunately. Wingo: IsnÊt this the major question that governs your board in deciding such questions? DonÊt you consider what your policies should be in regard to meeting the needs of legitimate business in the country. threatens to curtail. business credits that may be demanded. and not the effect on the stock market? If the needs of legitimate business require easy money. Wingo finally declared: „That is.‰16 When one of the congressmen asked „As a matter of practical banking. also testified. Mr. who declined to testify in earlier hearings.

insightfulness. in efficiency of production and transportation. in cheapness and adequacy of distribution. We cannot be sure of cause and effect in 1929. Miller did not learn the lesson. 7) reported that Professor C. We are in his debt. the Times ( p.‰21 Despite the fact that he was suffering from ill health during the hearings. he was replaced in Congress by his wife. 7): „the great economic developments in wealth. kind and considerate. Mr. His ideals were high. Wingo deserves more than a few words of praise. She did not offer herself as a candidate for renomination in 1932 but proceeded on to other activities. 1929. 1930. the cards were not dealt that way. and served in Congress from 1930 to 1933. his emotions deep. A. He was elected to Congress nine times and served in Congress from 1913 until his death in 1930. self-confident. When he died on October 21. and in all relations he was loyal. which took actions to stop them. It is a tragedy that Miller did not listen more carefully to the congressman from Arkansas. and aggressive. But we should ask. his questions were unusual in their consistent fairness. in invention and engineering and in public good-will and confidence. He was one of the prime authors of the Federal Reserve Act. with Miller as the intellectual leader. had declared. Dice of Ohio State. He effectively dispelled the myth that credit given to brokers kept credit from being given to the real economy. tried by several significant actions to stop stock market speculation. Arkansas. He was admitted to the bar in 1900 and practiced law in Sevier County. what if a healthy Otis Wingo of Arkansas had been the governor of the Federal Reserve Board in 1929? His questions during the hearings indicated a knowledge of economics and finance exceeding that of all members of the board. who then ran for Congress. Unfortunately. By August it had succeeded. was elected. A contemporary offered the following description of Wingo: „A man of commanding appearance. In 1929 the Federal Reserve Board. Wingo was a natural leader. Effiegene Loeke Wingo. But we can be sure that Miller did not understand the lesson being taught by Wingo in 1928.14 BEATING THE BEAR definitely at this time. We will not be able to conclude that the board caused the stock market price declines in the fall of 1929.‰ . „Stock Prices Will Stay at High Level for Years to Come. October 13. Unfortunately. fearless. an economist. No one can support or contradict conclusively the conclusions resulting from „ what if ‰ statements. and intelligence. but there is evidence that the stock market price increases (arising from speculation) were a major concern of the board. On Sunday. and Adolph Miller was the guiding force behind the actions of the board in 1929. The congressman did well.‰ He gave the following justifications ( p.‰20 Miller thereby became the de facto leader of the board.

p. Keynes wrote in the New York Evening Post (October 25. 3. For the first nine months of 1929. 154). One should not invest in stocks if stock prices are too high. p. The dividend payout was 64percent in September 1929. The conventional wisdom is that speculation was the cause of stock prices being too high.THE EVENTS PRIOR TO THE 1929 AND 2008 CRASHES 15 He concluded „The day of the small investor is here.3 percent compared with 1928 (November 1929. If stock prices were too high because of speculative buying and the crash was inevitable. August 1929). if not easily executed. Thus Malkiel (1996) writes ( p.1 percent larger than for 1928.‰ Dice was an advocate for the „new era. corporations. only 955 announced an increase.509 firms. The March 1930 issue showed that for 1. dividends were $399 million compared with $278 million in 1928. 95).4 billion in 1928 (a 29 percent increase). It is not difficult to see why the market was using high expectations of earnings growth. compared with 75 percent for September 1928. most of the industrial stock prices for September 1929 can be justified with a dividend growth valuation model. cash dividends were $3. Thus. the show-business weekly. 1925. 5. In the first nine months of 1929. then the lesson to be preached is simple.1 billion. which headlined the story. which was readily available in 1929: 1. In the first nine months.Ê The speculative boom was dead and billions of dollars of share values · as well as the dreams of millions · were wiped out. reflecting increased earnings.‰ Laying the blame for the „boom‰ on speculators was even more common in 1929.436 firms announced increased dividends (Forbes. 51) about a speculative boom: „Perhaps the best summary of the debacle was given by Variety. 1929): „The extraordinary speculation on Wall Street in past months has driven up . It is important that we more fully understand the causes of the 1929 stock market crash and correct some of the widely held misconceptions. In September 1929.4 percent increase versus 1928 for the first six months (National City Bank of New York Newsletter. immediately upon learning of the crash of October 24. In 1928. the earnings of the 638 firms had increased 20.5 percent for 1929 compared with 1928. up from $2. a total of 1. ÂWall Street Lays an Egg. Earnings compiled for 650 firms showed a 24. With reasonable (for the time period) estimates of growth. 4. October 15. annual earnings had increased by 13.‰ Consider the following information regarding performance of U. 2.S. The earnings for the third quarter for 638 firms were 14. an increase of 44percent.

making the crash inevitable. a drop of 40 percent. stock market was too high. The identified possible causes include the following: 1. 2. 1981. 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. thus „proving‰ that the prices had been too high. relative returns and costs of buying on margin are relevant to evaluating margin buying. Actions of the Federal Reserve Board excessively restricted growth of the money supply. But if the conventional view of history is not correct and if U. On both sides of the Atlantic. hence there was a „war‰ against the speculators. then what did cause the great crash? The stock market index hit a high of 386 in September 1929. The results of the crash were devastating to individuals and to nations. There was a real downturn in business activity. I present some reasonable evidence supporting my hypotheses. The lessons for investors and students of history are important. 5. 2 of vol.S. xx). stock market had been too high (November 2. by November. stock market was too high. A CATALOGUE OF EIGHT CAUSES Consider the eight „suspects‰ that may or may not have caused the crash. . By the time the crash was completed in 1932 · and thanks to the oncoming of the real economic depression · stocks had lost in excess of 70 percent of their value. p.16 BEATING THE BEAR the rate of interest to an unprecedented level‰ (Moggridge. when stock prices reached their low for the year.‰ The key phrases in the above quotations are „exaggerated balloon of American stock values‰ and „extraordinary speculation on Wall Street. repeated the theme that the U. a message was being sounded by both the media and important governmental figures that the U. 1929. This book reviews a small set of possible causes of the crash and reaches specific conclusions that might cast some light on this important event.S.‰ The common viewpoint was that the U. And the Economist. it had dropped to 230.S. Although I cannot prove that I know the exact specific causes of the crash. The stock market was too high in September 1929 (values did not justify the prices) because of excessive speculation. The crash helped bring on the depression of the thirties and the depression helped to extend the period of low stock prices. stocks were not universally too high. 3. p. 4.S. There was excessive buying on margin and excessive buying of investment trusts.

and far more credible.S. 7. resulting in a drastic restriction of credit available to industry. However. other stocks tumbled. and margin buying are all considered. holding companies. The mortgage defaults spread to the default on collateralized mortgage obligations held by financial institutions financed with over $30 of debt for each dollar of equity. The first is that the Âeasy moneyÊ policies of the Federal Reserve produced the U. the interest rate that mattered was not the federal-funds rate. With falling operating results. 17 We will choose number 7 as the triggering event. subprime mortgages defaulted. which were rapidly validated by poor income measures in the fourth quarter of 2008. financial events (house prices decreased in value. but the rate on long-term. The problems in the financial sector led to an inability of these firms to lend. This led to a string of financial institutions having more debts than assets. to a worldwide recession in 2008 – 2009. the stock market crash led to a decrease in business activity in 1930 –1932. and business activity decreased) triggered stock price decreases. many borrowers stopped making their mortgage payments. THE 2008–2009 MARKET CRASH When real estate prices started to go down in 2007 and homeowners found that their mortgages were larger than the value of their houses. in turn. which led. 8.‰ . The stocks of the financial sector were battered. 2009) that: „There are at least two broad and competing explanations of the origins of this crisis. There was a setback in the public utility market arising from an adverse decision for utilities in Massachusetts combined with an aggressively priced utility market segment. There was excessive leverage when the debt of operating utilities. In 1929.THE EVENTS PRIOR TO THE 1929 AND 2008 CRASHES 6. The second. investment trusts. The leverage (number 6) and the repetitive statements that the market was too high were also major factors. housing bubble that is at the core of todayÊs financial mess. as business activity slowed. The market overreacted. In 2008. then. the lower stock prices observed in the fall of 2008 were soon justified. The drying up of credit led to a decrease in business activity. given the lower operating earnings. fixed-rate mortgages. The stock price decline in 2008 was more severe than that in 1929. explanation agrees that it was indeed lower interest rates that spawned the speculative euphoria. Alan Greenspan wrote in The Wall Street Journal (March 11.

but the banks were paid if the borrower did not pay the mortgage in a timely fashion. the buyers of risky components seemed to be able to divest themselves of the risk by engaging in credit default swaps. May 10. Ian Jarvis makes the point that if a real estate investor „would have walked down Main Street just once pretending to be a homebuyer and spent one day having liarsÊ loans thrust at him. Mr. it would be unable to pay. Since the bank unloaded its risk to the swap counterparty. Why were credit default swaps a reasonable strategy for the banks buying the subprime mortgages? The mortgage originators were lending money to real estate buyers with a low probability of being able to make their mortgage payments and with little incentive to pay if the value of the real estate was less than the value of the mortgage obligation. when real estate prices stopped going up and borrowers lost the incentive to pay on mortgages that were larger than the value of the real estate. The banks that had purchased protection would (and did) find that the losses were not effectively hedged. he would have met the real estate agents selling overpriced merchandise to underinformed dreamers and heard the agentsÊ pitch ·„Investors like you. ________ might not have played the part he did in devastating our economy. Unfortunately.‰ If he had done his homework.18 BEATING THE BEAR The long-term fixed rate was more relevant. sir. Thus we have low long-term interest rates fueling a vigorous real estate market. If the counterparty who promised to pay in case of mortgage default accepted too many swaps in a bad year. the risk still existed. Credit default swaps (CDSs) grew from a market of a few billion dollars in 2001 to $60 trillion in 2007. In addition. All seemed to be going well until 2008. Banks bought subprime mortgages and then engaged in swaps. it could buy additional risky mortgages. In a letter to the editor (The New York Times. where they paid the risk taker in good years. are making a fortune. 2009). Wall Street encouraged the real estate boom by packaging the mortgages so that even segments with the worst credit were given a triple-A rating.‰ . since it is the rate that should be used to value long-lived real estate.

from September 2008 to March 2009. By contrast.Chapter 3 MARKET MYTHS IN 1929 AND 2008–2009 WHO KILLED COCK ROBIN? Are the Prophets of Disaster Now Satisfied? ·The Magazine of Wall Street. We want to consider two basic questions in this book: Was the stock market unreasonably high in October 1929? Was a crash inevitable? We will present explanations for the initial decline in stock market value which are . including John Maynard Keynes and Irving Fisher. We will show that there are good reasons for thinking that the stock market was not obviously overvalued in 1929 and that it was sensible to hold stocks in the fall of 1929 and to buy stocks in December 1929 (admittedly this investment strategy would have been terribly wrong). In the calendar year 1929. Our misconceptions about the events of the fall of 1929 have been fed by the easy generalizations of authors more interested in being dramatically clever than in analyzing the facts. the stock market lost in excess of 50 percent of its value. In December 1929.9 percent of its value. The largest losses to the market did not come in October 1929 or the winter of 1930 but rather in the following two years. after having gained 37. 1929 There is a great deal wrong with our understanding of the 1929 stock market crash. many expert economists.9 percent in the previous year. November 16. and by April 1930 the Dow Jones Industrial Average had recovered a large percentage of the October losses. the market lost only 11. felt that the financial crisis had ended. Even the name is inexact.

England was at war with Spain and the companyÊs original charter lost its value. the crash of 1929.3 They were unable to reject the hypothesis that bubbles were absent from the German hyperinflation of the 1920s. It is normal practice to describe the 1929 stock market prior to October as a bubble or speculative orgy. for example. M. the company then proceeded to repackage the debt securities of the English government. the existence of price bubbles (large price increases followed by large price decreases) in financial markets has been explained. The firmÊs stock tremendously increased in value as new capital was used to pay old capital and more government debt securities were . they are appropriately circumspect in making claims about more specialized asset markets: „The professionÊs folklore on the existence of bubbles emphasizes such markets. The famous „South Sea Bubble‰ was a combination of the above two factors. The South Sea Bubble (1711–1721) occurred in England. Throughout economic history many events have been defined as bubbles. Changes in market psychology are not perfectly explained by reference to specific events. But we will not fully explain why the market turned down in the fall of 1929.20 BEATING THE BEAR not dependent upon an assumption of overvaluation.2 One empirical investigation of the existence of a price bubble was performed by R. In 1718. C. no one has verified that a bubble of the type defined in the current rational-expectations literature has ever existed. the South Sea Bubble. The objective of this book is not to determine whether the fall in stock prices triggered the Great Depression of the 1930s but to describe more accurately the stock market crash of 1929–1932 so that we can better understand the present stock market situation and better predict the future.‰1 In 2008. in part. For example. the real estate bubble burst. Faced with the loss of its reason for existence. However. The word mania emphasizes the irrationality. The South Sea CompanyÊs first ship to approach Latin America was driven off by the Spaniards in 1717. the Tulip Bubble. Flood and R. How do we now there was a bubble in 2008? Prices went down in 2008 and 2009. R. Kindleberger explains bubbles in the following way: „speculation for profit leads away from normal. bubble foreshadows the bursting. It started out as a legitimate business enterprise (the South Sea Company with a charter for monopoly of trade with Latin American countries) but ended up being the high-pressured selling of nearly worthless securities. R. Historically. Garber.‰4 Many of the so-called bubbles are actually interesting economic ventures that failed or well-managed scams that were vigorously sold by expert con artists. rational behavior to what have been described as manias or bubbles. Since their research dealt with rates of changes associated with an overall price level. the Mississippi Bubble. by the assumption of irrationality on the part of traders.

Harding was elected president of the United States. Before concluding that only fools get taken in by such bubbles. Vice-Governor. Warren G. Young. and Adolph C. James.MARKET MYTHS IN 1929 AND 2008–2009 21 purchased.000 of South Sea Company stock at a profit of 100 percent. Pole): Roy A. the University of Chicago. James was a Memphis merchant. Hamlin. and the negative psychology of the market became more important than the underlying economic facts.‰6 The 1929 stock market situation was intrinsically different from the classic examples of bubbles.S. New York. Mellon and Comptroller of the Currency J. There were solid reasons for buying stock in October 1929. These two presidents do not rank high in performance. Edward H. banking system. W. never letting his right hand know what his left hand was doing. Calvin Coolidge was elected. Edmund Platt. a director of the South Sea Company and the prime promoter of its securities from 1717 to 1721. At the beginning of 1929. Governor. and Cornell. . including the South Sea Bubble. Adolph C.5 It has been said of John Blunt. consider the fact that Isaac Newton in a single month sold his £7. Hamlin. He was the first governor of the Federal Reserve Board. however. these appointees were not the most talented or best prepared for controlling the U. but the market sentiment soon shifted from optimism to pessimism. BEFORE 1929 It is important to understand some of the most significant events that led to the 1929 stock market decline. Miller. Platt was an ex-newspaper editor and ex-congressman from Poughkeepsie. and in 1924. Miller had been a professor of economics at Harvard. W. In 1920. Hamlin was a Boston lawyer who had been an assistant secretary of the treasury with Cleveland and Wilson. that „he continued to live his life with a prayer-book in his right hand and a prospectus in his left.000 after making further investments in the company. The Federal Reserve Board in January 1929 consisted of the following six members (omitting the two ex-officio members: Secretary of the Treasury A. several months later. and their appointees left something to be desired. Charles S. Miller · had originally been appointed by Wilson). Charles S. he lost £20. Young had been governor of the Minneapolis Reserve Bank before joining the board. Cunningham was an Iowa farmer. George R. Unfortunately. the Federal Reserve Board consisted of Harding – Coolidge appointees or reappointees (three members of the board · Edmund Platt. Cunningham. The 1929 stock market crash was more the result of the misjudgments and bad decisions of good people than the evil actions of a few profiteers.

banking from 1921 to 1928. when direct pressure on banks to control speculation was recommended by the board as a strategy. The board . This easy money policy succeeded and the recession was avoided. Although he had an academic background.S.22 BEATING THE BEAR Young. and that it would mean rationing of credit. „Governor Strong disagreed.S.ʉ7 Although he died in 1928. although Young actually opposed many of the boardÊs actions in the first six months of 1929. but the other members of the board required on-the-job training. pointing out that direct pressure could not succeed in New York unless the Federal Reserve Bank refused to discount for banks carrying speculative loans. bankers. The „speculation‰ being financed by the New York banks became increasingly distasteful to members of the Federal Reserve Board. securities. Later Miller would blame the resurgence of stock speculation in 1928 on StrongÊs easy money policy of 1927.S. was the head of the New York Federal Reserve Bank from 1914 until the fall of 1928. Miller was very influential in leading the board to avoid this „mistake‰ in 1929. From 1921 to August 1928. banking. especially Young and Miller. governor of the New York Federal Reserve Bank. In the summer of 1927. his style was that of an autocrat. Miller was by far the most decisive member of the board and became the de facto intellectual leader. In addition. Hamlin kept a diary that is an important source of our understanding of what happened in the meetings of the Federal Reserve Board. Benjamin Strong. the most respected (internationally) of U. StrongÊs intellect and personality (including a great sense of humor) led to New York being the power center of U. STOCK SPECULATION Throughout the 1920s.8 Strong was an acknowledged leader of international finance and truly a giant in U. Productivity had dipped down and significant economic signs were negative. Most important. New York banks had financed broker loans. Europe was losing gold to the United States and European bankers feared an international disaster. Âwhich would be disastrous. Chandler has written the definitive biography of Strong. This frustrated several members of the Federal Reserve Board.S. the United States was on the verge of a recession. and Miller had relevant experience or academic qualifications. In 1925. Lester V. Neither Young nor Hamlin were very insightful or forceful and did not supply the leadership needed by the board. Strong led a move to reduce the discount rate and increase the reserve banksÊ holdings of U. Hamlin. StrongÊs influence extended to 1929. the real financial genius and power in the United States was Benjamin Strong.

the board had sent out a clear signal that it believed there was excessive speculation in stock.‰ The bulletin stated that the Fed „means to restrain the use.S. Senate reacted immediately to the boardÊs public condemnation of the bankÊs practices of fueling the „speculative boom‰. wanting to expand its ability to make more loans. Strong disagreed with the Federal Reserve Board. the Reserve Bank of New York wanted to increase the rediscount rate from 5 to 6 percent. That the Federal Reserve Board is hereby requested to give to the Senate any information and suggestions that it feels would be helpful in securing legislation necessary to correct the evil complained of and prevent illegitimate and harmful speculation. it adopted the following resolution in support of the board: Whereas in press dispatches recently. with the board advocating restricting broker loans and the New York Bank wanting to increase the rediscount rate. the dispute between the board and the New York Reserve Bank accelerated. which was then used to finance broker loans. After his death. The Federal Reserve Board refused the repeated requests until August 1929. In October 1928. it represents a cost to the bank and defines the rate it must charge. there evolved a series of explicit conflicts between the board (wanting to control speculation by direct pressure) and the New York City Reserve Bank (wanting to avoid an arbitrary tightening of credit · with the banks deciding who would get credit). and that it wanted the banks to decrease their broker loans. would send the loan to the reserve bank in its district and receive in return federal reserve notes or the accounting entry equivalent.MARKET MYTHS IN 1929 AND 2008–2009 23 advocated „direct pressure‰ on New York banks to limit borrowing by member banks from the Fed. The rate paid by the commercial bank to the federal reserve bank is called the rediscount rate.‰ By early 1929. of Federal reserve credit facilities in aid of the growth of speculative credit. The Federal Reserve Bulletin of February 1929 made it clear that the federal reserve banks would take steps to decrease the flow of credit to „speculators.9 . either directly or indirectly. Strong died after a long illness. and that some of said speculation is illegitimate and harmful: Therefore. Beginning in February 1929. Over the next several months. He successfully argued that penalizing banks that carried speculative loans would be a disastrous policy.) An increase in the rediscount rate translates immediately into an increase in the rate the banks charge their customers. A commercial bank that had made a loan. be it Resolved. (This bank loan rate must be larger than the rediscount rate. The U. the Federal Reserve Board has complained that money is being drawn from the channels of business and used for speculative purposes.

J. Even Trowbridge Callaway.‰11 The FedÊs restrictive credit policy on speculative loans started to affect broker loan rates early in 1929.‰13 By March 1929.‰10 M. although not as much (from 51Î4 to 6 percent). Although the Fed expressed concern regarding excessive speculation in stocks. Broker call loan rates were 6. Friedman and A.15 The National City Bank of New York Newsletter reported that there was a „growing reluctance of the banks to extend their loans on collateral ineligible for rediscount at the Reserve Banks. Far from being an inflationary decade. spoke of „the orgy of speculation which clouded the countryÊs vision. and spring agricultural requirements) resulted in a withdrawal of funds from the New York call loan market.94 percent in January 1929.‰16 . the twenties were the reverse. Schwartz describe the situation at the end of the 1920s as follows: „The bull market brought the objective of promoting business activity into conflict with the desire to restrain stock market speculation. not restrictive enough to halt the bull market yet too restrictive to foster vigorous business expansion.24 BEATING THE BEAR The mood was firmly established that the levels of 1929 stock market prices were the result of unthinking.40 percent by the end of March 1929. call rates were reported by National City Bank to reach a maximum of 20 percent. „The stock of money.14 There was a drop in stock prices. As described by Friedman and Schwartz. president of the Investment Bankers Association of America. there was a deflation in the prices of goods and services. but the New York City banks provided funds for broker loans and the stock price decrease was very small. In May alone the call loan rates ranged from 6 to 15 percent. The investing community was bombarded with statements from both financial experts and policy makers at the highest levels that there was excessive speculation. but they were reported by the Fed to have increased to 14. too. evil speculation. quarterly payments of dividends and interest. But it is important to remember that while the Fed was implicitly fighting speculation and price increases in the stock market.12 Rates on commercial paper had also increased. failed to rise and even fell slightly during most of the expansion · a phenomenon not matched in any prior or subsequent cyclical expansion. The conflict resolved in 1928 and 1929 by adoption of a monetary policy. the real economy as measured by published statistics was fundamentally sound. The normal credit demands (income tax payments. The rates on call loans fluctuated violently in April and May. the tight money policy of the Federal Reserve Board was successful in increasing the price of credit. resulting in stock prices that were too high. The difference between the rates on broker loans and rates charged for other commercial activities was dramatic.

But. 1929. There was a growing feeling among business writers that the Fed did not want the market to go up further. that stocks actually decreased in value in the fourth quarter of 1929. Dishonest manipulation drove stock prices up.) 4. ( It was not stock prices but the action of the Federal Reserve to bring down stock prices that jeopardized prosperity. ( It was just as likely to observers at the time that stocks would go up as down. He was informed by Saint Peter that the quota for promoters was filled and no more of . ( It was very difficult to distinguish good investors from bad speculators. 2. The Great Crash occurred in October 1929.) Gerald Sirkin also takes the position that descriptions of 1929 as a period of „speculative orgy‰ are misleading. The crash was inevitable.MARKET MYTHS IN 1929 AND 2008–2009 25 The July 15.) 3.) 6. by the usual standards for such things. Stocks were obviously overpriced (the evidence suggests stocks were reasonably priced). using historical data. Speculators deserved to be taught a lesson. issue of Forbes reported (quoting R. He concludes that „some showed signs of over-indulgence. the conclusions would have to be: not much of an orgy. there is no evidence that the level of the market was materially affected by these actions. We know. McNeel) that the policy of the Federal Reserve Board was destroying the confidence of investors and that a continuation of the policy would undoubtedly stop the free flow of capital into American industry. it certainly does not have to be valid.‰17 The following fable is typical of the stories told about promoters and speculators in 1929: Consider the story of the oil promoter who appeared before Saint Peter and presented his credentials for admission to Paradise.) 5. (There is evidence of some bothersome but not significant manipulation. MYTHS AND FABLES A myth exists only in imagination. There are seven great myths about 1929: 1. W. Credit given to brokers kept credit from being given to the real economy (this would be true only if Federal Reserve actions rationed the total credit. The high level of stock market prices jeopardized the nationÊs prosperity. But other things that we „know‰ about 1929 are less clearly based on fact.) 7. (Most of the losses took place in 1930 –1932. The war against the New York speculators had begun.

I guess you may come in now. it is difficult to conclude that this act was a major contributing factor to the October stock price declines (there had been considerable hope that the president would veto the bill). . and waiters in the market. oil has been discovered on Jupiter!‰ The words were no sooner spoken than several thousand of the tribe stormed out through the gates. the only condition under which I can gain admission is that a vacancy be created?‰ „Precisely. . unquestionably there were great numbers of clerks. turned to the candidate. F.‰ The reply: „Saint Peter. it was apparent that he could meet that situation. „Fellow promoters. somewhat surprised by the exodus. „Well. everyone knows that in 1929. A faint smile appeared on the candidateÊs face.19 Given that the first major stock market decline occurred in October 1929 and the act passed in 1930. . chauffeurs. stenographers. and the president of the United States to bring the stock market speculators to their knees. L. It was not the New York speculators. There may be some truth in that report.S. the promoter queried. called speculation. fixing the average rate of duties at about 41 percent. IÊve changed my mind . „Who killed cock robin?‰ remains a valid question. Not dismayed.‰18 HAWLEY–SMOOT ACT (1930) In 1930. From reading articles and books. The constant attack on the New York speculators and the „overpriced‰ stock market created a situation where any negative news or a combination of relatively minor events could generate a psychological reaction that would lead to a market decline. But no one knows how many people lacking the necessary qualifications (whatever they were) were in the market (speculating or possibly even investing). janitors. industry. Congress.‰ replied Peter. „As I understand it then. . .26 BEATING THE BEAR his profession could enter for the time being at least. bathroom attendants and bellhops were speculating in stocks. Directed to the celestial microphone he delivered himself of a brief message.‰20 Most of us are in favor of broad-based ownership of U. One hypothesis is that the stock market was not excessively high in 1929 but that there were effective efforts by the Federal Reserve Board. Allen writes: „Unquestionably there were far more people speculating than ever before. But in 1929 the ownership of stock by nonprofessionals was looked at as a bad act. Yet probably not much more than one person in a hundred in the American population was playing stocks on margin. the Hawley – Smoot Act was passed. He asked for the privilege of making an announcement to his former colleagues. . Peter. but it probably did contribute to the subsequent stock price declines and the Great Depression. IÊm going too.

Not exactly a carefully targeted award. I know Cornell University gets a chunk for projects. Hardly anyone knows what spending has been approved for specific projects. the family would have received $500 in total. If husband and wife both received Social Security. That $250 was not subject to federal income taxes and the amount did not depend on the income or wealth of the recipient. The correct question is whether. Does this mean that the $800 billion of stimulus spending will not stimulate the economy? This is not the issue. a better set of projects and strategies to create jobs and increase economic activity could not have been approved. few of which were high priority for the United States. . Consider the $250 grant each recipient of Social Security received in the spring of 2009. it was a grab bag of the projects Democratic congressmen and senators had wanted to implement for the previous eight years and were not able to obtain because of the eight years of President George W.MARKET MYTHS IN 1929 AND 2008–2009 27 THE GREAT MYTH OF 2009 The great myth of 2009 is the administrationÊs stimulus plan passed in March 2009. But much of it cannot be justified as part of a stimulus plan. Rather than a pure stimulus plan. with a month of careful evaluation. since few persons have read the stimulus bill as passed. I do not mean to imply that all the projected spending under the stimulus bill is bad. Bush and a Republican Congress.

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the crime wave and the policies of the Federal Reserve Board there is little to disturb the even tenor of our commercial ways. farm relief. Wall Street and Washington By the beginning of 1929. this meant that the banks should divert credit from loans financing stocks to loans to be used for normal business activity. there were other more important factors that contributed to the lack of cooperation: „The close of the period was marked by open conflict between the Federal Reserve Board and the Federal Reserve Banks over the technique for controlling stock market speculation. ·Joseph Stagg Lawrence. In the first half of 1929. Although the difference in the desired course of action could be described as an intellectual one. This was the crucial engagement in a struggle for power within the system that had always been potential and that was to lead in the course of the next few . The board did not want to increase interest rates but rather to take „direct action. The New York bank thought the best method to control credit was to increase its rediscount rate.Chapter 4 THE FED’S ROLE IN GOOD TIMES AND BAD At home high wages and little unemployment have promoted industrial peace and excepting the issues of prohibition. both the Federal Reserve Bank of New York and the Federal Reserve Board believed that speculation in stocks was excessive and had to be controlled.‰ This referred to the utilization of publicity to make the boardÊs position known and then moral persuasion (threats?) to convince banks that they should go along with the boardÊs desire to restrict stock market speculation.

a very influential member of the board. ambitious of spirit. one has to go back to the years 1914 –1928. Stock prices went up in 1927. the late Benjamin Strong. that the Federal Reserve Board acted in a manner Miller approved. strong of will. was first too quick to fall in with a daring . and the first nine months of 1929.30 BEATING THE BEAR years to a near-complete shift of power from the Banks in general and the New York Bank in particular to the Board. he had extraordinary skill in impressing his views and purposes on his associates in the Federal Reserve System. It was not until February 2. no one claimed responsibility. 1929. . Adolph Miller. He blamed the Federal Reserve Bank of New York for not supplying the necessary leadership: „But it is abundantly clear that acceptance by the Board of aggressive easing action proposed by the New York Federal Reserve Bank in 1927 and of complete abandonment of restraining action in the second half of 1928 proves that the Board.‰1 To understand the hostility of the Federal Reserve Board toward the Federal Reserve Bank of New York. central banker of this era. In 1927. Washington was a side show compared with New York when it came to issues of national and international finance. engaging of personality. Some of our critics damn us vigorously and constantly for not tackling the stock speculations. Brilliant of mind. Strong was the dominant U. Strong believed that credit should not be restricted solely to prevent of stock speculation and feared the consequences of the credit restriction policy: I think the conclusion is inescapable that any policy directed solely to forcing liquidation in the stock loan account and concurrently in the prices of securities will be found to have a widespread and somewhat similar effect in other directions.2 When the fall in stock prices came. or more particularly by its distinguished Governor. at the urging of Strong.‰3 Miller felt that the federal reserve system during 1927 and 1928 had followed policies of easy credit with disastrous results. 1928. business activity was relatively flat and the Federal Reserve Board. was originated by the New York Federal Reserve Bank. blamed this policy for the bad events of 1929 and subsequent years and stated that Strong was its originator: „The policy . .S. I am wondering what will be the consequences of such a policy if it is undertaken and who will assume the responsibility for it. fertile of resource. under the established tradition. when Benjamin Strong was governor of the Federal Reserve Bank of New York. From 1921 to 1928. decided on an easy money policy. By 1921. mostly to the detriment of the healthy prosperity of this country.

Herbert Hoover lived on the same block.‰6 This radical view of banking and the function of the Federal Reserve was held in check by Benjamin Strong. Miller was able to impose his philosophy on the board and on the country. he had taught economics at Harvard. Governor Bailey of that bank was addressing the Reserve Bank Governors Conference: Hardly had he begun to speak when one of his colleagues shouted: „Tell us Governor. Ultimately its anxiety reached a point where it felt that it must itself assume the responsibility of intervening in the dangerously expanded and expanding speculative situation menacing the welfare of the country. His obsessive goal was to put an end to speculation. And New YorkÊs leadership proved to be unequal to the situation. the University of Chicago. . For 24 years before joining the Department of the Interior and then the Federal Reserve Board. Cornell. This it did early in February. . With StrongÊs death in October 1928 and the election of Herbert Hoover in November 1928. Finally.7 When Hoover moved into the White House in 1929.‰4 Adolph Casper Miller had been a member of the Federal Reserve Board from its beginning. Miller lived on S Street in Washington.‰8 Before 1929 Strong and President Coolidge stood between Miller and control of the Federal Reserve. The fact that the monetary policies of 1927 advocated by Strong helped to avoid a recession and resulted in the prosperous years of 1928 and 1929 did not enter his thinking. The persuasive power and leadership capabilities of Strong are further illustrated by a story told by Chandler concerning the Kansas City Reserve Bank. why your Federal Reserve Bank led off in the reduction of the discount rate?‰ . . the Federal Reserve Board was growing more and more anxious at the course of developments. Miller was never able to shift his focus from the speculation taking place on the New York Stock Exchange to the real economy.THE FEDÊS ROLE IN GOOD TIMES AND BAD 31 and dangerous proposal and later too slow to assume the leadership which was needed and was lacking at a most critical time. . Miller declared war on speculation: „It is clear therefore that no bank has a proper status as an applicant for reserve-bank accommodation which is supplying credit for speculative purposes. William Hard described Miller as the „brains of the Board. in February 1929. 1929. he convinced the Federal Reserve Board that direct action was appropriate: „In this period of optimism gone wild and cupidity gone drunk . . Hoover and Miller became fast friends and undoubtedly HooverÊs economic policies were heavily influenced by his friend (or Miller was influenced by Hoover).‰5 As early as 1925 in a speech to the Boston Commercial Club. Miller was finally in a position of tremendous influence. and the University of California.

he said with some show of feeling: „IÊm not afraid to follow the lead. He would have trouble with the Federal Reserve Board. In three telephone calls that afternoon Young had not indicated that the board was displeased with .S. Harrison was a very intelligent and competent leader with a high sense of morality. he was appointed assistant general counsel of the Federal Reserve Board. George Harrison was appointed as governor of the Federal Reserve Bank of New York.S. The Federal Reserve Board waited until the beginning of 1929 to fling down the gauntlet and challenge the New York bank. On January 3. He graduated from Yale in 1910 and from the Harvard Law School in 1913. 1929. The Federal Reserve Board was determined that the New York Bank should no longer play that role.‰10 The election of Hoover also ensured that the restrictive credit policies of the Federal Reserve Board would be supported by the White House starting in March 1929. Supreme Court. but he was not an effective political strategist. Young had been governor of the Federal Reserve Board for well over a year and should have understood the accepted process for changing the bill rate. That evening a telegram was received by Harrison from the board indicating that the board was not prepared to approve of the increase. Harrison was shocked by the telegram. „StrongÊs death left the system with no center of enterprising and acceptable leadership. Harrison was the son of a U. This was the normal procedure followed by reserve banks for changing the minimum buying rate for bills. In 1920 he became a deputy governor of the Federal Reserve Bank of New York and accompanied Governor Strong on his last trip to Europe in the summer of 1928. After a tour of duty with the American Red Cross in France during World War I. At the formation of the federal reserve system.32 BEATING THE BEAR „I donÊt mind telling you.‰ said the Governor. Army career officer.‰9 In October 1928 Strong died. „I did it because Ben Strong wanted me to. the board acted. On November 23. of such men as Ben Strong and Andrew Mellon. When Governor Bailey resumed. Hoover had been elected president of the United States and had already spoken out against speculation. The rate increase was to be effective the next morning. However. Harrison called Governor Young of the Federal Reserve Board to advise him that the New York directors had increased the minimum buying rate for bankersÊ bills (a bill in this context is a bankerÊs acceptance). he served as general counsel of the Federal Reserve Board.‰ At this remark there was much laughter. He served for a year as legal secretary to Justice Oliver Wendell Holmes of the U. 1928. With Hoover about to be inaugurated. in financial matters. The banks voted to change the rate and then informed the board of their actions.

. Adolph Miller wielded the effective power. S. Young had not indicated that he disapproved or that the Reserve Board would have to approve such an increase. that the board had just noted the . we have from time to time changed our buying rate merely advising the Board that we had done so. I assumed that we were acting quite in accordance with the BoardÊs understanding and wishes. a week previously Harrison had told Young that the bill rate might be raised. „Platt said that would seem like a slap in the face. never asking their approval. and that. and he strongly disapproved of a rate increase.‰ At 10:00 A. Harrison received the blasts that were intended for Benjamin Strong but were never delivered. as I saw the matter. He told Young that he was sorry that there was any misunderstanding as to procedure and that the New York bank had followed the same procedure it had followed for many years in the past without any question or disapproval by the board. Harrison telephoned Young and tried to be a peacemaker: I told him again that. Hamlin reports in his diary that Young was furious at not having been consulted by New York for his approval and that he wanted to order the rate suspended.‰ Young was frustrated by the fact that the New York Federal Reserve Bank raised the bill rate and that an activist majority of his board would not accept the increase. Hamlin writes that the board tried unsuccessfully to find a regulation that showed New York had acted illegally. Harrison tried to call Young at his home and finally made connection at seven oÊclock that evening. .‰ Harrison added that „he seemed very much out of temper‰· this about a man described by contemporaries as „jovial. more particularly only last Monday. . that Governor Young said that was what he wanted. having discussed the matter with him from time to time in the past. He was in the middle. Pent up emotions were being released. That afternoon Young called Harrison and told him that since New York had already made the rate effective. on January 4.‰ Young thought Harrison had not treated him courteously.M. C.THE FEDÊS ROLE IN GOOD TIMES AND BAD 33 New YorkÊs raising the bill rate. But Young was „very much put out‰ and said that „he did not intend any longer to be a rubber stamp. Miller thought a new regulation was needed that „henceforth all acceptance rates must be approved by the Board before being effective. Harrison did not realize that Young was only nominally in charge of the Federal Reserve Board. that our action on yesterday was quite in accordance with this procedure. In fact. we had acted in complete good faith in accordance with what we understood to be the established procedure for a number of years. without any intimation on his part that he wanted a different procedure to be followed.

„We discussed all sorts of matters. In February. and Cunningham. In a conversation with Alexander of the National Bank of Commerce on January 9. That direct action drew a great deal of criticism. brokers are a necessary part of the machinery. and loans to brokers are a necessary incident to their business and the business of the banks with whom they carry balances. Harrison made the point that the same objection „might apply · though.‰ This is the end of the bill incident. Not only was the board sensitive to actions of the New York Fed. But when Young said to Harrison that „he did not intend any longer to be a rubber stamp. The incident reflected attitudes that were to become more evident in subsequent events. Harrison went to Washington and met with Young on January 6. the board did just that. in different degree · to brokersÊ loans. Hamlin reports that there were violent discussions between Young. that we must assume. according to Hamlin. There was extensive discord within the board. since each proposal that he had made had not met with the approval of the Board. Young also said that the board was preparing new regulations.34 BEATING THE BEAR action without approval or disapproval. if so. and that. especially all those matters likely to come up for consideration at the Open Market Investment Committee meeting. I did not bring up the subject myself until just about as Governor Young was to leave for lunch. about bill rates or prospective regulations. The events of January 3 and 4 clearly indicate that Young and the Federal Reserve Board intended to reaffirm their control of the Federal Reserve Board over the Federal Reserve Bank of New York.‰ Young did not agree with the preparation of a statement and said that the board could not issue a statement in favor of direct action and restraint of broker loans. He described a federal reserve bank that had in the past adopted a policy of not making loans to any member banks that had outstanding loans to finance automobiles. perhaps. The new regulations never surfaced. James. however. He smiled and said not very well. Miller wanted to issue a statement that would help. „prevent seepage into Wall Street. that it is. but there was internal strife.‰ it is likely that he was not reacting to the polite-to-a-fault Harrison but rather to the years of StrongÊs administration and to YoungÊs personal relationships with the other board members.‰ He then made a stronger statement regarding his opposition to direct action against broker loans: „We were not the ones to determine whether the Stock Exchange was a legitimate part of the economic life of the country. so long as it exists. I then asked him how his regulations were progressing. Harrison emphasized his philosophy regarding what federal reserve banks could and would not do.‰ . and the policy was soon changed. He made no mention.

11 . 1928.‰ Young did not think direct pressure on federal reserve banks would be successful and was not in favor of the letter. Both did not believe in direct action ( pressure on banks to direct their loans away from speculative loans). The events of January 3 and 4 prepared the foundation for Harrison being inclined to implement the boardÊs direct action campaign even before the board had announced its policies. governor of the Bank of England. and that since July 1. On January 21. as well as we. that both with respect to the continuity and frequency and average of their borrowings. Miller offered the board members a draft of a letter defining the direct actions to be taken. .THE FEDÊS ROLE IN GOOD TIMES AND BAD 35 Harrison then applied direct action (before the BoardÊs letter of February 2 was sent or published): I referred to the fact that since April 1. letting the market price determine resource allocation. Banks were being told to restrict loans to brokers. . The New York Bank believed that the way to control loans was through an increase in interest rates. was also in New York visiting the Federal Reserve Bank of New York. suggested that this might be misunderstood and strongly urged that he visit Washington. On January 25. The paradox was that Young and the New York Bank were in agreement. Harrison. Norman said this was agreeable to him and he went to Washington. Young went to New York to attend the meeting of the New York board of directors. Miller telephoned Hamlin to say that the banking system had gone to pieces and that the appointment of Harrison in New York was a „severe disaster‰ ( Hamlin. 1928. January 25). Young and Norman talked in New York and Norman interpreted that conversation to eliminate the need for a trip to Washington. . This was an effective illustration of direct action at work. Young feared „it would be construed as an attack on the stock market and cause trouble‰ ( Hamlin. I added again that he would know better than we just how best to make the adjustment. Harrison clearly did not relish conflict and would attempt to avoid it by anticipating the actions of the board. they have been out of our debt only six days · those during October. January 25). might avoid the possibility of criticism both here and in Washington. they were pretty much out of line with other banks in New York. On January 31. YoungÊs objective was to „put MillerÊs draft in the least objectionable form. that I thought he was entitled to know this fact in order that he. the National Bank of Commerce has been out of our debt only 28 days. wanting to avoid difficulties with Young. The war on speculation had begun. Governor Montagu Norman. MillerÊs proposed letter was discussed at great length.

of the largest member banks. These were described in 1935 by Miller: „In the six months following the BoardÊs declaration of its position of February 2.) Not only was there a battle between the board and the New York Bank but there were also disagreements within the board. Hamlin states that „evidently these three are oblivious or reckless of the dangerous consequences which might ensue if the letter were so construed. Eleven times. The Federal Reserve Bank of New York believed that direct action (as typified by the boardÊs letter of February 2. On February 5. Harrison agreed that a 6 percent rate would be „injurious to small manufacturers‰ and would „interfere with building operations.‰ But Hamlin voted to send out the letter despite these anticipated dangerous consequences. Feb. by the twelve federal reserve banks and. but by no means all. This was a formidable opposition. that the board approved the increase to 6 percent. Miller failed to consider the possibility that he was in error.36 BEATING THE BEAR On February 2. He spoke to Young for two hours in the morning and joined the board in the afternoon.‰ Harrison said direct pressure had failed and „if 6 percent could not control speculation. „Platt said he hoped the public would construe it as a recommendation for drastic action as to existing speculative loans and James and Miller agreed with him‰ (Hamlin. New York favored increasing the discount rate. 1929. and it lost. . They only differed as to method. the New York directors voted to raise the discount rate of their bank from 5 to 6 percent. A motion that would insert „no desire for drastic action‰ in the letter was put to a vote. It was only on August 9. written by Miller) was ineffective and would lead to problems of implementation. According to Hamlin. by the Federal Advisory Council and many. Harrison stated „that speculative activity was steadily increasing. all members voted yes except Young.‰12 Despite the massive opposition. MillerÊs draft was again considered by the board. that in last year speculation loans of all banks increased 8 billion‰ (Hamlin. from February 14 to May 23. 1929. February 2). including the Secretary of the Treasury. Under questioning. (Appendix 1 to this chapter is a copy of the February 2 letter. Harrison was in Washington explaining the position of the New York directors on the discount rate.‰ There was no disagreement between the New York Fed and the Washington board that speculation must be controlled. Eleven times the board voted down the increase. higher rates must be resorted to. 5). the governor and the vice-governor. finally. the five members of the Board who took the responsibility of formulating the attitude and policy for the federal reserve system were opposed by a minority of their own members. On the letter itself.

The differences between the positions of the board and the New York bank are well defined by an exchange between Harrison and Miller (as described by Harrison): There were no specific suggestions made by anyone other than Dr. that we could not undertake to manage their institutions. he would either write a letter to each of the principal member banks in New York or else . especially with a view of determining whether they had anything in mind that we might be doing that we have not been doing. Miller who said that if he were running the Federal Reserve Bank of New York and received such a letter as that written by the Board. that I thought our meeting of the day before was of sufficient importance to report to the Board. he said that he thought that was a very important matter that should be determined at the time we would have to act. also out of which the bank would be making a profit represented by the spread between our rate and the return on the investments. although when I asked Dr. that we considered it a very serious period in our credit history. that we never had any difficulty in securing their cooperation in this regard. The New York bank thought that time had already arrived. but that we could indicate to them that we thought they had been borrowing too long or too much from us. Very little was said by members of the Board.THE FEDÊS ROLE IN GOOD TIMES AND BAD 37 HarrisonÊs report of the February 2 meeting is somewhat different than HamlinÊs: In the end I told the Board that we had no recommendations to make at this time. that we believed it was our right and our duty to inform individual member banks when they were out of line either in the point of continuity or amount of borrowings. Miller what he thought about an increase of one percent in the event that we should have to increase at all. either in relation to other comparable member banks or in relation to the character of their own business. having in mind the possibility that a bank might at times be borrowing the equivalent of capital funds from us as a result of a deliberate investment. but that whenever we did discuss this matter with our member banks we pointed out that the method of correcting their position with us was a matter of internal management for them to decide. that I would be glad to get their reactions and to discuss with them System policy. saying that I believed that the New York bank had already done practically as much as was in its power to do through so-called direct action. Harrison then discussed the letter of February 2 sent from the board to the reserve banks: I then discussed with the Board at some length their letter to us of February 2.

Only Young voted against publication of the letter. the functioning of the Federal Reserve system has encountered interference by reason of the excessive amount of the countryÊs credit absorbed in speculative security loans.38 BEATING THE BEAR call them into conference to say that he had been to Washington and had learned that the Federal Reserve Board was opposed to the use of Federal Reserve credit to support speculative credit and that. however. Goldenweiser. The Federal Reserve Act does not. Miller would get his wish. in those circumstances he would tell them to do „thus and so. The credit situation since the opening of the new year indicates that some of the factors which occasioned untoward developments during the year 1928 are still at work. The volume of speculative credits is still working. in the opinion of the Federal Reserve Board. . which has characterized the credit movement during the past year or more.‰ In October. Goldenweiser. The difficulty is to determine what is „thus and so. that he personally would like to see a sudden liquidation and crash. that nothing we could do would have that effect. . director of the Division of Research and Statistics of the Federal Reserve. warned against the insert: „Dr. said he would not be true to himself if he did not say that it would be a great mistake to include in the Bulletin a copy of our letter to the chairman. The February 1929 issue of The Federal Reserve Bulletin included the following statements: During the last year or more. contemplate the use of the resources of the Federal Reserve banks for the creation of extension of speculative credit. who happened to be there. . Hamlin notes that „in discussing its effect. According to Hamlin. deserves particular attention lest it become a decisive factor working toward a still further firming of money rates to the prejudice of the countryÊs commercial interests. that it would reveal a difference of opinion between the Board and the banks and would be washing dirty linen. Miller said he did not think it would cause any drastic liquidation of speculative loans. A. in the judgment of the Federal Reserve Board. A member bank is not within its reasonable claims for rediscount facilities at its Federal Reserve bank when it borrows either for the purpose of making speculative loans or for the purpose of maintaining speculative loans.‰ I told him that that was just the point.‰ Later on the afternoon of February 5 the board considered a proposed insert for The Federal Reserve Bulletin.‰ Miller agreed to include only the first page of the letter. The extraordinary absorption of funds in speculative security loans. E. The March issue of The Federal Reserve Bulletin contained the following statements: „In last monthÊs Bulletin. the Federal Reserve Board .

Governor Y. and possibly Platt would refuse to approve it. he faintly intimated. High money rates. but at the same time may result in a higher cost of credit to all lines of business. Feb. but at the same time may stimulate speculation in securities. If it raises the rate I think every member except Governor Y. 8). or real estate. deserves particular attention lest it becomes a decisive factor working toward a still further firming of money rates to the prejudice of the countryÊs commercial interests. told him it would be better not to act today. In determining upon credit policy the Federal Reserve system is always under the necessity of balancing the advantages and disadvantages that are likely to follow a given course of action. which has characterized the credit movement during the past year or more. The board feared that if it approved. Hamlin reports that „Harrison called up and said his directors were considering advancing their discount rate. which would tend to ease the domestic situation. and he seemed to act as if Hoover knew and approved of the BoardÊs action. it would be concluded that „what it meant in its letter was simply to increase rates · while the opposite was the fact as to most of the Board‰ (Hamlin. ultimately they may draw gold from abroad. and on February 7. The Board said that Âthe extraordinary absorption of funds in speculative security loans.‰ On February 8.THE FEDÊS ROLE IN GOOD TIMES AND BAD 39 defined its attitude toward the rapid growth of loans on securities in recent years and toward the present high level of this class of loans. Harrison briefly visited the board and expressed his regrets that the board had released its statement calling for „direct action‰ to limit speculative loans. Miller was a good friend (and ex-neighbor) of Herbert Hoover: During the discussion Miller spoke of Hoover as one who would back up the Board. Harrison returned to New York. Low money rates may have a favorable effect on domestic business. On the same day an interesting exchange took place between Miller and Young (as reported by Hamlin). and thus be detrimental to commerce and industry. may exert a moderating influence on speculation. . and that if the Board weakened. that he knew Wall Street well.ʉ The bulletin then gave a brief lecture on banking policy and credit policy: Credit policy is essentially impersonal and finds expression chiefly through the influence that the Federal Reserve system may exert on the volume and cost of bank credit through its policy of sales or purchases in the open market and through discount rates on member-bank borrowings and buying rates on acceptances. commodities. On February 6. on the other hand. Hoover might take position in the matter. the board tabled New YorkÊs request to increase the discount rate (Platt voted against the tabling).

‰ Harrison explained why a review and a decision was needed that day. On February 14. to wit.. unless advised in the interim that there is no objection to the Board acting earlier should it so desire.40 BEATING THE BEAR Young asked if this was a threat. next Thursday. said „No..M. Harrison explained to Young the vote establishing a rate of 6 percent. Mitchell (a director of the New York Federal Reserve Bank and president of the First National Bank) talked with Young about the problems of leaving the issue unresolved. informally. At 5:45 P. Young said he had not understood the need for urgency and said he would speak to the board again. C.) telephoned Young in Washington and requested a decision.M.M.. the directors of the Federal Reserve Bank of New York unanimously voted to increase the rediscount rate to 6 percent. but this fact was ignored by all). Harrison immediately (at 3:40 P. had inside information). At 5:30 P. Young read the following statement to McGarrah: „The members of the Board present have agreed. McGarrah again called Young. He stated „if the Federal Reserve Board did not act that day the action would lapse‰ (this lapsing would seem to solve one of HarrisonÊs problems. Harrison again telephoned Young and explained the problems with not knowing whether the board might approve a higher discount rate already approved by New York (the directors. Miller evidently abashed.M. some of whom managed banks. At 5:20 P.M. not having received a call from Young. At 6:01 P.M. there was a „lapse in conversation‰ while Young talked with . that they will take no action to change the rediscount rate of the Federal Reserve Bank of New York before the next regular meeting date of the directors of that bank.M.. Young telephoned Harrison and read the following statement: „The Federal Reserve Board has instructed me to call you and advise you that the Board has received the verbal advice of the Federal Reserve Bank of New York having established a rate of six percent and that the Federal Reserve Board will hold the matter for review and during the interim has determined that the rate of the Federal Reserve Bank of New York shall be five percent. „one way or another today.. E.‰ At 4:20 P.‰ At 5:30 P.. At 6:23 P. Miller later stated that he would never vote for higher discount rates unless it were clearly demonstrated that direct action was a failure. McGarrah (chairman of the New York Bank) called Young and extended HarrisonÊs concerns. Not at all!‰ YoungÊs defense of the FedÊs independence is praiseworthy. Young said the board wanted to think it over and needed time.M.

At 9:10 A. announce to the newspaper men that there was no announcement to make. the board agreed to review New YorkÊs decision. but it is not entitled to all the credit or to an unreasonable proportion of the total. Young stated: Financing business through shares or bonds can be on a sound basis and when it is sound is entitled to credit. At 6:40 P. Young telephoned Harrison to discuss the form of a report of call loans made for the account of others. These are the carefully thought out comments of the governor of the Federal Reserve Board in March 1929. In view of the incomplete report of the rediscount rate action taken by the directors of the Federal Reserve Bank of New York as furnished over the telephone by the Federal Reserve Bank of New York. The speech was released for publication the next day.‰ Governor Harrison then informed Governor Young that he would.M. Young explained that the board wanted to give direct action a trial and that the board would vote 7 to 1 against any rate increase request from New York.. After completion of that topic. Thus. trying to reopen the issue. Mitchell accepted defeat more gracefully. He talked with Young and told him „he was glad the Board had taken definite action. Young spoke before the Commercial Club of Cincinnati. 1929. on February 28. It seems to me that it would be the part of prudence for all who are lenders to see first that business gets credit at reasonable rates and let the others get what is left. On March 16. but then voted to disapprove New YorkÊs decision to increase interest rates. and in view of the fact that the Board now has the resolution before it as passed by the New York directors. it moves that the previous action of the Federal Reserve Board in reference to the rediscount rate of the Federal Reserve Bank of New York be reconsidered. Moved that the Board disapprove of the action of the directors of the Federal Reserve Bank of New York and determine the rate of that bank to be five percent. Harrison.M. Motion carried. in accordance with our usual custom. Aside from offering a variety of solutions without recommending any of them. Young read the following motions to Harrison: 1. Harrison shifted to the rate situation. offered to supply more information if the board desired it.THE FEDÊS ROLE IN GOOD TIMES AND BAD 41 other members of the board. 2. .

E. Harrison then called Jackson Reynolds. Reynolds saw some benefits from the decrease in stock prices: He repeated that he thought it was „fine‰ and that „these fellows were getting what they ought to get. Mellon. as Harrison wrote. Harrison had a telephone conversation with Andrew Mellon. Mitchell also took steps (making loans to brokers) that helped stop the fall in prices. The action by Harrison is significant. as I explained to Mr. that stock prices had declined drastically. chairman of the Clearing House Committee. and that conditions .‰ The New York Fed supplied the liquidity necessary to stem the decline. C.‰ the Federal Reserve Bank did not want and could not be in the position of arbitrarily refusing loans on eligible paper to member banks. and had a similar conversation with him. Mitchell of the First National Bank described the situation in the exchange to Harrison as „panicky.‰ I told him.‰ On March 26. call money started at 12 percent. that I did not want him to feel that the Federal Reserve Bank. however.‰ Harrison also called Young: „At about 12:45 I telephoned Governor Young of the Federal Reserve Board to tell him of conditions in the money market. In other words. but by noon. „I never heard anything further from Mr. Mitchell. call money had risen to 20 percent. Mellon agreed that rates had to go up sooner or later but. because of all of its efforts to seek cooperation of the member banks in the past to avoid unnecessary uses of its credit. that in circumstances such as these which he described as bordering on the „panicky. since he directed the resources of his bank and the New York member banks toward stemming the panic. Harrison wrote: I then mentioned. Mitchell was not to be thanked for his efforts. that the impression should not be spread about that we were refusing loans and that I had advised the officers of the bank that if inquiry should come to them they should not imply that we would refuse loans. should be understood as refusing to grant credit on eligible paper. One has to wonder who „these fellows‰ were who were „getting what they ought to get. my opinion was that in a period of great stress the Federal Reserve Bank should be in the position of freely lending money at its going rate in order that there might not be any charge that it had arbitrarily refused or rationed credit. however. mentioning that the call rate was then 20 percent. This was a dry run for the October crash. Stock prices were down drastically. that $60 million was wanted.42 BEATING THE BEAR On March 21.

Mitchell is not thanked for preventing a March crash but rather is accused of encouraging the speculation that led to the October fall in prices.‰ March 26. The actions of the New York Fed and the National City Bank and „luck‰ turned the day. Mr. Mitchell as Class A director of the New York Federal Reserve Bank. Mitchell had announced that the National City Bank „was ready to lend $25 million on the call market. He said that he had already been advised of those facts. 1929. The actions of the New York Fed and the National City Bank helped prevent the panic from becoming historic.‰ On March 26. The April issue of The Federal Reserve Bulletin makes no reference to the panic of March 26.000 the day after. The challenge ought to be promptly met and courageously dealt with. compared with the previous dayÊs high of 311. The New York Times on March 29. and when the Federal Reserve Board mildly seeks to abate the danger by an administrative policy . whatever might be the attitude of the Federal Reserve Board. MitchellÊs proclamation is a challenge to the authority and the announced policy of the Federal Reserve Board. .51. is not a historical day compared with the black days of October.‰13 One might think that history would thank Mitchell for helping to prevent a collapse of the stock market.619.‰ Young stated that HarrisonÊs actions were „100 percent right. . However. The Board should ask for the immediate resignation of Mr.000 shares. This liquidation has been accompanied by a further rise in money rates. It does state that „The liquidation of brokersÊ loans by banks since the BoardÊs statement of February 7 indicates an effort by the banks to comply with the desire of the Board to restrain the diversion of bank credit into speculative channels. 1929. The volume on March 26 was 8. compared with 5. Appendix 2 to this chapter contains MitchellÊs 1933 testimony before a Senate committee on stock exchange practices.246. carried the following statement made by Senator Carter Glass regarding Mitchell: He avows his superior obligation to a frantic stock market over against the obligations of his oath as a director of the New York Federal Reserve Bank.55 · a drop of 9. on March 26.860. the low of the Dow Jones Index was 281. which has attracted funds from corporations and individuals in this country and abroad.6 percent. .000 shares the day before and 5. The whole country has been aghast for months and months at the menacing spectacle of excessive stock gambling.THE FEDÊS ROLE IN GOOD TIMES AND BAD 43 on the Exchange were very actively depressed.

rather than by a prohibitive advance in rediscount rates.‰ After a phone call to Young. On March 28. that was true and that he would therefore not mention it at the meeting. which might penalize the legitimate business of the entire country. Mitchell in the morning newspapers concerning Âloans on callÊ and ÂFederal Reserve Board warningsÊ without expressing his views in the matter.44 BEATING THE BEAR fully sanctioned by law. The New York banks had learned that massive actions to prevent stock market panic would not be thanked by the president. that that matter was of paramount importance and that I hoped he would discuss the matter with Governor Young before he decided not to attend our meeting. At 12:45 he informed Harrison „that he did not feel he could be present at our meeting of directors this afternoon in view of the reported statement of Mr. or the Federal Reserve Board. Miller that I hoped he would not persist in his intention not to join our meeting. Miller was in New York to attend a meeting of the directors of the New York Federal Reserve Bank.14 Hoover approved of the statement by Glass. Mitchell had said.Ê I asked him whether he wanted to discuss the question ÂofficiallyÊ at the board meeting. Miller indicated that „he would be glad to join our meeting and say nothing with respect to Mr.000. despite the express warning of the Federal Reserve Board to the contrary. Miller said that he did not want to discuss the matter with him Âpersonally. the Banking Act of 1933 fortifies the Board with power to call in immediately all advances made to any member bank which disregards a warning against increasing its stock market loans. Mr. the National City Bank poured $25. The stage was set for the October crash. I told him I was very glad of this result. that he had come here to discuss the Federal Reserve BoardÊs policy with our directors. „to prevent a repetition of the incident in March 1929.‰ Mitchell was a director of the New York Federal Reserve Bank. MitchellÊs statement. an officer of the System issues a defiance and engages in an attempt to vitiate the policy of the Federal Reserve Board. stating that perhaps the Federal Reserve board had not given him any mandate with respect to the matter. Mr. when.000 into the call-loan market. Harrison then notes: „I suggested the possibility of Mr. Congress. Miller sitting next to Mr.‰ The Banking Act of 1933 states. that to say nothing would imply possibly that he agreed with what Mr.‰ Harrison continued to try to act as a peacemaker: „I then told Mr.‰15 . Miller said that. of course. Mitchell at lunch and discussing privately and quietly with him what he had in mind.

Harrison called Mellon. if necessary. 1929. that the problem of providing funds for the call loan market or determining the rates for call loans was with the New York banks and bankers. but that the necessary corollary of that position was that we should be prepared to lend freely. 1929. Platt telephoned at about 4:15 to say that the board had voted not to approve the increase. Harrison advised Platt that the directors would await word from him as to the decision of the board.THE FEDÊS ROLE IN GOOD TIMES AND BAD 45 Thus an action by a member bank. since Secretary Mellon presided and argued the case for an increase. On April 26. They first discussed the foreign exchange situation and then the discount rate situation. that is. 1929. Harrison phoned Edmund Platt of the Federal Reserve Board to advise him of that fact and to tell him in some detail of the nature of the discussion of the bankÊs directors. April 11. Harrison stated his position regarding the availability of credit: I referred to the episode on Tuesday. On May 13. the directors of the New York Federal Reserve Bank voted to establish a discount rate of 6 percent. when money rates went to 20 percent and said that our position now was the same as it was then. On the afternoon of April 25. Mellon said he thought that that was absolutely the right position and an unavoidable one. Platt indicated that the board had acted on the rate increase that morning and had disapproved it. that that was their problem. that we could not request or suggest that they should or should not cut funds in a period of severe pinch. Harrison telephoned Platt to advise him that the directors of the New York Bank had voted unanimously to establish a rate of 6 percent. This meeting was different from past meetings. Harrison telephoned Platt to advise him that the directors of the New York Bank had again voted to establish a discount rate of 6 percent. Mr. 1929. Harrison requested that the board „reconsider the matter. Platt telephoned to say that the board had voted to disapprove the rate increase. president of Guaranty Trust Company. Platt again reported that the board had rejected the rate increase. Potter. to provide reserves against loans taken over by New York City banks. March 26. not with the Federal Reserve Bank.‰ About an hour after the request. made with the full knowledge and approval of the Federal Reserve Bank of New York and the governor of the Federal Reserve Board. led Congress to pass an unnecessary law. On the afternoon on April 18. On Thursday. Harrison related the January 2 bill rate incident (proudly stating that New York still had authority to change rates . Harrison spoke with William C.

McGarrah was chairman of the Federal Reserve Bank of New York). . Mr. Harrison then proceeded to explore direct action. W. of the First National Bank to discuss the credit policies of the First National Bank. Later Harrison called George Baker. The First National Bank wanted cheap money and Harrison did not want an easy money policy. said that in his opinion our position was precisely correct. that he was just as anxious as the Federal Reserve Bank to be in a position to take care of the increased demand that will arise during the fall. G..46 BEATING THE BEAR without getting approval from the Federal Reserve Board). As he was leaving my room. and that he hoped our letter would have the effect of raising a definite final issue with the Board on which this whole problem could be fought out. He then complained that „we have not only been denied the right to increase our rate but have been in a measure subjected to the test of so-called direct action. that it is becoming more and more impossible as things are going now. . . that the situation was such that it would be impossible for us to deal with banks on the basis suggested by the Board. Jr.‰ Harrison then dropped the other shoe: I said I thought it was most unfortunate that institutions of the standing and importance of the First National and the Federal Reserve were so obviously going in different directions. he said he hoped that they would be out of our debt inside of ten days or two weeks even though it meant a large loss to them to do so.‰ Harrison gave Potter a copy of McGarrahÊs May 10 letter to read (the letter was in reply to the boardÊs letter of May 1. He said that they obviously do not understand the operation of the New York money market and that he was glad we had taken the position that we did. Potter read the letter through. Harrison also thought it was unfortunate that people were saying that First National was „defying the Federal Reserve Bank. I mentioned to Mr. putting all the . Potter incidentally that the Guaranty Trust Company was one of the banks listed in the BoardÊs letter. and also to some heavy demands quite frequently by some of their best customers for loans on securities. Having established that the Federal Reserve Board was the common enemy. He said then that he wanted to discuss their problem with me and said that their difficulties were due largely to a loss of deposits which always takes place at the time of a merger. During the course of the conversation. I then mentioned.

THE FEDÊS ROLE IN GOOD TIMES AND BAD cards on the table as to our position, that, regardless of any difference of opinion about legal rights, we consider clearly that we have the right, in the case of a bank which has been borrowing as much and as long as the First National is borrowing, to deny credit, but that I saw very considerable difficulty in our exercising that right; that we had never had to do so in the case of any of our member banks and that I hoped we never would have to do so.

47

The direct action mandate was clear (although not stated without ambiguity): „At one time during the discussion I made it very clear to him that we had not asked and that we were not then asking him to reduce his call loans, that I was merely pointing out the fact that his bank has been borrowing continuously in sums wholly out of line with other banks in New York, and that I still hoped that within a reasonable time they might find it convenient to get their bank more in line with other banks.‰ In June 1929, the board relaxed (but did not abandon) its direct action campaign. Miller described in 1935 the change in June 1929 to be a relaxing of the direct pressure:
By the middle of June it became apparent that in the then existing psychological and economic situation continuance of unremitting pressure on the market, particularly with the known heavy financial requirements of many leading industrial undertakings at the approaching end of the fiscal year, might precipitate a catastrophe. The Board, after a conference with a delegation of New York reserve bank directors, decided to relax for the time being but not to abandon its Âdirect pressure.Ê It was moreover then becoming evident that the stock market was reaching a point where it would collapse of its own weight, and that the principal concern of the federal reserve system should be to prepare itself to help the banks and the country to absorb the imminent shock as soon as it occurred.16

The Federal Reserve Bulletin of October 1930 clearly shows the downward slope of the money in circulation during the period 1926 –1930. At the beginning of 1926, $5,200 million was in circulation. At the beginning of 1929 there was only $5,100 million. The real economy was growing in a robust manner, but money in circulation was shrinking. The Federal Reserve Board had focused on stock market speculation to the neglect of the need of the real economy for money. And it received bad press for its restrictive practices: „Undoubtedly a good deal of the restricted buying interest of the public may be attributed to the uncertainties of the credit situation and the Federal Reserve Board.‰17

48

BEATING THE BEAR

In September 1930, Young resigned his $12,000-a-year job as governor of the Federal Reserve Board to accept a $30,000-a-year position as governor of the Boston Reserve Board. Other Federal Reserve Board members received $10,000 per year. While $10,000 a year was not an attractive temptation to a highly successful person in commerce in 1929, it was a very tempting political payoff (the job carried 12 years of security, with a good chance of reappointment). Paul M. Warburg, a member of the first Federal Reserve Board and a very successful investment banker, described the boardÊs position as follows:
There is no desire to fasten blame on any individual who took part in fashioning the SystemÊs policies in this trying period. No doubt, everybody concerned acted to the best of his knowledge and ability, and the keener his realization of the gravity of his responsibilities, the greater, of course, was the persistency with which he held to his own views. The fact remains, however, that in the face of a most critical situation · possibly the gravest with which the Federal Reserve Board widely divided within itself and unable to agree upon a definite and effective plan. We find this Board, as rumor has it, at variance with leading Federal reserve banks and, against the advice of the Advisory Council, blocking timely rate increases urged by the Federal reserve banks most concerned.

Warburg would have preferred that the board raise interest rates early in 1929. However, he recognized that others wanted the board to minimize its control of the market.18 Throughout 1928 and 1929, both the Federal Reserve Board and the Federal Reserve Bank of New York acted aggressively to control stock speculation. In fact, „there is no doubt that the desire to curb the stock market boom was a major if not dominating factor in Reserve actions during 1928 and 1929. Those actions clearly failed to stop the market boom. But they did exert steady deflationary pressure on the economy.‰19 The tragedy of 1929 was that the Federal Reserve focused on stock market speculation rather than the real commercial activities that were taking place. On August 2, 1929, Harrison met with the Federal Reserve Board and again suggested an increase in the discount rate to 6 percent. Harrison was authorized to invite the governors of all the federal reserve banks to meet with the board on August 7. On August 9, the directors voted to increase the discount rate to 6 percent. This time the board approved the increase. The major difference between the Federal Reserve Bank of New York and the Federal Reserve Board had

THE FEDÊS ROLE IN GOOD TIMES AND BAD

49

ended. Soon there would be substantive real problems to occupy their attention. The high level of stock market prices did not jeopardize the nationÊs prosperity. These prices could be justified given the bright future expected for the U.S. economy. The actions of the Federal Reserve Board to bring down stock prices, however, jeopardized prosperity in ways that few predicted. THE FED IN 2000–2009 In the years preceding the 2008 crash, the Federal Reserve Bank facilitated the booming real estate market by making sure that long-term interest rates (real and nominal) were very low. The 10-year treasuries from 2002 to 2008 had average interest rates that were less than 4.79; in 2008, they were 3.78. The buying of U.S. bonds by China helped the Fed achieve its low interest rate goal. Ex post the pre-2008 real estate market has been described as a bubble. If one defined the pre-2008 real estate market as a bubble, then the Fed was guilty of encouraging the real estate price increases to be higher than desirable. However, during the pre-2008 period there was no general outcry against the FedÊs policies. It was only when real estate prices stopped going up that the extent of subprime mortgages was revealed. And the FedÊs faulty practices with regard to interest rates were identified only when the high risk borrowers stopped paying on the mortgages (decreases in real estate prices gave the borrowers an incentive to walk away from debts that were larger than the value of the assets underlying the loans). In early 2009, the Federal Reserve Bank bought $250 billion of low-interest-rate (less than 5 percent) mortgages guaranteed by Fannie Mae and Freddie Mac. These purchases drove mortgage rates to below 5 percent. Also, as mortgage prices went up, banks recorded gains on the sale of mortgages and also the fair value gains on mortgages held. The Fed, of course, can print money.

Appendix 1

LETTER SENT TO ALL FEDERAL RESERVE BANKS FEBRUARY 2, 1929 The firming tendencies of the money market which have been in evidence since the beginning of the year · contrary to the usual trend at this season · make it incumbent upon the Federal Reserve banks to give constant and close attention to the situation in order that no influence adverse to the trade and industry of the country shall be exercised by the trend of money conditions, beyond what may develop as inevitable. The extraordinary absorption of funds in speculative security loans which has characterized the credit movement during the past year or more, in the judgment of the Federal Reserve Board, deserves particular attention lest it become a decisive factor working toward a still further firming of money rates to the prejudice of the countryÊs commercial interests. The resources of the Federal Reserve system are ample for meeting the growth of the countryÊs commercial needs for credit, provided they are competently administered and protected against seepage into uses not contemplated by the Federal Reserve Act. The Federal Reserve Act does not, in the opinion of the Federal Reserve Board, contemplate the use of the resources of the Federal Reserve banks for the creation or extension of speculative credit. A member bank is not within its reasonable claims for rediscount facilities at its Federal Reserve bank when it borrows either for the purpose of making speculative loans or for the purpose of maintaining speculative loans. The board has no disposition to assume authority to interfere with the loan practices of member banks so long as they do not involve the Federal Reserve banks. It has, however, a grave responsibility whenever there is evidence that member banks are maintaining speculative security loans with the aid of Federal Reserve credit. When such is the case the Federal reserve bank becomes either a contributing or a sustaining factor in the current volume of speculative security credit. This is not in harmony with the intent of the Federal reserve act nor is it conducive to the wholesome operation of the banking and credit system of the country. You are desired to bring this letter to the attention of the directors of your bank in order that they may be advised of the attitude of the Federal Reserve Board with respect to this situation and the problem confronting the administration of Federal Reserve banks. The board would like to

(b) what methods they employ to protect their institution against the improper use of its credit facilities by member banks. By direction of the Federal Reserve Board. however difficult. . and (c) how effective these methods have been. The board. believes that. nevertheless. the problem can be more completely met and that the existing situation admits of improvement. The board realizes that the problem of protecting the credit situation from strain because of excessive absorption of credit in speculative security loans is attended with difficulties.THE FEDÊS ROLE IN GOOD TIMES AND BAD 51 have from them an expression as to (a) how they keep themselves fully informed of the use made of borrowings by their member banks. It also realizes that there are elements in the situation which are not readily amendable to recognized methods of banking control. The Federal Reserve Board awaits the reply of your directors to this letter and bespeaks their prompt attention in order that it may have their reply at an early date.

Those were brokers who had to make good the contract that day. Mitchell: I think not. Mr. Mitchell: It was regarded as that in certain quarters. Mr.000 into the call-loan money market. . Pecora: In other words.Appendix 2 Mr. Mitchell: I think not. It was one of those gambling deals. sir. yes. at a time when we were not borrowing a penny from the Federal Reserve Bank. there developed one day at the money post on the exchange a period when there was no money to lend. wasnÊt it? . Mr. to 15 or 16 percent. Mitchell: That I deny. I think. Mr. at the time when the Federal Reserve Board was seeking to apply the brakes to this inflationary process the National City Bank was nullifying that to the extent that it threw this $25. Pecora: Do you recall that at the same time the National City Bank threw $25. Pecora: In certain responsible quarters? Mr. We stepped in there to allay what was becoming a money panic. . (Some testimony omitted) Senator Brookhart: Who were those honest borrowers? WerenÊt they speculators? Mr. Mr. Mr. Mitchell: Yes. an inability of the legitimate borrower to borrow for his day contracts the money that was essential if they should be maintained.000.000. We were not leaning upon Federal Reserve credit to support speculation. There developed in New York. Senator Brookhart: (Interposing) That was a speculative contract. The rate had gone up. Mr. Pecora: Well. Mr. We went in and loaned . Pecora: DidnÊt it contribute to the opposite effect? Mr. The Federal Reserve BoardÊs warning was a warning against banks leaning on Federal Reserve credit to support speculation. Mitchell: Yes. Pecora.000 into the call-loan money market at rates of 16 percent and more. when we had plenty of government bonds and eligible loans for discount at the Federal Reserve Bank· as I say. for overnight. Mitchell: No. sir. and not rediscounting. What happened · and since the question has been brought up I think I should be permitted to reply to it · was this: We had not been borrowing from the Federal Reserve Bank at all. didnÊt it have the opposite effect from that which was intended by the Federal Reserve Board in raising its rediscount rate at that time? Mr. Pecora: And that that was regarded as a flaunt on the warning sounded by the Federal Reserve Board? Mr.

Mitchell: I do not believe that any man who has it within his power to stop a money panic is going to take the responsibility of seeing the money panic develop. and is. and we went to the Federal Reserve Bank for two days only. At the same time. recognized. . and it may be assumed the Federal reserve banks. and developed overnight. That there has been a most unusual expansion in credit is a fact that is generally admitted and that the largest element in that expansion is so-called speculative loans must also be. and the collapse would not have suffered such purchases to mean a loss. . the people of the country would be generally well advised to bear in mind the condition of the credit structure and voluntarily see to it that in their loan accounts they maintain wider margins and lean less heavily on borrowed money. and I caused this paragraph to be put in: During the last week of March these large credit demands. Mitchell: This was not in support of the speculative market. It is evident from the way money has acted here in the past few days that the crisis has passed and the incident is a closed book. was due primarily. resulted in a scarcity of call money that sent the rates up to 20 percent and caused a sharp reaction in stock prices. And four days later . wish to avoid a general collapse of the securities markets such as would have a disastrous effect on business. which I think was about March 26 or 27. The National City Bank fully recognizes the dangers of overspeculation and endorses the desire of the Federal reserve authorities to restrain excessive credit expansion for this purpose. as to undue expansion of the credit structure have changed. Mr. Pecora: Now. It wonÊt take but a moment. combined with the substantial withdrawal of funds from the New York call-loan market. Mitchell. On the 1st day of April our monthly bulletin was issued. which was sudden. whose policies over the past year have been marked by moderation. Mitchell: After the date when we made these loans. Mr. this expansion of the credit structure that is referred to in that bulletin. 1929. however. prevented them from buying. Prompt action by New York City banks. Senator Brookhart: If you had let it collapse in March that would have saved hundreds of thousands of dollars to people who invested later on. With this crisis past. wasnÊt it. to the unprecedented amount of speculation in the stock market over a period of two or three years prior to March of 1929? Mr. Pecora: (Interposing) Four days after what date? Mr.THE FEDÊS ROLE IN GOOD TIMES AND BAD 53 Mr. Mr. . in offering to provide funds to take care of the marketÊs requirements. the bank business generally. I take the opportunity of asking if you will just let me read a paragraph from our bulletin? This pertains to what occurred in March of 1929. Mitchell: It was the development of excessive speculation. At the same time it would be unfortunate that any action taken by this bank during the emergency should have created the thought that our views. again and again expressed. This was to prevent a money panic. it not that a fact? Mr. served to avert any fears of a money panic. including shifting of balances in connection with income-tax payments and in preparation of quarterly disbursements of dividends and interest.

. and it was an exaggerated statement made as the result. Mitchell: I may be an inferior banker.54 BEATING THE BEAR Senator Brookhart: That is what is wrong with our financial system. I was not . Mitchell: The banker could not see a panic occurring because of a money squeeze that was minor in its character. speculators and investors everywhere were borrowing more money than they should. that was a fact that we all appreciated and that we were trying to preach against and educate the public in regard to. but so long as I am in the banking business and can find a way to stop a money or a credit panic every bit of the weight I can put into the situation is going to be put in. Mr. . as I recall. would it? Senator Fletcher: Would not have been as great if this collapse had occurred in March. IsnÊt that so? Mr. not of any statement made by me. what would have been the situation? Mr. Mitchell: Senator Glass took that attitude at that time. would it? If that collapse had occurred in March 1929. . (Some testimony omitted) Senator Fletcher: The depreciation in securities that resulted in October in a drop of some $25. Security prices were high. . nobody is going to stop this speculation.000. (Some testimony omitted)20 . Senator Brookhart: (Interposing) Would not have been at all. would not have been as great .000. but as the result of the newspaper article. (Some testimony omitted) The Chairman: It has been repeatedly interpreted by Senator Glass as your saying to the Federal Reserve Board to go to hell.

to all Federal Reserve banks (see chapter 4. Appendix 1). By 6:40 P..Chapter 5 PRACTICE FOR THE OCTOBER CRASH: THE WEEK OF MARCH 25. The objective was to tell all member banks that a bank could not use the rediscount facilities at its Federal Reserve Bank „when it borrows either for the purpose of making speculative loans or for the purpose of maintaining speculative loans. 1929 Secretary of the Treasury Mellon opened 1929 with a statement for the January 1 newspapers.‰ His comments were eagerly awaited by the investment community.M.‰ In February. The New York Times said the comments were awaited „with unusual interest because of the unprecedented speculative activities on the Stock Exchange. On the afternoon of February 14. the Federal Reserve Bank of New York voted. due to the speculation on the Stock Exchange. to increase the rediscount rate from 5 to 6 percent. the Federal Reserve Board sent out its letter dated February 2. Member banks were urged not to borrow from the Federal Reserve Bank to finance stock market speculation. Mellon did not make frequent announcements. The New York Times ( p. forced the Treasury during the year to pay 43Î4¾ percent in selling one of its short-term issues. 1929.‰ The closest Mellon came to commenting on the state of the stock market was in reference to interest rates: „High interest rates in the open market. on its own initiative.‰ This letter alerted the participants of the New York Stock Exchange that the board believed there was too much stock market speculation. the Federal Reserve Board had passed a resolution that „moved that the Board disapprove of the action of the directors of the . 26) headed a column with „Mellon Optimistic on Business Trend.

Of course. Mellon responded as well as he could.‰ The article then went on to explain . the announcement indicated that the Treasury would not „revise FedÊs war on speculation‰ ( p. since Mellon did not reinforce the FedÊs war against speculators.‰ He then said. it may create a panic.‰ The board did not want borrowers (borrowing to finance speculative loans) who could pay the increased rate to have access to bank funds. neither did Mellon repudiate it. are too high in price to be good buys. „For prudent investors . Now. To top it off he sent a copy of the Federal Reserve BoardÊs letter to Levy to prove his point. now is the time to buy good bonds. given his sensitive position. On March 15. the New York Times had an important article regarding an announcement from the Treasury Department: „Mellon Not to Act in Speculation Ban.56 BEATING THE BEAR Federal Reserve Bank of New York and determine the rate of that bank to be five percent. It is interesting how perceptive LevyÊs was. March 28. but not the Federal Reserve Board. There was no reference to the availability of credit. In fairness. On March 12. In a letter dated March 12 (in the New York Times. the culprit being attacked by the board was speculation. . It was reasonable for him to deny that any federal government employee or body was pessimistic. which focused on economic activity. I fear that Mr.‰ MellonÊs response a couple of days later was not up to his normal standards. Levy was not reassured by the secretaryÊs letter. 44). . The Mellon announcement triggered a classic letter from a concerned lawyer ( I. p. however. Some. The rumor on Wall Street was that Mellon opposed the distribution of the letter. The board was not obviously pessimistic from MellonÊs viewpoint. Levy). This letter was before both the March and October crashes. He made the point to Levy that Levy probably meant newspapers and others were pessimistic. „Prosperity is very much a matter of psychology and if the Federal Reserve Board continues its pessimistic note. This announcement was good news for Wall Street. On the other hand. 1) had a headline reading „Mellon Advises Buying of Bonds by Investors.‰ Mellon cited the relatively high bond yields and low prices compared with high stock prices. The New York Fed wanted the cost of the funds to regulate who borrowed the funds and did not want to distinguish between investment and speculative purposes. the New York Times ( p. 20) Levy wrote.‰ The „ban‰ referred to the February letter from the board. It wanted the loans to be rejected because they were speculative and not accepted because the borrowers could pay the higher interest rate. M. „This does not mean that many stocks are not good investments.

‰ If Mellon had wanted to say this. p. we can conclude was very good investment advice. The news article revealed that Mellon „would not enter into a general discussion of present-day speculation in stocks‰ and that he had a long conference with Hoover on the day before his statement. His speech made clear that the Federal Reserve Board advocated the rationing of credit for buying stock securities: „It seems to me that it would be the part of prudence for all who are lenders to see first that business gets credit at reasonable rates and let the others get what is left. spoke before the Commercial Club of Cincinnati. he got a reasoned statement that. including the possibility of an increase in the rediscount rate. Instead. and we can assume that it was MellonÊs way of saying that some. The 14 percent cost of call money was very high (in October 1929 the cost of call money was 5 percent). Given that we know HooverÊs position with regard to speculation during 1929 (he wanted it checked). The next day the editorial in the New York Times ( March 16. governor of the Federal Reserve Bank and chairman of the Federal Reserve Board. but not having received it. March 26. we can conjecture what types of statements Hoover requested from Mellon. but not all. but this is unfair. Rather.‰ The New York Times would also have liked a blast at speculation. Mellon gave an intelligent evaluation and sensible recommendations. .PRACTICE FOR THE OCTOBER CRASH 57 why MellonÊs mild statement with regard to the investment climate was important. On March 16. The Federal Reserve Board had declared „warfare against the excessive use of Federal Reserve credit for speculative activities on the Stock Exchange. „Stock Prices Break Heavily as Money Soars to 14 Percent. with hindsight.‰ and Mellon had said only that some stocks were too high in price. Some cynics suggested that MellonÊs recommendation to buy bonds was related to the TreasuryÊs efforts to sell low-yielding treasuries. including the buyers of the stocks and bonds issued by the business that Young wants to help. 18) led off with „ The most significant thing in Secretary MellonÊs comment on stock market prices is the fact that he made any comment at all.‰ The „others‰ were the financial community. stocks were too high. there was a New York Times major first-page headline. At a minimum he wanted a statement describing the evils of stock market speculation. Roy Young. his statement would have included these words or something close to them. On Tuesday. the editor evaluated MellonÊs comments to be „a weighty statement‰ that described the „dangers of excessive speculation.‰ The Times conjectured that the market crash on Monday was caused by an expectation of drastic action by the Federal Reserve Board.

The analyst of the Times offered three reasons for the March 26 crash: 1. Funds to finance securities were not available. The 14 percent was the highest rate since July 1.6 percent. they were sent by telegraph. The article on the price break referred to „Hundreds of Margins‰ being called. since not all the investors had additional cash. Radio Corporation of America (RCA) went up 41Î4 points as the market went down. few or no rational investors could maintain a margin account. reflecting lower stock prices. The increase in the cost of call money from 9 percent to 14 percent shocked the market. RCA was a stock immune to market fluctuations because of its underlying strength (in October this obvious conclusion would turn out to be wrong).58 BEATING THE BEAR There was an interesting footnote to the dayÊs trading.246. 1). This reference to margin calls highlights the fact that the lenders intended to either get additional cash backing for the margin loans or sell the securities. Interestingly. but in March 1929. in the new high-tech world. 1920.‰ increasing by 67Î8 points. Bond prices were lower on March 26. exclaimed. but it was also the result of investors being in a state of shock regarding securities in general. There were too many speculative positions. „Stocks Crash and Then Rally in 8. 2. closing at $93 (the high for the year to this date was 1093Î8 and the low was 681Î4). The tight money.700 shares. Obviously. In fact. 300 stock issues hit new lows for the year. International Telephone and Telegraph also went „against the tide.‰ One suspects that the reporter was actually thinking of investors new to the stock market rather than the conventional expert manipulators that Washington looked at as speculators. the margin calls had been sent by the mail.‰ The volume of trading beat the previous dayÊs record by 1. in its right-hand headline.740 Share Day: Money Goes to 20 Per Cent. The article said the speculators were „prone to do the wrong thing at the right time. . in this down market. This was partially the result of convertible bonds selling at lower prices. One has to assume that many securities were sold as a result of the margin calls. March 26) was even worse than that of Monday. The Wednesday Times ( p. During the day. The fear that the Fed would increase the rediscount rate or do something else to dry up credit to finance securities. RCA was up 11Î8 points. In addition. At an interest cost of 20 percent. The next dayÊs market performance ( Tuesday. or the right thing at the wrong time. 3. there was a shortage of available loan funds even at these interest rates. some broker loans were at 22 percent.292. In the past. The average market price dropped 9.

If more funds were needed. March 28 („recoveries‰ are not as important as „crashes. In a left-hand front-page headline on Thursday.‰ But rationing credit is exactly what the Federal Reserve Board wanted the Federal Reserve banks to do. it would charge 20 percent.‰ thus the recovery had a downgraded headline). Wednesday. and Congress for reversing the stock market crash of March. the press. It offered to lend $5 million at 16 percent. the events of March 25 and 26 pale in comparison with the events of October.‰ GlassÊs position was heartily supported by other senators. The bank was part white knight and part profit-maximizing bank. the market recovered some of its losses. it would lend $5 million more at 17 percent.‰ and „National City Bank Offers $25. March 26). Harrison wanted the New York Federal Reserve Bank to be „in the position of freely lending money at its going rate in order that there might not be any charge that it had arbitrarily refused or rationed credit. On page one.‰ Obviously.000 in 5 Lots. HarrisonÊs position was that the Federal Reserve Bank should „grant credit on eligible paper. Rightly or wrongly.000. . March 27. Mitchell was blamed by the Federal Reserve Board (especially board member Adolph Miller). The bank was acting as a lender of last resort. the market did not continue its drop on March 27.‰ „Glass‰ was Senator Carter Glass of Virginia. The New York Federal Reserve Bank (under Governor George Harrison) also supplied liquidity to member banks so that they could finance brokers. Stocks Up in Buying Rush. Glass called for MitchellÊs resignation as a director of the New York Federal Reserve Bank.‰ The assistance of the bankers had occurred toward the end of the day (Tuesday. On Wednesday. But still the sequence of events in March is very important. He denounced MitchellÊs „contempt of [the] Board. For the fifth $5 million unit. The chairman of National City Bank was Charles Mitchell. the New York Times had „Stocks Rally Vigorously As Bankers Aid Market. In fact. As a result of MitchellÊs actions or because of good fortune. he did not want to analyze whether the purpose of the borrowing was for investment or speculation. but at these high rates it was not exactly encouraging investment in stocks. March 27) was „Bankers Aid Recovery. the headline of the Times ( March 29) was „Glass Assails Mitchell For BankÊs Aid to Market.‰ „Call Money 15 Per Cent.‰ The National City BankÊs offer to lend $25 million is very interesting. Mitchell was castigated by congressmen of both houses for his actions that were said to indicate contempt of the Federal Reserve Board. All Needed Funds Ready.PRACTICE FOR THE OCTOBER CRASH 59 One of the subheadlines on page 1 (New York Times. Mitchell was not the only banker who took steps to stem the fall in stock prices.

or the thought that MitchellÊs bank stopped the price decline. if in place. THE BANKING ACT OF 1933 The Banking Act of 1933 is a law of the United States. the existence of speculators. Miller went to the meeting (we assume he also went to lunch). p. It offered to make loans at very high rates. Adolph Miller. March 29) the Times reported that RCA was up to 1061Î2 and that the cost of call money had dropped from 15 to 8 percent. a senior member of the Federal Reserve Board. It includes the words „to prevent a repetition of the incident in March 1929.000. Senator Brookhart of Iowa made page 2 of the Times with the statement that he „would forbid the widespread use of banking resources in speculation. „Congress Inquiry Likely Into Stock Speculation. Miller did not want to have lunch with Mitchell. when despite the express warning of the Federal Reserve Board to the contrary.‰ The act gives the Federal Reserve Board the power to prevent member banks from disregarding the wishes of the board (Stock Exchange Practices. The April issue of the Federal Reserve Bulletin describes the ongoing policy of restraining the diversion of bank credit into speculative uses but does not mention the stock market drop of March 25 and March 26. On March 28. but I have no comment to make. the Banking Act of 1933. the National City BankÊs offer to lend at 16 to 20 percent did not cause this drop. was not in debt to the Fed and thus not restricted in its actions. On Friday. Mitchell Explains Stand. p. at the time. The New York TimesÊs right-hand headline ( March 30.‰ MitchellÊs explanation of why he thought the Federal Reserve BoardÊs February letter did not apply to his bank in March was that the National City Bank. Of course. March 29. Obviously. 1934.000 into the call-loan market. nor did he want to meet with him. 18). Congress announced that an inquiry would take place. Since National City Bank had not borrowed from the Fed. was in New York to have lunch and attend a meeting with the board of directors of the New York Federal Reserve Bank.60 BEATING THE BEAR When informed of GlassÊs denouncement of him and his bankÊs actions.‰ It was not clear whether Congress was more upset about stocks going up. After persuasion from George Harrison and after Miller called Governor Young. Mitchell said. 1) said. National City Bank did not „pour‰ $25 million into the callloan market. the National City Bank poured $25.‰ On the same day (Friday. „ThatÊs very interesting. would not have stopped National City Bank from acting just as . Mitchell was a board member.

and not rediscounting . We stopped them to allay what was becoming a money panic. Also. .PRACTICE FOR THE OCTOBER CRASH 61 it acted.‰ .‰ Mitchell pointed out that at the time that „We were not borrowing a penny from the Federal Reserve Bank.S. would not try to tell MitchellÊs National City Bank whom to lend to and at what rate.‰ Brookhart modified his thought to „Nobody is going to stop this speculation.‰ Mitchell said he wanted „to stop a money panic. „Who were those honest borrowers? WerenÊt they speculators?‰ Mitchell explained that they were brokers. Senate Committee on Banking and Currency.S. „That was a speculative contract.‰ While not exactly accurate. counsel for the committee. . THE 1933 STOCK EXCHANGE PRACTICES HEARINGS (1933) Mitchell was questioned extensively by Ferdinand Pecora. in turn.‰ and that rates had gone up to „15 or 16 percent. an inability of the legitimate borrower to borrow for his day contracts the money that was essential. Pecora wanted to establish that MitchellÊs action in March 1929 was „a flaunt [sic] on the warning sounded by the Federal Reserve Board. The Federal Reserve Bank used interest rates to ration capital rather than to give „a particular admonition to particular banks. Senate Committee on Banking and Currency in 1931 to review the performance of the Federal Reserve system. It was one of those gambling deals. Governor Harrison of Federal Reserve Bank of New York said he had never asked member banks in New York to reduce their loans to brokers.‰ Pecora then placed the blame on Mitchell: „If you had let it collapse in March that would have saved hundreds of thousands of dollars to people who invested later on. Harrison. THE 1931 SENATE HEARINGS In hearings conducted by the U. since elements of „direct action‰ can be found in the actions of the New York Fed in 1929. it does describe how Harrison wished to operate his bank. at the 1933 stock exchange practices hearings conducted by the subcommittee of the U. wasnÊt it?‰ Mitchell then explained the purpose of a bankÊs lending to a broker and that National City Bank wished „to avoid a general collapse of the securities market.‰ Senator Brookhart then asked. it is not clear that we would want to prevent National City Bank from taking the actions it took in March 1929. Brookhart interrupted to say.

Mitchell and National City Bank received blame for stopping the selling panic and saving the day. in October the New York banks did not stop the crash. reaching its peak in September. „It has been repeatedly interpreted by Senator Glass as your saying to the Federal Reserve Board to go to hell. at the lower prices. didnÊt they?‰ This unrealistic view of the market was not uncommon. the market had risen above the March level. thus it had further to fall and the consequences would be more severe. they would learn that not even the powerful Wall Street bankers could stem the tide of a selling panic. but it is shocking. In October. The March declines were probably triggered by the high cost of call money. the actions taken by the New York banks were not effective in stopping it. Washington thought the additional speculation was made feasible by Mitchell (actually Harrison and the New York Federal Reserve Bank deserved a large share of the credit). some of them. see the appendices to chapter 4. Mitchell was asked by the chairman. „How much higher did they go before they broke off · by three or four times. 1929. Mitchell was blamed by some for the more severe consequences. were a dry run for October. After March. There is one thing that the New York bankers learned. For more detail. but as the result of the newspaper article. the stock market resumed its climb. but we cannot be sure of the effect of National CityÊs offer to lend $25 million. They also thought the action was ill considered.62 BEATING THE BEAR The misconceptions of the senators were immense. Not surprisingly.‰ but it was not the result „of any statement made by me. .‰ Mitchell pointed out that the Federal Reserve Bank of New York was kept informed of the actions of National City Bank and did not object to its actions. By September. The turnabout in stock market prices might have resulted from MitchellÊs offer to lend. This was looked at by Washington as the result of more speculation. The chairman (Senator Norbeck) asked of Mitchell. CONCLUSIONS The stock market price declines of March 25–26. but many people (especially those in Washington) thought it did. investors stepped in and bought. IsnÊt that so?‰ Mitchell agreed that Senator Glass „took that attitude. In October 1929. At these rates. or it could be that the good business news could not be ignored and. The bank loans were to be at 16 to 20 percent interest cost. Washington would be very upset if the banks repeated the actions of National City Bank in any future crash. investors could not use the bank financing to hold stocks with confidence. when the real crash happened. It is not obvious that National City Bank acted decisively or effectively in March.

The Federal Reserve Bulletin of February 1929 stated that the Federal Reserve would restrain the use of „credit facilities in aid of the growth of speculative credit. the overall revealed opinion in the federal government was that there was excessive speculation in stocks and the market was too high.Chapter 6 THE 1929 MARKET IN DEPTH: THE UPS AND DOWNS OF THE 1929 STOCK MARKET Someone is said to have asked Newton what he thought of the prospects of the stock. and received the reply that he could calculate the motions of the bodies. „The mass escape into make-believe. president of the Investment Bankers Association of America. If the media and respected people in authority say something often enough.‰ The U. By October 1929. started in earnest.‰ Trowbridge Callaway. pp. so much a part of the true speculative orgy.S. The South Sea Bubble During 1929. Galbraith (1961). a large percentage of the investing public is likely to believe it. but not the madness of the people.‰ John Kenneth Galbraith wrote (1961.‰ . Kindleberger (1978). ·John Carswell. and Malkiel (1996) all clearly accept the assumption that the market was too high. 16–19). Senate adopted a resolution stating that the Senate would support legislation „necessary to correct the evil complained of and prevent illegitimate and harmful speculation. the public was bombarded with statements of outrage regarding the speculative orgy taking place on the New York Stock Exchange. gave a talk in which he spoke of „the orgy of speculation which clouded the countryÊs vision.

64 BEATING THE BEAR Adolph Casper Miller. p. an outspoken member of the Federal Reserve Board from its beginning and an influential member in 1929. which would have as its effect a sobering influence on speculative sentiment. „The largest part of this sum is used for speculation in the New York Stock Exchange‰ (Hearings of Senate Committee on Banking and Currency on BrokersÊ Loans. A Senate committee defined speculation as follows: „Margin purchasing is speculation in securities with borrowed money‰ (Committee on Banking and Currency. 1934. Now what is that but gambling?‰ (Hearings of Senate Committee on Banking and Currency on BrokersÊ Loans. Steel Corporation. should be the very thing to keep business on a sound and enduring basis‰ (National City Bank of New York Newsletter. p. In England. 1929) to the member banks described „the extraordinary absorption of funds in speculative security loans. both the Economist (October 8. The attacks on speculation were not limited to the United States. A Senate committee (in reference to $3. Senator Robert LaFollette described „the great American evil of stock exchange gambling‰ (Hearings of Senate Committee on Banking and Currency on BrokersÊ Loans. pp. Stock Exchange Practices. 774) and the Financial Times (October 4. 7) reported that the remarks of Philip Snowden. „Investments that turn out wrong are speculations‰ (Committee on Banking and Currency.S. December 15. described „the folly of the speculative frenzy that lifted securities to levels far beyond any warrant of supporting profits‰ (Forbes. Senator Glass „proved‰ the speculative aspect: „It was selling at 108 in January. to your notion?‰ Albert Henry Wiggin responded. p. p. „What percentage of the public is [sic] speculating in the stocks of the stock exchange understand the real intrinsic value of the stocks in which they deal?‰ (Hearings of Senate Committee on Banking and Currency on BrokersÊ Loans. Myron C. 1933. head of the U. 1929. 26). on speculation were . 80). October 1929. An important letter from the Federal Reserve Board ( February 2.8 billion of loans of the member banks of the New York Federal Reserve district on January 11. 2). p.‰ Senator Carter Glass asked.) Ferdinand Pecora asked. appendix 1. Stock Exchange Practices. It was selling in the market yesterday at 69. National City Bank seemed to recommend a recession to solve the speculation problem: „A temporary slackening of the business pace. 9). EnglandÊs chancellor of the exchequer. described 1929 as „this period of optimism gone wild and cupidity gone drunk.‰ (See chapter 4. 1928). 1928). p. 1928) stated. 1929. p. 2327 and 2418 –19). 1929. Taylor. 197). „What is the difference between speculation in stock and gambling in stock.

. 4. „to strangle the speculative movement. Hoover titled his second chapter „We Attempt to Stop the Orgy of Speculation. and the Washington Post. He was a neighbor and good friend of Adolph Miller (see p. he later wrote. October 21. 2. 1930) thus: „During the final period of inflation and stock market plunging not one single step was taken by the responsible officials of the National Administration to put on the brakes or to suggest even that the situation was economically false and unsound. The following groups are possibilities implied by the above quotations: 1.‰ In his memoirs (1952). THE INVESTMENT ENVIRONMENT IN 1929 The Dow Jones Industrial Average was 203 at the beginning of 1928. The speculative enemy was not clearly defined. the Wall Street Journal. in his 1930 campaign for the New York State governorship.‰ Hoover then pressured Secretary of the Treasury Mellon and Roy Young. Herbert HooverÊs election to the presidency was a very significant event. unfairly attacked HooverÊs administration (New York Times. Anyone who did business on Wall Street Before placing blame on Hoover. 3.THE 1929 MARKET IN DEPTH 65 widely quoted in the United States. Fears of excessive speculation also grew throughout this period. President Hoover was an aggressive foe of speculation. For example. Snowden had referred to the „speculative orgy‰ in the United States. „I sent individually for the editors and publishers of major newspapers and magazines and requested them systematically to warn the country against speculation and the unduly high price of stocks. and Miller reinforced HooverÊs fears. Franklin Delano Roosevelt. 5.‰ Thus Roosevelt would have taken (or would have intended to take) even stronger action to stop the „inflation‰ of stock prices than did Herbert Hoover. During 1929 the market continued upward.1 This was also the high for the year. and it closed at 300 · a 48 percent increase. They were reported by the New York Times. „Gamblers‰ and „speculators‰ (neither term was well defined) Buyers of stock on margin Buyers of any stock in 1928 or 1929 Buyers of risky stock Buyers of stock who sold at a gain after holding for a short period of time 6. governor of the Federal Reserve Board.‰ his use of the specific words reflecting SnowdenÊs influence. consider the position of his rival for the 1932 presidency. reaching 380 on August 30 · a 27 percent increase for the first eight months of 1929. 31).

Forbes illustrated the difficulties of forecasting accurately and the foolishness of putting unambiguous forecasts in print: „The position of the Federal Reserve Banks has improved to such an extent that all talk of an advance in the 5 percent rediscount rate has disappeared. declared that „the time was opportune for the prudent investor to buy bonds. On the other hand. 1928. After the close of business on Tuesday. of course. 1929. it was easy to stage bullish demonstrations all along the line. This was even more impressive given that the Stock Exchange–reported broker loans at $7. finally. but publicly · except for the bit of investment advice · he was quiet. U. in insisting on bonds rather than common stock. Mellon. covering of shorts. 1929. the New York Times Magazine declared in May 1929 that Andrew Carnegie. the quarterly statement of the Steel Corporation appeared. The feeling . The Financial Chronicle of August 3. „made one of the most colossal mistakes in market history when the Carnegie Steel CorporationÊs plants were taken into the United States Steel Corporation. Steel on that day established a new high record for the year. reported with shock and apprehension the increase in broker loans.S. and.‰ B.‰3 In July 1929. Steel started a new revival and carried the whole market with it. the fundamentals underlying the stock market were still strong.‰4 It cited the numbers of the Federal Reserve Bank of New York.838 billion on July 31. C.474 billion on July 31. to $5. 1928 · a 54 percent increase.960 billion on August 1. While the Chronicle reported that prices had doubled and even trebled within 12 or 18 months.259 billion on August 1. who had been quiet regarding the state of the stock market.‰2 Privately Mellon made clear that there was excessive speculation. In August 1929. and it was of such a strikingly favorable character that it led to very extensive buying of all the different steel stocks. as a matter of fact. aided by the aggressive rise in the steel shares. The same issue of the Chronicle carried the following news article on the stock market activity for the week: On Tuesday. stating that „the record is one that should make the most confirmed optimist pause and ponder whether we are drifting. given the massive construction activity. and the exchange had only reported $4. showing an increase from $4. The Commercial and Financial Chronicle reported that not only stocks but also New York real estate was enjoying a boom. in March 1929.S.66 BEATING THE BEAR Secretary of the Treasury Andrew W. aiding the rally. it also raised the specter of excess supply of rental space. but they were receiving less attention than the growth in broker loans and the „excessive speculation. 1929. U. and.

The rate of expansion.‰5 In July.‰6 On Thursday. For over a year the object of Reserve policy has been to prevent the further absorption of bank credit in speculative channels. indeed. or has this step of raising the rediscount rate · which step. the Chronicle reported that the increase in the discount rate had not checked stock speculation and that there was a new bull movement in which the bears had been scattered to the winds. and the increase that was first requested in February was finally approved by the Federal Reserve Board. was 2. On August 10. the rate was only 8 percent. On August 24. while after the rate increase on Friday. but history indicates that August 1929 was too late for the increase. Day after day the story has been the same and spectacular and sensational advances have become a mere matter of routine.8 million shares.0 million. August 8.‰7 Interestingly. The volume on Thursday.THE 1929 MARKET IN DEPTH 67 is that money rates will rule appreciably lower between now and the end of the year. call loans on the exchange were renewed at 10 percent on Monday. the market rebounded. when the discount rate was increased to 6 percent in August. the bill rate was further decreased to 51Î8 percent. Has this been accomplished. it was 5. has latterly been increasing. But after the first shock. but this did not . On August 10. The board probably thought that bill money flowed to commerce and money raised by discounting of securities flowed into securities. week after week. the Chronicle reported that prices had been moving up almost without interruption and that many new high records for the year had been established. which have been recording new high totals. the bill rate had been lowered to 51Î4 percent. On August 31. 1929. with only an occasional interruption to the expansion. It is not clear that the discount rate should have been increased in 1929. should have been taken long ago · contributed in any way to bring such a result about? The answer is furnished in the course of brokersÊ loans. the Federal Reserve Bank of New York increased the rediscount rate from 5 to 6 percent. The Magazine of Wall Street reported that „prices broke sharply.Ê and the market has since conducted itself pretty much as if nothing had happened. as they always do in the face of unexpected adverse news. on Friday. August 8. the major portion of the list recovered under the leadership of the Âinvestment issues. The Financial Chronicle reported that „the stock market yesterday suffered a tremendous collapse. After the increase in the rediscount rate to 6 percent. by the way. Call loan rates were up to 9 percent. A feeling has again grown up that there is no limit to the upward surge of Stock Exchange values.

like the Florida boom. 1929 (see Note 9). Hence. to take advantage of special opportunities as they arise.‰9 This was reported on September 6. He maintained that „forced accounting has probably been the greatest factor in prolonging the present period of prosperity. Roger W. He predicted that sooner or later the stock market boom would collapse. showed a reduction during August in the aggregate of unfilled orders on the books of the subsidiary . and if they appear. Fisher admitted that „there may be a recession of stock prices. and be in a position to take advantage of bargains when. Babson addressed the National Business Conference at Babson Park. instead of attempting to guess what the market will do. Babson also discussed the investment outlook. but The Evening World sided with Babson: „We are thus obliged to regard his advice to investors as wiser than Professor FisherÊs.44 on September 7. He identified two factors keeping the market up: foreign buying and investment trusts. reduction of risk to investors largely brought about through investment diversification made possible for the investor by investment trusts. A 9 percent annual cost does not deter investment if the investor thinks the stock will increase by 40 percent in a year.‰ The September 14 issue of the Chronicle hinted that there was weakness in the economy but that the weakness was minor: Much has been made of the fact that the monthly statement of the United States Steel Corporation. two.‰8 He warned businessmen to watch their steps and listen to the advice of the accountant or the result could be a serious business depression. Fisher was bullish. He warned that borrowing for speculation could lead to trouble.68 BEATING THE BEAR seem to deter the market. reaching a high of 381. the anticipation of large dividend returns in the immediate future. and.‰ and proceeded to explain the reasons for his view: „The present high levels of stock prices and corresponding low levels of dividend returns are due largely to two factors. BabsonÊs basic investment advice was good in 1929 and is good now: „We advise investors to keep always a certain amount of money in stocks and a certain amount of money in bonds and a certain amount of money liquid. I advise you to keep in a position so that you will be safe whatever happens. but not anything in the nature of a crash. but Babson had long predicted a collapse and the market took little note. The market took little note of BabsonÊs pessimism.‰ Irving Fisher of Yale University responded to BabsonÊs forecast of doom. issued on Tuesday. This prediction received a lot of attention in the press. as. Massachusetts. today. Prefacing his remarks with the statement that no one was infallible. On September 4. One.

966 tons. or against the lure of speculation and its golden rewards for audacity? Only second and third mortgages can compete with the stock market. The flow of loan funds from the rest of the United States to New York was impressive. 69 The same issue of the Chronicle identified speculation in the stock market as the number one problem. there is nothing particularly harmful in that. The high rate of return that could be earned on call loans to brokers was difficult to resist. „is Wall Street. with absolute security. and a thousand other building and loan officials echo his remarks.‰ these plants are engaged at 91% of capacity. There is no first mortgage money.‰ continued the Illinois man. and so we have no money to lend for home building.1 shows broker loans for 1929 as reported by the New York Stock Exchange.‰ Contemporary observers identified the increase as the result of excess speculation. The loans had very little risk of default: „Our members are withdrawing their deposits. The Chronicle of September 21 predicted that a crash was near. „The cause of the withdrawals. What chance has 5 percent against anywhere from 6 to 20 percent for call money in Wall Street. or far in excess of general expectations. Granting that it may mean a slackening in the pace of activity which has characterized the iron and steel trades for so long.THE 1929 MARKET IN DEPTH companies in the large amount of 429. The increase from January to September was 27 percent. and even now. The increase in the loans of New York banks was 25 percent and from „others‰ was 37 percent. which is a pretty good rate.‰10 Table 6. Our money has gone into stocks or into brokersÊ loans. . But the precise significance of this remains to be seen. according to this weekÊs issue of the „Iron Age. „Nothing could be more harmful at such a period than a continuation of the unbridled speculation in the stock market with serious menace that this will involve if it is allowed to go on unchecked. so much needed and so long delayed. blaming speculation and inflation in security values. failing to note that fundamental economic conditions had justified a rise in prices.‰ says the president of an Illinois building and loan association. even in the rush times like those through which the country has recently been passing. For many weeks the plants of the Steel Corporation were turning out products in excess of the theoretical capacity of the works. and it has its compensating advantages in that it will permit the overhauling of furnaces and mills. The fact that these speculative excesses are now in process of correction is most assuring on that point.

804 6. on Black Tuesday. etc. The drop was 44 percent from the 380 level reached on August 30. which paid him $12.183 1.109 4. In mid-September.51 on Tuesday.882 8.077 5. Ruth spent his salary. On Black Thursday. the market held steady.370 From Private Banks. In millions of dollars.10. but the close was not too bad at 299. Brokers. Stocks closed at 320.472 796 585 620 Total End of month January February March April May June July August September October November December 1929 6.679 6.713 5. The October 1 issue of Forbes had a long article describing how Babe Ruth invested his money. October 24. the New York market closed at 343.77 to the monthÊs low of 212.45 · down 10 percent from the September high of 386.664 5. 1929 1.47.320 1.017 3. . it was probably not heavy in common stocks. the low was 212.33.432 3.11 The trust was set up so that Ruth could not touch the principal (Ruth had allegedly lost $100.775 6.990 Source: Adapted from The Federal Reserve Bulletin.154 6. Only his „side‰ income went into the trust.000 a year. Net borrowings on demand and on time. but with an 8 percent current yield.85 on Wednesday. the first major break in stock prices occurred.071 1. Ruth had a trust fund of approximately $150. On Friday and Saturday.390 1.580 5. 621.474 7. The article did not describe the portfolio mix of the trust.492 7.091 1.665 7. Foreign Banking Agencies. October 1930.194 1. During the week of October 21.000. 326. On Monday.1 Broker Loans Reported by the New York Stock Exchange From New York Banks and Trust Companies 1929 5. the market dropped to a low of 256.91 on Monday.482 5.735 6. From the monthÊs high of 358. the low was 272.33 there was a drop of 41 percent in the market index.797 6.060 1.313 3. October 29. p.70 BEATING THE BEAR Table 6.32.619 5.549 6. and 305.75.000 on horse races in Cuba on one visit).071 7.275 1. October 28.

‰ It even anticipated one of the most famous lines in U.13 At least the actions were in the right direction (although too small to have a significant effect).56). stating that the stock market slump was only temporary.‰ the article closed with „Tomorrow is another day!‰ Could Margaret Mitchell (or Scarlett OÊHara) have read The Magazine of Wall Street?14 INVESTMENT TRUSTS In the late stages of the market rise. movies. Interestingly. were selling at only 13 times the total earnings as compared with 14 times the total earnings in August of the preceding year.8 billion on October 16. Steel Corporation and American Can Company both declared extra dividends. Fisher also spoke in Washington. On November 21. The Magazine of Wall Street estimated the loss in stock value during October to be $50 billion. which were $6. stocks were underpriced. not overpriced.95 but recovered in December to close the year at 248. They offered professional management and. Broker loans.S. relatively cheap diversification. investment trusts became a very popular investment vehicle.000. on October 23. it drifted downward to 238. as when in the war we shot away $20. even at their peak in August.C.000 worth of it.S.6 billion by the middle of November. It properly noted that „there has been no loss of the sum total of tangible property. The Federal Reserve Bank of New York bought $160 million in government bonds on the open market in October 1929 and $210 million in November.12 Attempts were made to engender enthusiasm. Since the beginning of the year. had contracted to $3. there was no way to be diversified against a market crash and to invest 100 percent in . value was 300. D.THE 1929 MARKET IN DEPTH 71 The October 26 Chronicle carried an address by Irving Fisher made on October 21. During November. the Federal Reserve Bank of New York reduced its discount rate from 6 to 5 percent (the 11 other reserve banks were already charging 5 percent). The U. the market had recovered to 273. the market had lost only 17 percent of its value from the beginning of the year to the end of the year. FisherÊs position was that stocks. Call money could be obtained in November at 3 percent.48 (it reached a high in December of 267. Unfortunately. Resumption of speculative fever was still the main fear. After stating „But in America imagination is deathless.000. more importantly. According to Fisher. By the end of October. The Bank of England reduced its discount rate from 6 1Î2 to 6 percent..51. the Chronicle questioned the reduction.

Z. essentially riskless return.‰16 Investment trusts were a good idea in that they offered the average investor diversification. This illustrates the destiny of the stock price of a leveraged investment company during a down market. John Kenneth Galbraith discusses investment trusts in detail. as a wastebasket in which to put the things which cannot be successfully placed in the hands of the public. so to say. Thus in November 1929 he wrote. Sachs and Company in December 1929 with investors paying $104 a share. I have seen that happen a number of times. most did not. He also had good reasons for thinking in 1929 that stocks were not overvalued. The corporation was highly leveraged. an investment corporation that was formed by Goldman.75 after the succession of market crashes in 1930 to 1932. He was wrong. The debenture holders would always get something (although not necessarily their contractual amount). This is very unlikely. A more severe drop and the preference sharesÊ value would be eliminated. and diversification could not offer investors much solace. but there were major faults in execution.72 BEATING THE BEAR the stock market. „stocks will soon recover a considerable part of lost ground‰ and „business prospects are excellent. Many had invested funds in the call money market and thus earned a high. W.15 He focuses on the Goldman Sachs Trading Corporation. Some analysts attributed the market rise to the existence of the investment trusts. A slight drop in the market and the common or founder shares would be wiped out. His son wrote: . The stock value dropped to $1. but they were probably a positive factor for the market. since their availability encouraged relatively risk-averse investors to enter the market. He obviously felt he could forecast the future based on logic. The British trust was normally leveraged with debentures and preference shares. WHEN YOU KNOW THE FUTURE Irving FisherÊs academic accomplishments were impressive. The October crash was too extensive. The equity investor in the typical British investment trust fund fared even less well. Although the American investment trusts could borrow.‰17 But he ignored the virtues of diversification either among stocks or between stocks and other assets. Ripley of Harvard University made a very interesting observation regarding the operation of investment trusts: „One of the cardinal weaknesses of the investment-trust plan is that when tied in any way with banking institutions · bankers or brokers · it offers a very great temptation to use the trusts.

August September October November December 1930.8 128. and lost his proverbial shirt.THE 1929 MARKET IN DEPTH His wire to me in California. SIX MONTHS OR A YEAR LATER YOU COULD PROBABLY SELL AT SUBSTANTIAL ADVANCE AND THEN DIVERSIFY. the partial recovery from November 1929 to April 1930.4 123. Instead.8 95.9 97.1 95. October 1930. 622.7 96.6 126.7 Source: Adapted from The Federal Reserve Bulletin.5 126.0 94. . but we would each have fared much better if we had followed it to the letter. This seemed like a dizzy figure in comparison with its ultimate nadir.8 97. Monthly data are averages of weekly figures.5 96.2 98. reflects his current state of mind: November 17. he waited for that elusive rise which never came.4 126.2 Security Prices Preferred Stocks 20 126. when it sank to one dollar. A year later it was still worth $28 per share.2 127. p.3 126.9 98. I disregarded this advice. Just before the crash Remington Rand was selling for $58 per share. and still have retained a net of between eight and ten million dollars. Index numbers of Standard Statistics Company.2 shows the drop in common stock prices in October 1929. At the peak of the boom Father could have liquidated enough of his Remington Rand stock to pay off all his heavy bank loans. replying to my inquiry about the advisability of selling some of my Remington Rand in order to diversify.9 126.4 97.9 127.5 96.9 Common Stocks (1925–1930) Total Industrial Railroad Public Utility 404 218 225 202 151 154 156 166 172 181 171 153 149 337 210 216 194 145 147 149 156 163 171 160 143 140 33 165 168 157 135 136 137 143 143 142 136 125 124 34 304 321 277 195 201 209 231 242 264 250 224 215 Month or Date Number of issues 1929.8 125.8 126. and then the Table 6.18 73 Table 6. January February March April May June July Bonds 60 95. 1928 SUGGEST YOU MIGHT RISK HALF YOUR PRESENT HOLDINGS BY BORROWING ON IT AS COLLATERAL AND USING PROCEEDS OF LOAN FOR BUYING MORE.

Wanniski argues vigorously that „the stock market crash of 1929 and the Great Depression ensued because of the passage of the Smoot–Hawley Tariff Act of 1930.‰20 However. The trading activity on organized U. the market was vulnerable. Note that high-grade bond and preferred stock values actually increased in 1930 compared with 1929.22 Although stocks may have been reasonably valued in September 1929.8 billion shares in 1929 to . We know that from the high point on September 1. exchanges went from 1. CONCLUSIONS It is clear that the Federal Reserve Board in 1929 thought that the use of bank credit for speculation was bad and that the stock market was too high.6 billion. the loss was 82. Although the bill was signed into law on June 16. economy. 1932. but the fact is that in 1929 the proposed tariff act was not a major issue with the business news media and not likely to have significantly influenced the level of the market.‰19 Wanniski is on stronger grounds in arguing that the act helped bring on and prolong the depression than in maintaining that it triggered the 1929 crash. is a reality. 1930. the market rebounded. from November to April 1930. 1932. the market had fallen to a value of $15.74 BEATING THE BEAR resumption of the fall.6 percent. . the stock market crash beginning on October 24. THE SMOOT–HAWLEY TARIFF J. but it fell to $71. 1929.S. it was not one kick that triggered the disaster but rather a set of events that amplified the consequences.8 billion on November 1. even though during that period it became more apparent that the Smoot – Hawley Tariff bill would become law.7 billion on September 1. 1929. The result was a drastic decline in stock prices in 1929 and an even larger decline over the next three years. The market values of all stock securities listed on the New York Stock Exchange was $89. The financial press in 1929 was much less occupied with foreign trade than perhaps it should have been. to the low point on July 1.21 Not only did the stock market value decrease in 1929 but trading activity was reduced to about one-third of its former level. Unlike the great Chicago fire. 1929. THE 1929–1932 CRASH Despite the relatively sound fundamentals of the U.6 billion in 1932.S. Wanniski states that „the stock market anticipated the act and crashed in the last days of October. By July 1. 1929. 1929.

Senate Committee on Banking and Currency Hearings. It wanted gradually to attempt to put federal reserve credit back where it belonged. and take it out as a basis of these excessive speculative loans‰ (U. Thus. 1929). but except for Adolph Miller (described by Hamlin as wanting a „sudden liquidation and crash‰). they did not seek a crash.S. My position is that the efforts to stop the stock speculation created a climate that merely required a slight push or a spark to set off the selling panic. January 1931. They would have liked to have had stock prices decline a bit.THE 1929 MARKET IN DEPTH 75 But the board did not do anything in September or October 1929 that can be pointed to as a trigger of the 1929 crash. and HamlinÊs diary of February 5. Regarding the February 2 letter of the board. Hamlin stated: „The board did not desire by that warning to bring about any radical deflation of speculative loans. . the smoking gun that caused the start of the crash might comprise events that were relatively minor in themselves but that were major in their consequences.

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2008. Fuld. —Richard S. Jr.S. the consequences were a much larger number of subprime mortgages equal to or larger than the value . members of Congress wanted to make home ownership available to a wider segment of the U. the Dow Jones Industrial Index reached a high for the year of 13.470 (on March 9. C4).Chapter 7 The GreaT Crash of 2008: The 2008–2009 MarkeT in DepTh As we enter 2008 we are proud of how far we have come and excited about the opportunities ahead. a drop of over 50 percent.91 (see New York Times. The first policy of the Federal Reserve to capture attention after the crash was the low interest rates that made it possible for real estate buyers to buy bigger. Gregory Lehman Brothers 2007 Annual Report In the Spring of 2008. and Joseph M. more costly properties. In less than a year. Second. Frequently. March 9. but when banks lowered the financial requirements for obtaining a mortgage. This fall in stock prices resulted in a trailing P/ E of 9. This spreading home ownership may be considered to be a worthy social objective. 2009). p.. population and encouraged banks to make loans available to people without adequate resources. the index fell to 6.058. the buyers did not have to make any initial payment (no money down). GovERnMEnT PoLICIES 2002–2009 There were two important government policies during the period 2002– 2008 that contributed to the economic boom (some would call the economy of 2002–2008 a bubble).

supplemented by real estate price declines. This loan expansion was too often combined with more generous ratings by the bond rating agencies and acceptance of these ratings by too many investors in mortgages. as stock prices fell. lenders approved loans that were unlikely to be repaid unless real estate values continued to increase and the economy prospered. By the fourth quarter of 2008. and inventories. The falling corporate profits soon justified the falling stock prices and even justified another round of stock price reductions. up from $210 billion in 2001. who then leveraged their investment in very risky real estate loans with too much debt. so that the falling profits in the financial sector were soon reported in other business sectors. equipment. Unlike the october 1929 stock market crash. ThE PAnIC AnD CRASh As the world entered a new millennium. The beginning of the credit debacle occurred. or. The opportunity for large losses when home buyers stopped paying their mortgages was immense.” By 2008. the magnitude of the subprime mortgage market was in excess of $1 trillion. The credit default swap market was in excess of $60 trillion. When the inflation of real estate prices ended. As job losses increased. Management of Wall Street firms that did not fully understand the risk of risky assets financed to an excessive extent by debt. Companies were unable to obtain credit for investing in plant. Job losses. many borrowers ran away from their loans and securitized mortgage securities rapidly lost value. in 2008. This effort was reinforced by banks willing to make the loans and bond rating agencies to give inflated ratings. increasing numbers of borrowers were unable to pay interest and principal. . the stock market crash could be justified by statistical indicators that reflected a severe business recession. The commercial credit market all but disappeared. where the business indicators were still good. alternatively. ThE FInAnCIAL MARkETS: 2008 Daniel Gross writes that1 “Subprime origination rose to $625 billion in 2005. naturally a drop in business activity followed.78 BEATInG ThE BEAR of the property being purchased. the credit markets in the United States were paralyzed as financial institutions failed or contracted. 2. Among the causes of the financial sector’s difficulties in 2008–2009 were: 1. added to the reasons for borrowers to fail to pay. Government efforts to promote home ownership among a subset of the population who could not afford home ownership.

AAA ratings and the like were given to collateralized bond tranches. 79 A list of those factors that were unlikely to have caused the financial crisis of 2008 is interesting. Some criminal activity (e.. The mortgage defaults had a drastic effect on the health of those financial institutions that had purchased the mortgages or had insured the investors against losses. But we know only that real estate values increased until the summer of 2008 and then decreased. there were few tie-ins of private equity and the 2008 stock market collapse. Madoff ). which initially made public offerings of their overpriced stock. The actions of the eight-year Bush administration (a failure to take action can be cited) 2. Robert J. the popping of the real estate bubble was identified as the major cause of the 2008 stock market crash. We do not know that real estate values were too high in 2008. Wall Street crime 4. 4. but this was not central to the relevant economic events. This had the potential to be a major cause of the 2008 stock market crash. but it was not. Profits .g. Shiller) who knew that real estate values were too high prior to 2008. the public found out that bond rating firms had been too generous in the ratings they gave to collections of mortgages. Corrupt CEos 3.ThE GREAT CRASh oF 2008 they understood and were driven by greed and competition to follow these financial strategies. Insufficient regulation (some of the proposed regulations are likely to cause as many problems as they solve) Since house prices and real estate in general dropped in value before the stock market crash. When real estate values started to decrease. As these events unfolded. The lending by banks to private equity firms. but most of us did not. 3.. Private equity activities 5. the owners of the real estate increased the rate on which they failed to pay their mortgages. B. 1.g. Except for the private equity firms Fortress and Blackstone. They were a few exceptional scholars (e. They offered mortgages to people who could meet the mortgage payments only with a very low probability and with very low or zero initial payments. where the probability of default was much larger than with the AAA securities of the past (with practically zero probability of default). Confounding the problem was the fact that banks originating mortgages were being less demanding in their loan requirements.

The rescue of Citigroup by the Federal Reserve was done in order to prevent a horrible financial situation from developing into an unbearable financial mess that would more or less destroy the U. as the borrowers’ ability to pay went down.S. Morgan Chase absorbed the profitable remainder of Bear Stearns when Bear Stearns was headed for bankruptcy. Unfortunately. P. the volume of loans to risky borrowers went up. Also affecting the lending institutions were the encouragements of Congress to make house buying available to a sector of society that had formerly been excluded by economic considerations from the opportunity to buy a house. but the lenders could still engage in credit default swaps or the equivalent. the financial market was shocked by the collapse of Bear Stearns. in 2008. two firms sponsored by the federal government. were encouraged to commit their resources to making house buying more widely feasible.80 BEATInG ThE BEAR and bonuses were the normal incentives leading the banks to offer these generous lending terms. the number of defaults on mortgages increased immensely. The Basel banking standards (mandated by the Fed) established that bank assets be valued using the credit ratings awarded by approved credit agencies. Thus banks frequently relied excessively on the credit agency scores rather than conducting credit research of their own. While AIG was rescued from bankruptcy by the $122. (AIG) was the counterparty accepting the risk on too many mortgages by being the payor on the credit default swaps. Freddie Mac and Fannie Mae. the Fed merely watched as Lehman Brothers went under. especially subprime mortgages. but the fact is that as house prices stopped going up. Earlier. With no defaults. First. The banks were vulnerable to credit risk if the credit rating firms too readily awarded investment grade ratings to less worthy paper. You can weight the factors described above as you wish (or based on your political inclinations). some of the risk of subprime mortgages could not be eliminated. it would collect a fee. obviously. Inc. This was a form of insurance where a counterparty who could afford to take risk (or thought it could take on more risk) did so in exchange for a fee. the Fed did broker a deal where J. The swap counterparty promised to pay if the borrower defaulted on the mortgage payment. American International Group. . economy. so that even the more risky collection of loans could be sliced up in such a way that part of the investment set was rated AAA. The growth in real estate debt was facilitated by Wall Street’s clever packaging of mortgages. even though the entire mortgage collection was not of investment grade.8 billion line of credit given by the Federal Reserve.

To avoid the financial havoc that would result from a bankruptcy. there will be economic incentives for owners of real estate to default on their mortgages. Goldman Sachs. When the prices start going down. July 31. dividend increases. Bear stock. accompanied by tight federal restrictions. For those banks that repaid $50 billion of TARP loans in 2009. The government also received preferred stock and warrants to buy common stock. The TARP funding was $175 billion. Bear Stearns collapsed under the burden of too large an inventory of subprime mortgages and too much debt. The U. 1). Unfortunately. We will always have real estate values go up and then slip downward. P. TRoUBLED ASSET RELIEF PRoGRAM The Troubled Asset Relief Program (TARP) was created in 2008 to unfreeze the credit markets. and spending on corporate jets and conferences.S. many of the causes of a financial melt-down are very difficult to identify as they are happening. BEAR STEARnS In March 2008. government (via the Department of the Treasury) would purchase troubled assets and equity from financial institutions and offer loans in order to strengthen the weakened financial sector. it is not reasonable to assume that the path of stock prices or real estate values will always be upward. was sold for $10 per share on May 30.ThE GREAT CRASh oF 2008 81 The next decade will be spent analyzing what went wrong and how to prevent it from happening again. The government still held warrants to buy the common stock of the banks (the warrants were worth between $3 and $5 billion). ten banks returned $68. new York Attorney General Andrew Cuomo revealed that nine banks that received TARP assistance paid $33 billion in bonuses in 2008 to their employees. 2009. and Morgan Stanley. 2008 (it was initially sold for $2 per share.4 billion was given to banks. By June 10. but the price was increased to $10). Each of 5. Morgan. P. Morgan Chase a $30 billion credit to buy Bear. p.000 employees received at least $1 million (Wall Street Journal. A total of $244.3 billion of the government’s money in order to avoid the restrictions. Why did the Fed arrange the transfer of Bear Stearns to J. the bonuses for 2008 were $23 billion (of the total $33 billion). P. the Federal Reserve gave J. These included curbs on executive pay. 2009. Morgan Chase but two months later allow Lehman Brothers to sink under its burden . which had sold for $172 in 2007. Although many of the factors contributing to the 2008 stock market crash can be avoided in the future. These banks included J.

1 billion of equity.) A broker–dealer could apply to the SEC to become a CSE.3 ThE AUDIT oF ThE ConSoLIDATED SUPERvISED EnTITY PRoGRAM (2008) The audit was of the SEC’s oversight of Bear Stearns and six other financial holding companies in the SEC’s Consolidated Supervised Entity (CSE) program. raised its offer to $10 per share. Merrill. In the week of March 10. especially given the large amount of subprime debt (risky assets) owned by the firm.6 to 1 of equity. The crucial word is “supervised. Chase initially offered $2 per share and then.82 BEATInG ThE BEAR of debt and assets that had rapidly fallen in value? There are many who think that Lehman’s fall triggered the world’s financial crisis in 2008.” The SEC accepted the function of ensuring that these firms (each a CSE) had an appropriate amount of capital. This was a gamble with at best a very low probability of success. and $11. unlike Bear. Those who want a more complete telling of the collapse of Bear Stearns may wish to read kelly’s Street Fighters2 and Cohan’s House of Cards. to avoid possible lawsuits. 2008. the firm was exempt from the SEC’s standard net capital rule and could use an alternative. They believe that the Federal Reserve made a major error in allowing Lehman to fail. The report is over 120 pages long and should be required reading for anyone who thinks that federal government’s supervision and Federal regulations will guarantee against financial shocks like those that occurred in 2008. Thus Bear. This was a large amount of debt. (Merrill Lynch and Lehman Brothers were also in the program. 2008. could borrow money from the new York Fed. . Bear Stearns in 2008 had $395 billion of assets. It had a debt ratio of 384/11. $384 billion of debt. If accepted as a CSE. Morgan Chase $30 billion of financing if it would buy Bear. It was a voluntary act. P. Chase. Bear was one of seven firms in the SEC’s Consolidated Supervised Entity (CSE) program. rumors about liquidity problems at the Bear Stearns Companies prevented Bear from securing financing and pushed it to the verge of bankruptcy. on March 14. more flexible method of computing the firm’s required capital. and Lehman were all CSEs. the Federal Reserve Bank of new York offered J.1 = 34.4 It was conducted by the SEC’s office of Inspector General.

viii) “Thus it is undisputable that the CSE program failed to carry out its mission in its oversight of Bear Stearns. LEhMAn BRoThERS (2007–2008) The 2007 fiscal year of Lehman Brothers ended on november 30. The leverage ratio was an aggressive 30. 2) states “Bear Stearns was highly leveraged with a large exposure (i.7 22.5 billion. Lehman made $4. the only possible faulty financial decision I could identify was that the firm used more than $30 of debt for each dollar of equity. I started my financial review of Lehman in order to find the stupid mistakes they made.2 billion of net income. Leverage Ratio = 668.. and Lehman from making disastrous financial decisions. this statement understates the failure of Bear’s asset and liability structures.7 22.5 This is a large amount of debt.59. In the year 2007. The high for the year was $67.e.73. The execution of the oversight failed.7. the firm’s total assets were $691. 64 – 69).7 or = 29.5 22.63.6 691.5 The total liabilities were $668.” Although accurate. on november 30. Lehman Brothers removed $50 billion of debt (a repro transaction) to window dress its end-of-year financial measures. concentration of assets) in mortgage-backed securities. When .” Deficiencies are explained in the audit in more detail. . Risk management is covered in 6 pages ( pp. 64). oversight by a federal agency did not prevent Bear Stearns. nothing else reported mattered. with some words but mostly a large amount of relevant financial data. This audit stated ( p. The Lehman 2007 annual report is 128 pages long.1 billion and stockholders’ equity was $22. “While risk cannot be completely eliminated. we have designed our internal control environment to put appropriate risk mitigants in place” ( p. The idea of oversight was excellent and foresighted.1 = 30. 2007. This was a record earning year for the firm. The 2007 closing stock price was $62. The SEC’s oversight of Bear (as well as Merrill and Lehman) failed miserably. The above measures of debt usage understate the firm’s use of debt leverage. . the low was $51.6 = 29. .6 billion Debt per dollar of equity = 668.ThE GREAT CRASh oF 2008 83 The audit report ( p. From reading their annual report. Merrill.

6 and earnings growing rapidly. GE earned $19. Lehman Brothers filed for Chapter 11 bankruptcy protection on September 18. including $89. and in 2008 it earned $18. with the amount of leverage it used. A rule preventing more than $10 of debt for $1 of equity would have improved the likelihood of Lehman surviving. . The important lesson here is that a prosperous. The bankruptcy of Lehman Brothers (over $600 billion in assets) was the largest bankruptcy filing in the history of the United States. 95) in its asset portfolio that were called “U.1 billion of financial instruments. Thus reported subprime mortgages were only 0. The total assets were $691.3 billion of securities ( p. the firm owned $313.63 per share and then.1 billion.84 BEATInG ThE BEAR the value of some percentage of assets (subprime mortgages) went down.5 billion. The only concern is the amount of debt. Barclay’s Bank acquired the core business of Lehman. This author does not understand the $122. that is a mistake). The Dow Jones index closed down over 500 points on the day of the bankruptcy. on november 30. the stock can be close to worthless. 2008.1 billion of mortgage-backed securities. Careful financial analysis does not achieve safety. Maybe if I spent a month studying Lehman’s 2007 annual report I would find a second smoking gun. eight months later. The logic of the government allowing Lehman to become bankrupt will be debated for many years. Looking at the Lehman 2007 annual report more carefully than if I were making a real investment decision. could not pay its debts. McDonald and Robinson tell the tale of Lehman’s collapse in more detail. only diversification can save an investor from an investment disaster. With a P/ E of 8. but I think not. This was the largest drop in points in a single day since September 11. but if the assets are reasonably conservative and if I respect management. Lehman had $5. 2001. In 2007. it looks like a reasonable conservative common stock investment. widely respected firm can be worth $62.” on the same date. but such a rule did not and does not exist.3 billion (income from continuing operations). in 2007 it earned $22. residential subprime mortgages.5 GEnERAL ELECTRIC (2006–2009) In 2006. on September 20. An investor reading the annual report would not have been warned of the risky nature of the assets. I would buy the stock.77 percent of assets. the firm. I can live with the amount of debt (yes.8 billion bailout of AIG by the government while it refused to offer Lehman a lifeline. 2008.1 billion. 2007.S.

In 2008. Immelt stated (p. the stock market could not trust the accounting measurements leading to $1. the high was $29. CITIGRoUP 2006–2009 In the year 2006. In 2008. 6) that “we are repositioning our financial services business to operate as a more focused and smaller finance segment. Why did its stock price fall? Why was its price–earnings ratio only 3.69 and the low was $3. Unfortunately.77. it could wipe out the $141. it was $38. Citigroup earned a net income of $3. the new York stock price in 2009 would drop below $1. With this amount of debt. The U. In February 2009.20.9 percent return on equity.54 billion for its stockholders. Wall Street repackaged mortgages . Citigroup was very heavily leveraged.” The rest of Immelt’s statement regarding GE capital glows about its achievements for the year. 2008. Citigroup and other banks in a comparable situation stopped lending money. In March 2009. If there was a 10 percent overstatement (or that degree of optimism).938. The stock market anticipated a significant loss (in March 2009 not yet recognized) in GE’s assets. 2008.5 billion of assets. The 2008 earnings per share was $1. credit market was frozen.66 percent. The recession had started.10 per share. there did not have to be a large percentage of bad assets to put a large dent in the firm’s stock equity.29.62 billion — a 2. GE capital earned nearly $9 billion in 2008 (p. What caused Citi’s financial difficulties? We start with subprime mortgages and related financial securities. In 2007. the stock price was $16. In December 2008. on December 31. Citigroup earned $21. it had total assets of $1. the low was $29.938. was 3.8 percent. In 2008.7 billion.6 billion of stockholders’ equity. 5 of GE’s 2008 annual report).15 per share.25.5 billion. Mr.S. it had an operating loss of $27. Accompanying the bank’s financial disaster. GE reduced its quarterly dividend from $0. By not revealing the problems with its loans. Immelt raises concern among investors that there is bad news hidden in the good news. in 2008. GE stock fell to levels below $7.31 per share to $0.52. with no hint of why a repositioning would be desirable. Shortly thereafter.78.ThE GREAT CRASh oF 2008 85 the high stock price for the year was $42. There was $684 billion in liabilities. The ratio of common stockholders’ equity to assets on December 31.9? on GE’s consolidated balance sheet were $798 billion of assets financed by $105 billion of common stock equity. In 2007. The return on its stockholders’ equity was 18. Citigroup’s high stock price for the year was $55.

97 billion loss for the first quarter of 2008. by contract. on September 14.6 billion of bonuses to Merrill’s management at the same . who had promised to pay if the assets were not good. Bank of America announced that it had bought Merrill for $50 billion ($29 per share). Some banks sought to reduce risk by engaging in credit default swaps. But they frequently did not check to make sure that the counterparty. In the summer of 2009. Citi was left with bad paper and a large amount of debt.7 billion write-down of subprime mortgages). AIG was too frequently the counterparty promising to pay if the bonds held as assets did not pay. To reduce the risk.1 percent premium over the September 12 closing price. 2008. it engaged in credit default swaps but failed to make sure the counterparties would be able to pay if there were a large number of debt defaults. The Citi stockholders paid dearly for these bad management (financial) decisions.83 billion in losses (including a $16. an improving economy could result in that reduction in value being mitigated. of course. It is alleged that the Bank of America was forced to acquire Merrill at the above terms by the federal government. AIG was willing to collect the swap payments in good years but was not able to pay if there were defaults and AIG. but we shall have to wait and see. Citigroup had too many risky assets financed by too much debt. was able to pay. MERRILL LYnCh In January 2008. but AIG did not back up this payment promise with a sufficient amount of real assets. When house prices stopped increasing and owners stopped paying on their mortgages. Since this was typical of too many financial institutions. The credit rating agencies were generous in their ratings and the banks rarely sought out the basic documents backing up the mortgages to check the conclusions of the rating agencies. had to pay.86 BEATInG ThE BEAR and banks bought them. it was generally believed that Citigroup still had loans on its books that were overstated in value by over $60 billion. Merrill reported $9. Bank of America’s acquisition of Merrill was complicated by the payment of $3. This was a 70. next there was a $1. Citi’s risk management was a victim of a strategy of maximizing expected profits without adequate consideration of what would happen if many mortgages were not paid. the world economy also was severely harmed as credit for business activity disappeared.

with B of debt  V − B  Var X   replacing B of stock. Why did the U. Paulson Jr. When the financial panic hit. July 17. The new risk measure is now 2  1  var X where v–B is the reduced amount of stock. AIG did business worldwide and was the largest underwriter of commercial and industrial insurance in the United States. Consider a type of security that has a risk which can be measured by its variance (var X).ThE GREAT CRASh oF 2008 87 time as Merrill was receiving $9. (The Fannie Mae and Freddie Mac bailouts were larger. The Federal Reserve Bank.8 billion. It had over $860 billion of assets in 2007. created an $85 billion credit facility in exchange for stock warrants for 79. The variance of the return on its stock equity is then 1/v2 var X. The government eventually increased the credit available to AIG to $122. now substitute B of debt for B of stock. assume that var X = 100 and v = 10 (the firm is financed with all stock). But what we do know is very useful. where v is the stock equity with zero debt.7 billion. in September 2008. AIG suffered large losses. then it increased the amount further to $182.S. .” AMERICAn InTERnATIonAL GRoUP AIG was founded in 1919 and went public in 1969. Treasury (under henry M.) During the final three months of 2008. but they had government links. To clarify the above relationships.9 percent of AIG’s stock equity. AIG lost $61. This was the largest government bailout of a private company in U. We may not know the value of var X. There were immediate problems with the magnitudes of managerial bonuses and frivolous fringe benefits for AIG executives. one business of AIG was insuring investors against financial difficulties with their investments. 2009): “What the taxpayer got was an averted calamity.) become involved with the sale of Merrill to Bank of America? In Paulson’s words (New York Times.945 billion of federal bailout money and reporting billions of dollars in investment losses.S. AIG also sold auto insurance. DEBT AnD RISk There is much about decision making under uncertainty that we do not know.5 billion. history. but that does not affect the conclusions to follow.

There is no model that gives an exact answer to how much debt should be used. If the firm’s assets are somewhat risky. If the money can be borrowed.32258 and B = $9. but the risk measure with $9 of debt is 100 times larger. note that we can define reasonably accurately the increase in the amount of risk caused by the substitution of debt for equity.g. The ratio of debt to stock is 30 to 1. then using $30 of debt for each dollar of equity is equivalent to committing financial suicide. using a little debt in the capital structure is acceptable. If the firm’s assets are very risky (e. The firm’s risk was 1 with zero debt. The $1 risk measure with all stock may not be correct. Assume that debt costs 0. one can argue that we do not know that the risk is one with zero debt. there are likely to be economic pressures on the investors to borrow the funds. Risk = var (r) = With zero debt. . Using debt to finance the risky investments will add to the expected return. now assume that the firm used $9 of debt and $1 of stock equity.6774 Risk = Var(r) =  1   2  Var X = (3. subprime mortgages). we cannot define the optimal amount of debt.61(100) = 961. the risk measure is 1. Thus S = $0. We now have for risk: Risk = var (r) =   Var X = 100  10 − 9  With $9 of debt.08 and that risky investments earn an expected return of 0. But one cannot argue that the risk is 961 times as large when the capital structure is $30 of debt for each dollar of equity. Finally. consider an example more consistent with the financing of banks and investment banks in 2008. however. There is no financial barrier to the investors using too much debt except for lenders refusing to supply the debt.10) Var X  0. the risk is 961 times as large as with zero debt.. there is 100 times more risk than with zero debt.10.88 BEATInG ThE BEAR 1 102 (100) = 1 .32258  2  1  2 = 9. With $30 of debt for each $1 of equity.

commercial banks had over $4 trillion and mutual funds $5 trillion of assets. It engaged in various trading strategies (long and short) involving: 1. LTCM was a hedge fund. By 1998. this is a debt-to-equity ratio of 25 to 1. there were over 3. Futures and forwards Interest rates Equity index 3. LTCM was founded in 1994. Government bonds Mortgage-backed securities Emerging market and country bonds Equity securities 2.8 billion of equity. In addition. the Federal Reserve organized a rescue effort. For comparison.000 hedge funds with approximately $1 trillion in total assets ($300 billion in equity capital). the fund was able to raise $5 billion of equity capital and $120 billion of debt.ThE GREAT CRASh oF 2008 89 LonG-TERM CAPITAL MAnAGEMEnT (1998): ThE CAnARY In ThE MInE In September 1998. The first hedge fund actually hedged the assets it purchased with other assets and liabilities. Wall Street became aware that Long-Term Capital Management (LTCM) was in severe financial difficulties. With $4. LTCM had $125 billion in assets. Derivatives (interest rate and equity) Swaps Call options Put options 4. a teacher at Stanford and one of the two Black–Scholes authors) David Mullins (a teacher at hBS and former vice chairman of the Federal Reserve Board) At the end of August 1988. The first hedge fund appeared in 1949 and the term “hedge fund” first appeared in a Fortune magazine article in 1966. . Foreign exchange rates Despite the fact that the details of its operations and financial strategies were secret. thanks to the reputations of its major participants including: John Meriwether (ex-trader employed by Salomon) Robert Merton (a nobel Prize winner and teacher at harvard Business School [hBS]) Myron Scholes (a nobel Prize winner. To avoid worldwide financial and economic disaster.

when the problems hit.408 0.90 BEATInG ThE BEAR there were swap contracts of $750 billion and other derivatives of over $400 billion.3 billion and LTCM needed an infusion of capital.. and AIG. offered to supply $4 billion of new capital. Buy high-yielding newly issued Treasuries (“on-the-run”) Sell lower-yielding seasoned Treasuries (“off-the-run”) Small margins but can win. By August. sell U. the value of the equity investment fell to close to zero (with a bailout). Warren Buffett.02 of the fund’s assets.428)(1. yields just increased and Treasury yields decreased.408)(1. an investment of $1 billion grew to $2. Meriwether would be terminated.125. Expect spreads to narrow (high-yield debt’s rate to decrease and Treasury yields to increase).428 0. Sample transactions of LTCM were: 1. In many of the markets in which it traded.250 of the firm’s profits.354 billion: SE = 1 (1. Goldman Sachs. on September 22. adding additional implied leverage. LTCM’s portfolio was a multiple of its closest competitor in that market. In 1998. LTCM’s capital base was below $2. LTCM’s partners would own 5 percent of the equity. This is a “convergence trade. the fee was reduced to 0.S. the management fee of LTCM was 0.354 billion In 1998.” 2. Prior to 1998. ThE RETURnS LTCM earned the following returns on the equity capital: 1995: 1996: 1997: 1998: 0.625 billion in exchange for 90 percent of the equity (average investment about $250 million apiece). the principals received 0. “Flight to quality. There was a flight to quality. Inc. . the Federal Reserve Bank of new York organized a 14-member creditor consortium to inject $3. Buy high yield debt. In addition. on September 23. Treasuries.171) = $2.” In 1998. 3.171 ? From 1995 to 1998. Pay dollar LIBoR Receive Russian rubles and fixed interest rate. Meriwether refused the offer.01 and the split of the profits was reduced to 0. Swaps.

Speculate in emerging market securities (fell in August). the Fed and the U. and the unfortunate lack of action that resulted in the Lehman Brothers bankruptcy. Mergers and Acquisitions risk arbitrage (unraveled mergers created losses). 91 The major losses suffered by LTCM in 1998 were: Swaps Equity volatility: Emerging markets: Bond trades: Equity: $1. in turn.6 billion $1. . ThE RoLE oF ThE FED In 2008 When Bear Stearns collapsed in March 2008. the question of whether the amount of debt leverage used by financial institutions should be regulated.”7 shows how hostility to federal government oversight of financial institutions during the years of Alan Greenspan (from 1987 to 2006. Wessel. Roger Lowenstein has written a classic book on the demise of LTCM.6 Unfortunately. But the two major failures to learn from the death of the canary were the issue of the degree of regulation of hedge funds and banks and.ThE GREAT CRASh oF 2008 4. the bailout of AIG. in “In Fed We Trust.3 billion $430 million $471 million $489 million Fortunately. led to the need for Ben Bernanke taking unprecedented actions as head of the Federal Reserve. so the details are readily available.S. 5. The Fed’s activist story is told well by David Wessel. he headed the Federal Reserve) led to excesses that. the implications of the dead canary were not adequately noted by the financial community. Should the amount of leverage be a function of the amount of the riskiness of the assets owned by the firm? The obvious answer to this last question is yes. The bailout by the Fed possibly helped avoid a financial calamity in 1998. Since Greenspan was not in charge when the 2008 collapse occurred. but it sent an incorrect signal to the market that the Fed would be able to correct mistakes made by the financial market participants. there are limits to the amount of blame that can be heaped on his shoulders. These actions by Bernanke included the sale of Bear Stearns to Chase. most importantly. Treasury stepped in to direct the rescue by Chase.

ThE FDIC BAnk DEBT GUARAnTEE After november 2008. But then the stock price went to $1 per share. It was not obvious in March 2009 that one should buy stocks. neither the Fed nor the Treasury acted to save Lehman Brothers. The program was scheduled to end in october 2009. But then Citigroup stock went to $10. it is just as difficult to determine when it is time to buy. In 1932. when the stock of Citigroup reached $20 per share. In like manner. Barclay’s Bank acquired the core business of Lehman after the bankruptcy. ThE PRIMARY LESSon FoR InvESToRS The prime lesson to be taken from both the 1929 and the 2008 crashes is that it is not possible to predict when the stock market has reached its peak and is about to decline. it was obviously a time to buy stock of Citigroup. J. in March 2009. Bank of America. If it was a good buy at $20. The program included (among other banks) Citigroup. the program saves the bank $60 million per year. the program stimulated bank lending. Goldman Sachs. American Express. 1932–1933 was the time to buy stock. Morgan Stanley. on $1 billion of new debt. how do I know this? From the historical stock market price statistics. Assume that the program saves a bank 600 basis points or 0.92 BEATInG ThE BEAR In September 2008. P. Instead of a bank having to earn in excess of 0. even if we successfully called the time to sell (if the decline were about to start). I certainly would not have known that it was the time to buy. and General Electric (GE Capital). I knew that the market had fallen 50 percent in less than 12 months.09 (the cost of debt without the FDIC guarantee). In fact. Wells Fargo. This program continued past the summer of 2009. . Was it time to buy? next the price went below $1 per share and Citi’s horrible operating results were reported. in the fall of 2008. the Federal Deposit Insurance Corporation ( FDIC) guaranteed the payment of new debt issued by financial firms. Morgan Chase. it was a great buy at $10. obviously. After suffering almost four years of stock price declines and with the world in a severe depression.06 on its borrowings. It is not difficult to understand the complaints by the federal government when an employee of a bank benefiting from the program is paid a very large salary or bonus. Equally important. the bank has to earn only more than 0.03 with the guarantee program.

but at any moment in time there is a great deal of financial information not yet published that helps determine stock values. investors reacted to the devastating investing experience of the last half of 2008 and the first quarter of 2009. They bought U. To what conclusions does this all lead? Since we cannot forecast when a stock portfolio will lose 50 percent of its value. when stocks have the most miserable performance record is the time when you should consider buying stocks. let us consider a different question.94 (growth). There will be long periods of time when 100 percent investment in stocks will be better than any mix of stocks and other assets. over the 10-year period ending December 31. The problem is that we can read and analyze the published financial statements. stocks. Diversification into other assets than stock is one necessity. driving the yield on short-term Treasuries down close to zero. But this is the exact time when diversification into other asset classes is most desirable. ThE InvESTMEnT PERFoRMAnCE The 2008 annual report of the College Retirement Equities Fund (CREF) included the 10-year results of its four different stock portfolios (stock. and equity index). we have to act as if the portfolio will lose 50 percent of its value. the best-performing portfolio earned – 0. 2008.ThE GREAT CRASh oF 2008 93 Instead of the Citigroup stock. an investor did not want to be invested in U. what do we recommend? Although this question is difficult to answer. and many other stocks. Second. During this 10-year period. the primary investment objective has been met and the $2 million . As of December 31. For a person starting a career in 2009.S. global equities. the same game can be played with the stock of GE.S. Since only $2 million is needed. Treasury bonds.73 percent (stock) and the worst earned – 4. Assume the owner of a retirement account has computed that the amount necessary for a successful retirement would be $2 million and there is currently $3 million in the stock account. The correct decision based on the investment history of 1955 to 2005 was 100 percent in CREF. ThE FLIGhT To SAFETY: 2009 Early in 2009. Bank of America. 2008. what did you want your investment portfolio to be? When I started teaching at the University of Chicago. one had to choose the percentage of investment funds that went to CREF (stock) and the percentage that went to TIAA (more or less fixed income and real estate). growth.

our knowledge of stock market crashes (1929 and 2008) leads to a strategy of avoiding large losses when large gains are not necessary to achieve the investor’s objectives. . states “Wall Street bought the ideas of the efficient market theorists. remembering Irving Fisher’s 1929 – 1930 experience (he lost his entire wealth). Unfortunately I could not have predicted either one. . but then. . I continued to buy in December 2008 to February 2009. it happened. ConCLUSIonS I have studied the two largest stock crashes of the last 100 years. rejoiced in my tax losses.94 BEATInG ThE BEAR invested in stocks could be transferred to portfolios of other assets whose returns are relatively independent of stock market returns.” The bankers who dictated that their firms buy subprime mortgages with $30 of debt for each dollar of equity did not need the “efficient market” hypothesis to execute their deals. So. while it is difficult to be sure of recommendations at all times. EARLY WARnInG IGnoRED McDonald and Robinson5 accuse Lehman’s chairman and chief executive of ignoring advice from other Lehman executives that would have led Lehman to avoid the worst consequences of the fall 2008 panic. . by judicial financial planning. The calculations of expected return and the bonus arrangement were all that was necessary. and wrote a book. I avoided the most severe consequences of the 2008 crash. The purchases of high-risk securities and overpriced real estate financed by more and more debt was a sure recipe for financial disaster. in a book review of Justin Fox’s9 The Myth of the Rational Market. I stopped buying. A knowledge of the 1929 – 1932 crash saved me a lot of money in 2009. however. I allowed myself the luxury of assuming that stocks were oversold in october – november 2008. Paul krugman8 (The New York Times columnist and nobel Prize winner). In September 2008. Being human. in many cases literally.

SHORT SELLING. one could run out of fingers and toes counting the references to speculators and the effects of speculation on the stock market. Bond and mortgage investors bought high-risk securities. Citigroup. British Chancellor of the Exchequer. In 2008.‰ And thus brokersÊ loans become sinister in the conversations of English pubs. addressing British workingmen in defense of the Bank of EnglandÊs 61Î2 percent discount rate. TRUSTS. before and after the great crash of 2008. and GE.‰ says Snowden. 1929 In 1929. Lehman Brothers. . ·The Magazine of Wall Street.‰ first offered by Philip Snowden on a visit to New York. „that an orgy of speculation on the other side of the Atlantic should disturb our internal economy. Most of these stocks were considered blue chips. Freddie Mac. we know investors were about to lose over 90 percent of the value invested in these stocks. POOLS. A popular expression was „the orgy of speculation.Chapter 8 STOPPING THE SPECULATORS: MARGIN BUYING. October 19. With hindsight. AND THE 1929 CRASH „It is a terrible thing. but investors in stocks were not knowingly speculating when they bought Fannie Mae. Bear Stearns. one could count the references to speculation in the stock market on one hand and have fingers left over. Wachovia. Wall Street is the center of interest of the whole world.

Where were they in 2008? My conclusion is that there were as many (or as few) speculators in 2008 as in 1929. It is interesting that the amount of margin buying and the level of the loans to brokers were major concerns to the financial community in 1929. The fact that stock prices continued downward did result in three major brokerage firms going bankrupt in the first nine months of 1930. and in 2008–2009 these factors received little or no attention in the financial press. it was as high as 75 percent. the president. and stocks listed on other exchanges. 641) $82. and the Federal Reserve Board chose in 1929 to focus on the speculators without effectively defining the term. margin buying was not the only factor causing the upswing. Obviously. the $1. The market value of all stock securities (common and preferred stock) listed on the NYSE was $89. There was no a speculative orgy in 1929 or in 2009. It was controlled by brokers interested in their own financial well-being. Could they have been important in 1929 but not in subsequent years? .2 billion during that eight-month period. Prior to October 1929. no major brokerage firm was bankrupted because the brokers managed their finances in a conservative manner. With a value of $67. New York Stock Exchange (NYSE) member firms had 560. 7).7 billion on September 1. p.814 million increase in broker loans would support $3. Using WigmoreÊs (1985. margins were lowered to 25 percent. In 1929.628 million of stock investment.4 percent. The level of the margin requirements at the beginning of October compared with the end of October implies that the broker community either thought some stock prices were too high on October 1 or too low on October 31.549 million from January to September 1929.735 million to $8. 1929 (Stock Exchange Practices.5 billion on October 1. the market increased by approximately $22. Broker loans increased from $6. p. bonds.5 billion in January. With a 50 percent margin.1 billion estimate of value of all common stock on the NYSE as of September 1. 1929.549. Basic human nature does not change in a 90-year period. 1929. Margin buying during the 1920s was not controlled by the government.96 BEATING THE BEAR Why the difference between 1929 and 2008? We can assume the speculators of 1929 had children and grandchildren with inherited personality faults. When the crash came. On selected stocks. Stock prices can go down by 50 to 80 percent without the prices initially being unreasonably high.000 customers. At the end of October. and the brokersÊ loans of $8. the ratio of loans to market value is 10. This ratio could be reduced by the fact that the broker loans would also be used to finance preferred stock. The press. the average margin requirement was 50 percent of the stock price.000 margin accounts out of 1. 1934.

This fact made the investors who bought on margin sensitive to any large selling activity and the possibility of stock prices not going up. MARGIN BUYING The Senate Committee on Banking and Currency defined the margin transaction as follows: „Margin purchasing is speculation in securities with borrowed money. 1925. if a stock costing $100 was purchased. Thus.5 billion in 1925 and $8. excessively leveraged.3 The increase of broker loans was only from 5.STOPPING THE SPECULATORS 97 Margin buying in 1929 was a likely factor in causing stock prices to go up by increasing demand.8 percent of market value in 1925 to 6.2 Broker loans as reported by the NYSE were about $3. 626–27). The NYSE had unwritten margin requirements that ranged from . Because of the stock collateral.5 billion at the end of September 1929. the calling of margin loans probably exacerbated the price declines. in several segments. Compulsive gamblers found margin buying to be a reasonable substitute for the race track.9 percent in 1929. The buying of stock on margin was one more layer of leverage in a market that was already.5 billion on January 1. Wigmore (1985) gives excellent statistics concerning the dividend yield and call loan costs ( p. the investor would pay in $25 cash and the broker would keep the stock as collateral. the investor buying on margin needed the expectation of stock price increases. the broker was not concerned with the creditworthiness of the investor–borrower. If the stock price went to $90.‰ Although margins required to buy common stock could be as low as 10 percent in 1929. 1929. and during 1929 the loans from corporations and other brokers increased dramatically. Given the low stock yields (3 percent) and the high costs of the loans to finance the stocks (5 to 14. On July 1. brokers generally required a minimum margin of 25 percent of market value and liquid collateral for the remainder. The value of all securities traded on the NYSE was approximately $60. the value was estimated to be $124 billion.‰1 Note the choice of the word „speculation‰ rather than „investing. but there is no reason to conclude that margin buying triggered the October crash. The broker would normally obtain a call loan from a bank. Once the selling rush began. There were no legislated margin requirements prior to 1934 (the Federal ReserveÊs margin authority is derived from the Securities Exchange Act of 1934).4 percent). If the cash was not forthcoming. the broker would likely ask for an additional $10 cash. the stock might be sold before the price of $75 was reached. 572 and pp.

The call interest rate reached 20 percent in May 1929 and 15 percent during the summer of 1929. or collateral. Broker loans were a small percentage of total investment and even a small percentage of the value increase.35 billion of additional call loans. Appendix 1). Immediate revisions in marginal accounts.5 The August 1929 issue of The Federal Reserve Bulletin highlighted the dramatic increase in total broker loans from 1926 to 1929. and the individual must be prepared and willing to adapt to changes deemed necessary. Liquid. A minimum margin of 25% of market value 2. 1930.98 BEATING THE BEAR 10 percent of higher-priced stocks to 25 percent for lower-priced stocks. The total broker loans increased from 3 billion in 1926 to 6 billion by the middle of 1929. Additions to cash.5 billion increase in security value from 1925 to 1929 with a 10 percent margin. to conform with such price changes as may occur in securities held 4. it should be recognized that the boom was not fueled solely by borrowed funds. A second factor at work is that early in February 1929 the Federal Reserve announced its concern about the amount of speculation (see chapter 4. If speculators fueled the $63.‰ . as and when required. the margin in customer accounts with brokers averaged 40 percent of the market value of long stocks. The actual reported increase was approximately $5 billion.5) = $6. but most brokers required margins of 50 percent or more. Although the margin debt is very important to any explanation of the crash.4 The following extract from January 25. there would have been 0. upon reasonable notice Margin requirements vary with market conditions. issue of The Magazine of Wall Street ( p. easily handled and stable collateral 3. loans to brokers were at a high point in the latter part of July. Public utility common stock dividend yields were only 3 percent.10(63. The head of the NYSE indicated that in the first six months of 1929. and the recent increase has been for the most part in loans by domestic banks. The explanations in the bulletin emphasize the FedÊs excessive concern for the participation of domestic banks in the financing of speculation: „As is brought out by the chart. with a resulting increase in interest rates. It urged (with threats) banks to reduce speculative loans and proceeded to tighten credit. 531) gives insights relative to the requirements of margin buying during the period 1929–1930: Brokers Generally Required 1.

4 to $1. But the loans of others increased more dramatically.4 billion. New York bank loans to brokers and dealers decreased from $1. New York City member banks from October 23 to October 30 increased broker loans from $1. given the fact that domestic banks had not increased their loans to brokers. the rest of the country (and world) supplied the fuel for the stock price increases in the first nine months of 1929.3 billion. offering an extremely high return.STOPPING THE SPECULATORS 99 This is a strange statement.‰ The desire for the Fed to curb domestic bank loans to speculators had become extraordinary. .07 billion.08 billion to $2.5 to $1. Broker loans during 1928–1929 were financed not by banks but rather by individuals and industrial corporations. but there was an increase in the „accounts of others. As reported by First National City Bank of New York: „one of the marked differences between this one. They did withdraw their funds in late October 1929. But in October 1929.8 billion to $3. At the same time. the New York City banks increased the loans for their own account as loans of the out-of-town banks and the accounts of others shrank. broker loans decreased from $6. but total loans had expanded.8 New York banks did not expand their loans to brokers from 1928 to 1929 for their own accounts.7 Prior to October 24. the market was being sustained by high-cost money and the gap between the stock dividend yields and the carrying cost of the stock was between 1200 and 1700 basis points (assuming 3 percent dividend yields and costs of borrowing between 15 and 20 percent). the funds being supplied were very unstable. and it was forecasted that they would withdraw their funds with any significant drop in interest rates or drop in stock prices. From January 1928 to October 16. reducing total broker loans via New York City banks by more than 20 percent in the last week of October. 1929. the greatest of market disasters on record. The increase of the loans of others is extremely significant. The financial institutions were amazingly resilient to the October crash.8 billion.6 to $5. ready to leave New York at the first hint of risk.6 National City Bank reported in one week (October 23 – 30) that broker loans dropped from $6.9 to $3.1 billion. From September 25 to the end of December. Once the break in prices occurred. The loans of outof-town banks increased from $1. They were attracted by the high interest rates. domestic and foreign nonbank lenders. the Federal Reserve Board had effectively prevented New York City banks from increasing their broker loans. broker loans contracted sharply. from $0.538 billion. In addition. the out-of-town accounts and accounts of others decreased by over $2 billion. When the crash came. Given the fact that broker loans were a very safe investment. This forced the interest rate on broker loans up to as high as 20 percent.

These ratios appear to be high. 51) that this „provides clinching evidence of wide-scale stock-market irrationality during the 1920s.1 is meaningless. Berkshire Hathaway shares were selling at a hefty premium over the value of assets it owned. compared of $400 million in the entire year of 1928. We have current evidence that rational investors will pay a premium for what they consider to be superior money management skills.‰9 INVESTMENT TRUSTS By 1929. the investment trusts sold at a premium. 442). 665): „Much of the recent increase is to be accounted for by the extraordinary burst of investment trust financing. If we were to conclude that rational investors would currently pay a premium for Warren BuffetÊs expertise. thus Table 8. These trusts were the 1929 version of closed-end mutual funds. then we should reject a conclusion that the 1929 market was proven to be irrational.1). investment trusts were very popular with investors. seasoned closed-end mutual funds sell at a discount to their fundamental value. $643 million was invested in investment trusts (Financial Times. . p. Malkiel also notes ( p. since we do not know their net asset values. We do not know if these investment trusts were overvalued in 1929.100 BEATING THE BEAR and all the others is that there has been no failure of a brokerage house on the big exchange and only two small failures on all of the New York exchanges. Hedge funds in 2008 – 2009 were another example where investors paid a multiple of book value in order to buy rare expertise. p. Malkiel concludes ( p. But remember that book values were historic cost measures and not the market value of the trustÊs assets. We do know that they dropped by over 30 percent in price from their highs in the crash. October 21.‰ Warren Buffet is the guiding force behind Berkshire HathawayÊs great success as an investor. 3). A total of $1 billion of investment trusts were sold in the first eight months of 1929. But the underlying stock prices also dropped by this magnitude. 4) shows the ratios of market price to book value for five investment trusts in 1929 (see Table 8.‰ However. In 1929. The fundamental value is the sum of the market values of the fundÊs components (securities in the portfolio). both sets of numbers indicate that investment trusts had become very popular with investors by October 1929. Wigmore ( p. 1929. The Economist reported that this was important (October 12.‰ In September alone. „As of the mid-1990Ês. In recent years. While the two sets of numbers (from the Economist and the Financial Times) are not exactly comparable.

DeLong and Schleifer (1991) followed one path.1 The Stock Market Price to Book Value Market Price Divided by Book Value Goldman Sachs Trading Lehman Corp. reduction of risk to investors largely brought about through investment diversification made possible for the investor by investment trusts. 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. United Founder 2. in 1929 a diversification of stocks was not going to be a big help given the universal price decline. 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. and the value of its common stock fell from its high of $104 a share in 1929 to $1.‰ . since the intrinsic values are not objectively well defined. this is impossible. Tri-Continental Corp. on September 6.95 1.45 101 The common stock of trusts that had used debt or preferred stock leverage were particularly vulnerable to the stock price declines. and two. investment trusts were a sensible investment alternative. DeLong and Schleifer state ( p. 1929.05 2. 1929. but the leverage of choice was not debt but rather preferred stock. the Goldman Sachs Trading Corporation was highly leveraged with preferred stock.75 in 1933. and the market values of the securities in the fundÊs portfolio provide a very reasonable estimate of the intrinsic value. In concept.56 2. They offered expert management and diversification. We conclude that the stocks making up the S&P composite were priced at least 30 percent above fundamentals in late summer.49 3.STOPPING THE SPECULATORS Table 8. Unfortunately. There are two exceptions. Irving Fisher. Some of these funds are traded on the stock market.‰ The ideal information to establish whether market prices are excessively high compared with intrinsic values is to have both the prices and values at the same moment in time. United Corp. For example. For the normal financial security. very cleverly choosing to study closed-end mutual funds. Many of the trusts were leveraged. One. the anticipation of large dividend returns in the immediate future.

Thus a premium for investment trusts does not imply the same premium for other stocks. There was frequently an organization fee of $X per share and an ongoing management fee (based on size and /or profits). If investors in the third quarter of 1929 did not know the current net asset value of investment trusts. 682).102 BEATING THE BEAR Unfortunately (p. 1) took note of increasing investment trust prices: „The rapid advances in prices of some trust stocks to substantial premiums above liquidation values have injected a new complication into an already involved security market. the organizers received options to buy at net asset value. In addition. the inclusion of any that were introduces a bias). if investors also lacked the information regarding the portfolio composition. After 1929. „Three types of event seemed to trigger a closed-end fundÊs publication of its portfolio.‰ It was only after the crash that investment trusts started to reveal routinely their net asset value. The Wall Street Journal of October 1 ( p. we would have to place investment trusts in a unique investment category where investment decisions were made without useful audited financial statements.‰ But the Journal then added that „management is the essence of investment trust valuation.‰ They were (1) listing on the NYSE (most of the trusts were not listed). (2) start-up of a new closed-end fund (this stock price reflects marketing pressure). In the third quarter of 1929 (p. In fact. it is not surprising that some investors were willing to pay for expertise and to buy shares in investment trusts. and (3) shares selling at a discount from net asset value (in September 1929 most trusts were not selling at a discount. These were impressive incentives to form funds and sell the shares. some trusts revealed 1929 net asset values. „portfolios were rarely published and net asset values rarely calculated. 682). Thus DeLong and Schleifer lacked the amount and quality of information that would have allowed definite conclusions backed by hard evidence. Given the conventional perspective in 1929 that financial experts could manage money better than the person not plugged into the street. They were also incentives to have successful funds. In 1929. THE GOLDMAN SACHS TRADING CORPORATION The Goldman Sachs Trading Corporation has received a large amount of attention because of its large losses.‰ Thus the premiums might be justified if expert investment management was being bought. the stock had a high . this fact is significant. A factor that would make generalizations from newly issued closedend investment trusts difficult is that the funds were aggressively sold.

2 of the income if the income exceeded 0. it would also have been correct for the Journal to have added. However. of course. The October 4. a falling stock market. The large variance investments combined with a large amount of leverage. It had been operating for approximately a year and was reasonably profitable (paid a special $2 a share cash dividend). Goldman Sachs Trading announced a policy of a 6 percent stock dividend per year. and it fell to a price of $1. buying 10 percent of the shares at $100 a share (100. The acquisition was implemented by the issuance of stock by Goldman Sachs Trading. Investment pools were formed by a group of investors to trade actively in a single security.08. is correct. Goldman had to undertake investments with a large variance. 8). p. but only if the amount earned in a year were in excess of 0. The stock dividend itself does not affect shareholder wealth.‰ Also. but some . Their stated purpose was to buy and sell stocks. „Payment of dividends in stock is akin to paying dividends in cash and selling new shares to the stockholders. and slackening economic activity spelled disaster for the Goldman Sachs Trading Corporation. Goldman was to get 0.‰ This. sometimes by disseminating misleading (fraudulent) information and by buying and selling the stock to itself (to stimulate interest). The corporation „ receives no compensation until the corporation earns during the year 8% on its capital. In 1933. We do not know if Goldman (the parent) bailed out early. 1929. the corporation was dissolved. but the underlying incentive plan for Goldman should have been attractive to an investor (New York Times. They might include a broker or an investment banking firm.‰ POOLS There were many questionable acts by manipulators of the stock market.75 a share in 1933. It was a major embarrassment to its parent.000 shares). issue of the Wall Street Journal had an extensive article on Goldman Sachs Trading Corporation. October 4. Pool operations could conflict with the rules of the NYSE.08 of the book value. One of these was the manner in which investment pools operated. The transaction was apparently structured to be fair to all parties.STOPPING THE SPECULATORS 103 price of $350. „Payment of dividends in stock is also akin to the corporation retaining the earnings. Goldman made a $10 million investment. 1929. The Wall Street Journal article said. The article described the details of the acquisition by Goldman Sachs Trading Corporation of the more profitable Financial & Industrial Securities Corporation. but in actual practice they were frequently vehicles for manipulating the price of stock. The execution of the investment strategy turned out to be a disaster.

is it not? Mr. The general purpose of pools is to distribute securities at profit to the members.000 of short positions had been taken.293 shares).447. but unfortunately we do not have the information we would like regarding short selling during the first 10 months of 1929. at least.000 shares at 401Î8. Pecora: The market price of a given security? Mr. Pecora: Is it easily possible for a group operating through the medium of a pool to exercise temporarily.10 During 1929. Pecora: This is the point I am trying to make. Pecora: And it is that sort of thing which the exchange does not like to have done. and the market value of the companies whose shares were shorted was $19. yes. The Senate hearings produced the following exchanges: Mr. None whatsoever.11 SHORT SELLING The „bear crowd‰ was active in 1929. driving up the stock price so that the pool could unload at the higher price. Whitney: I will answer yes. but unfortunately the information available does not cover the September – October 1929 period. . Mr. Whitney: If there are no improper transactions connected with such an operation my answer is that the exchange does not object. there were $57 million of shares short (759.12 As of November 12. or for the purpose of the operations. a control of the market price? Mr. sir. Pecora: But it is possible under the operation of the exchange for a group so to operate in the market as to more or less control prices for the time being? Mr. Whitney: If their stock and if their money holds out. is that not so? Mr.000 shares and offering 5. Bear raids and short selling were thought to be a very important part . A pool might buy shares of a firm and then spread stories in the hope that other people would buy the stock. on the conditions . Whitney: Yes. Whitney: As long as the stock and their money holds out.13 These totals were for firms in which over $500. sir. 1929. yes. a total of 107 stock issues listed on the NYSE were subject to one or more pool type of activity. Meeker provides us with some information for 1929. The exchange has no objection to a man or a pool bidding 40 for 5.373 million (234.710 shares). The short positions in September and October 1929 are not available. Mr. Mr.104 BEATING THE BEAR pools did not violate the ethical standards of the time or the rules of the NYSE. Mr. .

Fisher describes the October situation as holders not selling but rather being sold out. THE CRASH OF 1929 Once stock prices began to drop. the fall fed on itself as margin accounts were sold out. As more and more investors face the debt gap. No statistical material presented in this report. it is unfortunate that the sensational market operations so interestingly described in such books as those of Henry Clews or the biographies of Daniel Drew all occurred in the prestatistical age.15 But their study is of little help in evaluating the impact of short selling on the 1929 stock market: „From the statistical standpoint. except a brief series covering nine market days in November 1929. goes further back than May 1931. there seems little doubt that short selling often had a temporarily disorganizing effect on the price movements of a particular stock and sometimes on the market as a whole. more stock is sold driving the price of the stock even lower. even in those days. the investor is sold out). The new price will only support $81 per share of debt. Martin Mayer holds that „about 90 percent of the damage done on Wall Street has come from short selling. It can be readily seen that the crash can very well feed on itself.18 Imagine a situation where an investor owns 100 shares of stock with a current market price of $100 per share. Now assume that other investors sell the stock in sufficient numbers to drive the price down to $90 (more about the triggering event later). it was ever a serious factor in determining the larger and longer-term movements of the market in general or even of individual stocks. but continuous short-selling figures do not. The stock is financed by a 90 percent margin. our hypothetical shareholder must come up with $900 to eliminate the debt gap. Macaulay and David Durand for the Twentieth Century Fund. Therefore the stockholder has a debt of $9. If the investor cannot raise the money elsewhere some of the stock will be sold (i.STOPPING THE SPECULATORS 105 of all crashes. Statistical evidence is not available for the first eight months of 1929.e. but we cannot be sure of the magnitude of its consequences. Daily prices go far back.000 in total and $90 per share.. Therefore.‰16 They do conclude this: „From the nonstatistical records of the early days of the New York Stock Exchange. But there seems little evidence that. R.‰17 Thus we can hypothesize that short selling contributed to the marketÊs unrest in October 1929. What can trigger the initial sale? In the summer of 1929 the French and English had a disagreement and the French suddenly sold large amounts .‰14 How important was short selling in causing the 1929 crash? One exhaustive study of short selling was done by F.

The Chronicle of October 26 placed a large amount of blame for the stock . but the increase was less than usual. the editor of the Chronicle described the level of broker loans to be „of such appalling magnitude that the commentator is at a loss to find language adequate to describe the same. stocks. In explaining the weakness of the stock market for the week. borrowings by stock exchange members reached a total of $8. The Commercial and Financial Chronicle reported that Roger Babson had again predicted a crash and that „ this predicted Âcrash. but $8. There were also extensive liquidations of holdings on the London Stock Exchange.0 billion of new securities was issued.106 BEATING THE BEAR of English securities which they held. the Chronicle reported that the Bank of England had raised its discount rate from 5 1Î2 to 6 1Î2 percent (its highest rate in eight years). 1929.22 In September alone. October 24. and the failure resulted in English investors having to sell U. public utility stocks suffered severe declines. undoubtedly has in it the elements of serious disaster.23 On Tuesday.Ê if and when it comes. The Chronicle conjectured that „the primary cause is found in the gigantic speculation that has continued so long in the New York stock market.1 billion of new domestic corporate securities was issued in the first 10 months of 1929 compared with $4.3 billion in 1928.S. The bankÊs gold holdings during the week had dropped to £133 million. securities.‰20 The increase in discount rates by several central banks tended to reduce the willingness of foreign investors to buy U.5 billion. 1929. The Federal Reserve Board reported in September that the August production in basic industries was higher than in July. Also in England it was discovered in September that the respectable Hatry investment firm had forged securities and that it only had £4 million in assets and £20 million in liabilities. having lost £40 million in one year. the October 19 issue of the Chronicle identified the main depressing influences to be the indications of a recession in steel and the Massachusetts Department of Public Utilities not allowing the Edison Electric Illuminating Company of Boston to split its stock. On October 5.‰19 On September 28. Edison lost $100 of value per share. Was the Hatry affair a match thrown on the floor of a forest which had been dried out by the Federal Reserve tight money policy combined with low margin requirements? On September 21. As a result of the decision and explanations offered for the decision.‰21 As of September 30. as well as the Paris and Berlin markets. The firm failed.S. $1. Not only was credit being tightened during the spring and summer of 1929. The sale created a small panic in London. the first major break in stock prices occurred.

Bear Stearns. On June 30. But thanks to federal government assistance.‰ He identifies the importance of short selling in the destruction of financial institutions in 2008: „itÊs clear that AIG. A17). On the other hand.STOPPING THE SPECULATORS 107 market boom.‰ SHORT-SELLING 2008–2009 In 2007–2009. Bear was purchased by Chase and Lehman went bankrupt. 2009.4 billion. Banks were not feeding money into the economy either for stock market or real investments. March 24.24 THE SOROS RECOMMENDATION: 2009 In an editorial contribution (Wall Street Journal. there was $22.0 billion of loans and investments of reporting member banks. Lehman Brothers. their common stocks were battered. and others were destroyed by bear raids in which the shorting of stocks and buying CDs mutually amplified and reinforced each other. which reinforced the reluctance of investors to contribute capital. the presence of large amounts of risky debt-type assets. short selling of Bear Stearns and Lehman Brothers had a significant impact on the financial health of these firms. The short-selling and resulting fall in stock prices convinced the lenders of the short-term capital that there was more risk than they wanted. Bank of America. GEÊs stock went below $7. might have scared stock investors sufficiently to cause a drastic fall in stock prices. 1929. on the easy money policy of the federal reserve system which had begun in 1927. News reports indicated that subprime mortgages and related debt held by Bear and Lehman had become more risky than anticipated. The First National Bank of New York Newsletter for November 1929 showed that there was essentially no growth in bank loans and investments from 1928 to 1929. all three avoided bankruptcy. These two firms were financing long-lived bonds (mortgages) with short-term liabilities (overnight money and repurchase agreements). 1928. and they took their capital elsewhere. CitigroupÊs stock dipped below $1. there was $22. Of course. The November 9 issue stated that there was no mob selling. not marked to market. The stocks of Citigroup. The increase was insignificant. and Bank of AmericaÊs stock dropped to $3. . and on June 30. and General Electric were also hit hard by short selling. but rather that they were sold out. p. even without the short selling. and thus the bust. The short sellers won big. George Soros argues that the credit default swaps need stricter regulation and „Only those who own the underlying bonds ought to be allowed to buy them.

108 BEATING THE BEAR Many of the bad assets were held by off-balance-sheet subsidiaries of banks. the trusts added another level of leverage. The leverage made the investor in the stock of investment trusts (especially the stock bought on margin) very vulnerable to any change in value of the underlying stock held by the trust. with their relatively high dividends. CONCLUSIONS Many of the trusts in 1929 invested in public utility stocks. thus inflating utility stock prices above their already high values. the most significant factor was that they both added layers of debt leverage. For the level of both margin buying and investment trusts. More leverage was not needed and would turn out to be one of the accelerating factors of the crash. Also. but if the parent was responsible for its subÊs debt. . the complex financial structure would not save the parent from financial embarrassment.

and when the great calamity can be seen in its true perspective it will be recognized as the greatest financial disgrace in American history. but that the borrowing bank did. Sir. ·The Magazine of Wall Street. Senate Committee on Banking and Currency held hearings in January 1931 regarding the performance of the federal reserve system. The Chairman: You did not? Governor Harrison: No.S. . The Chairman: The Federal Reserve Bank permits the borrowing bank to do it. 1929 The U. It is the business of the Federal Reserve Bank to know what the borrowing is doing and for what purpose it is doing it. He wanted to establish the fact that the federal reserve banks financed speculative loans. governor of the Federal Reserve Bank of New York. . why should they feel · your board of directors ever feel. November 16. . Senator Peter Norbeck of South Dakota was the chairman of the committee. If that is not the meaning of this act. we never did it. in any sense or degree · warranted in admonishing member banks in New York to reduce their loans to brokers? Governor Harrison: Senator. The events of 1929 were of major interest to the committee.Chapter 9 THE SENATE HEARINGS OF 1931 CONCERNING 1929 No worse catastrophe has occurred in American financial history. We did it . The first person to offer testimony was George L. Harrison. Harrison responded that the Federal Reserve Bank did not finance speculative loans.

as others. I wish I could think. The Chairman: Well. It was not intended to enable the bank to get loans from federal reserve banks for stock speculative purposes.‰ The failure to distinguish real assets from the securitized claims to those assets was devastating to the economy. the so-called brokersÊ loans of the New York banks were not going up. . Governor. Harrison talked with the president of Guaranty Trust Company and the president of the First National Bank and exerted a great deal of pressure on them to restrict their loans. The Chairman: Should not you have done it? Governor Harrison: For two reasons: In the first place. 1929. said regarding the rediscount rate: „We made mistakes. our directors felt from the beginning the proper method of breaking such expansion. . was through the rate rather than through a particular admonition to particular banks. if it occurred. was to provide against emergency embarrassment. We never did it in New York . as you seem to imply. if you have no authority to abate or control that sort of thing. regardless of the cause of it. that there is not any excess in stock speculative activities in New York. Harrison. Because of the demand for money for speculative purposes. in the second place. was somewhat confused about the „countryÊs assets‰ and rights to those assets called „stocks and bonds. On the subject of speculation. ever the gentleman. when credit is expanding as it was in 1928 and 1929 at a great rate all through the country. . Harrison.‰ He never shifted the blame (or credit) to the Federal Reserve Board for not increasing the rediscount rate from February 1929 to August 1929. Harrison was either forgetful or too modest.110 BEATING THE BEAR The Chairman: Did not the Federal Reserve Board do it? Governor Harrison: That is a matter of public record. I do not think we went up fast enough. On May 13. They were staying stable at the figure at which they rested even before the period of speculation began and. we wanted to put up our rediscount rate believing that was a proper means of limiting a too rapid use of the countryÊs assets for speculative or other purposes. the intent of the provision of the law. why do you do it through the rediscount rate? Why do you apply the rediscount rate to a situation of that sort and penalize the legitimate commerce in order to control something you say you have no right to control? Governor Harrison: I think we have a perfect right to control an expansion of credit. Norbeck then asked some crucial questions: The Chairman: If not to be controlled. Harrison made clear that he could not always identify it.

chairman of the board of directors of the Federal Reserve Bank of New York. there was speculation in New York. It was not until the 14th of February. not only to you but to all of us in the federal reserve system. there was speculation all over the country and all over the world. Case. Miller: The rate was raised by the New York bank to 5 percent on the 13th of July. Of course. that the federal . in which was emphasized the dangers inherent in the extraordinary growth in the volume of speculative security credit. It was the fact that these funds were not bank funds that made the speculative movement so difficult to control.500. expressed several times in discussions at federal reserve meetings. attracted by high rates. in the opening month of the year 1929. it seems to me you belong to the school of thought that insists that the way to minimize speculative activities is to penalize legitimate commerce by raising the rediscount rate?‰ The second witness was J. I want to complete my statement on that because if I leave the record at this point it will appear that I am disingenuous. that the first proposal to raise the rate to 6 percent was made to the board. rose from $1. It was not until after the board issued that statement. 1929. and individuals not in the banking business. Case pointed out that the increase in broker loans in 1928/29 was not financed by the banks: „The bull market of 1928/29 was largely financed not by the banks but by corporations. firms. H. may I ask. But later Miller makes clear his position relative to a discount rate increase. Miller: It was my opinion.THE SENATE HEARINGS OF 1931 CONCERNING 1929 111 Governor Harrison: Well. The attention of the Federal Reserve Bank of New York was on controlling speculation that it could not define. At first Miller does not respond.000. in the form of advances classified in the report as Âloans for account of othersʉ These loans by corporations. that the Federal Reserve Bank moved. in a word. or seven months later and one week after the board issued a public statement to the country with respect to credit conditions. The Chairman: Then just exactly why. did the Federal Reserve Board decline to sanction further advances in the rate at New York? Mr. 1929.000 at the beginning of 1928 to something like $5.000 if the figures from all sources are put together.‰ Adolph Miller also testified. It was a matter of the greatest concern. 1928. This is an opportunity for us to better understand the boardÊs rejection of the New York bankÊs move to increase the rediscount rate on February 14.500. to the limit to do what was proper to control it. and individuals. Norbeck captured this thought with the following observations: „Well. We exercised our imagination and ingenuity. I think. Mr. which I do not want to be. firms.

and the discount rate would have been of no help to us whatsoever. With call rates mounting to 8. thinking that then it might have proved a curb. the discount rate had ceased to be an effective instrument for curbing speculation which had developed into a perfect mania. Charles Hamlin also revealed his thinking in rejecting the move by the New York bank to increase the rediscount rate in February 1929: „To make a long matter short. yet even after that. although the direct pressure was suspended in June. In June 1929. than were the banks and that.112 BEATING THE BEAR reserve system was drifting. Hamlin forgot his recording of MillerÊs desire for a „sudden liquidation and crash‰ (Hamlin. to have voted for a 6 percent rate in the middle of 1928. personally. right up to the time of the stock crash the federal reserve credit outstanding increased for the system as a . The speculators. But when you came to 1929. Hamlin added to his explanation: When a speculative mania is once under way you cannot do anything with it by the use of higher discount rates. I felt that in January. the board suspended its program of direct action. the period we were considering. would have been nothing but a futile gesture. it would have no effect whatsoever. January 1. wanted us to approve the 6 percent rate. I believe. 1929. Six percent meant to those men easy money. that it would have been a practical declaration to the speculative markets of the country that the doors of the federal reserve system were open to all comers with paper of the kinds eligible for rediscount provided they paid 6 percent. Hamlin: Another interesting fact is that. because it meant. in default of any program on the part of the federal reserve banks for dealing with the situation. higher rates might have been effective.‰ Later in his testimony. That solution was found in a rejection of discount policy as a suitable expedient in the circumstances. A 6 percent rate would have been to the speculator a relief. 1929. as they hoped. when speculation was beginning. for which it must find a solution.‰ If was our belief that an increase to 6 percent in February 1929. as they had then developed. 1929). It was also my opinion that the Federal Reserve Board was far more alive and aware of the terrific implications of the situation existing at the opening of the year 1929. on August 9. looking back. 10. Mr. 9. which I will explain in a minute. a 6 percent discount rate would have been an admission of defeat and given great relief to the speculating public. 15 and 20 percent. and a change was made in the discount rate. and the adoption of „direct pressure. that it was in the midst of a perilous situation without a policy. February 5. a discontinuance of direct pressure and permission to borrow all the money they wanted if they would merely put up good collateral and pay the increased discount rate. it had absolutely gone by the board. I believe that at that moment. While I would have been willing. the Federal Reserve Board owed a responsibility to the country and to the future of the federal reserve system.

the ramifications of which were great. when business started to decline in July 1929. fifth. and then. very definite nervousness was contributed to the Hatry failure in England.THE SENATE HEARINGS OF 1931 CONCERNING 1929 113 whole. even though we cannot estimate its effect. and perhaps the most important. second. and the objective of the actions in 1929 of both the Federal Reserve Board and the Federal Reserve Bank of New York. the increase of the Bank of England rediscount rate was a factor. HarrisonÊs comments regarding the causes of the October stock market price decrease are of interest: The Chairman: Do you think that is why the turn came? Governor Harrison: I think it came from a variety of reasons. it later began to have its effect on speculation. that was the objective of the increase. It is interesting that Harrison acknowledges that the August increase in the rediscount rate might have caused the market turn. third. fourth. . restraint was contributed to by the increase in our rediscount rate in August. It increased simply by the amount of the increased demand for currency in circulation. comparatively little. After all. First. things had gotten so top-heavy that they could not go on any further.

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1).Chapter 10 DISPELLING THE MYTHS OF 1929 Senator Fletcher: „Did you do anything to check this wild speculation up to October of 1929 that occurred on the stock exchange?‰ ·Stock exchange practices hearing.‰ „the Great Crash occurred in October 1929. the market was at 299. By November 13. the Dow Jones Industrial Average reached an all-time high of 381.‰ and „the crash was inevitable. the market had fallen to 230·a drop of 40 percent from the marketÊs high. unreasonably high in 1929? We need to review economic fundamentals and stock market prices in September and October 1929. respectively. The stock market crash is conventionally said to have occurred on Thursday October 24 and Tuesday October 29. The value loss for the year 1929 was only about 11. At the end of the market day on Thursday.5·a 21 percent decline from the market high.4 percent (Table 10. 1929. These two dates have been dubbed Black Thursday and Black Tuesday. 1933 In this chapter. October 24. On September 3. . On the single day of October 24 the market fell 33 points (using the low value for the day)·a drop of 9 percent for the day. driven by immoral and unthinking speculation. an attempt is made to dispel three myths: „stocks were obviously overpriced.2. THE STOCK MARKET·1929 The so-called great crash of 1929 was a very modest decrease in stock prices compared with 2008.‰ Was the stock market. 1929.

1 +46. Sergeant Florence (another leading economist): „Keynes may have made his own fortune and that of KingÊs College. The mass escape into make-believe. Ibbotson and R. also lost heavily. he lost his entire wealth (including his house) before stocks started to recover.9 +37. In England.7 Change in Index Percentage Change Source: Adapted from R. pp.2 The largest losses occurred in 1930 and 1931.384 1. VA: Financial Analysts Research Foundation. G.5 47.9 11.‰ Galbraith has no difficulty identifying the end of the real economic boom: „On the first of January of 1929.524 0. The fact that the stock market lost over 70 percent of its value from 1929 to 1932 indicates that the market. A.1 shows an index computed by R.540 0.057 0. Stocks. one of the leading economists in the United States at the time. Bills.1 The table shows the crash actually persisted for four years. and Inflation: The Past and the Future (Charlottesville. John Kenneth Galbraith implies that there was a speculative orgy and that the crash was predictable: „Early in 1928. A. It is a myth that the market „crashed‰ in 1929. Ibbotson and R. G. at least using this one criterion (actual performance of the market). Sinquefield for the years 1925 1933.057 1. Sinquefield.9 28. possibly the worldÊs leading economist during the first half of the twentieth century.096 +0.‰4 . The crash only began in 1929. and an acknowledged master of practical finance. during which time the stock market lost approximately 72 percent of its total value.202 0. John Maynard Keynes.1 Index of Stock Market Value Year 1925 1926 1927 1928 1929 1930 1931 1932 1933 Index of Value 1.116 BEATING THE BEAR Table 10. was overvalued in 1929.327 0.227 0. Paul Samuelson quotes P.636 0. it was most likely that the boom would end before the year was out. Bonds. was heavily invested in stocks and was bullish before and after the October selloffs.479 0.252 +5.1 15. as a matter of probability. Table 10. so much a part of the true speculative orgy. started in earnest.792 0.908 1. 1982).000 1.7% +30.566 0. but the investment trust of Keynes and Dennis Robertson managed to lose me my fortune in 1929. 17 19.681 1.‰3 Compare this position with the fact that Irving Fisher. the nature of the boom changed.

were not driven solely by fools or speculators. They included airplanes. a period of real growth and prosperity.DISPELLING THE MYTHS OF 1929 117 GalbraithÊs ability to „forecast‰ the market turn is not shared by all. and from 1923 to 1929 it rose 3. knowledgeable investors who were buying or holding stocks in September and October 1929. The 1920s were. written in the fall of 1929. During 1928. For the period of 1923 1929 wholesale prices went down 0. Also. The financial fundamentals of the markets were also strong. Samuelson admits that „playing as I often do the experiment of studying price profiles with their dates concealed.9 percent per year. The rise in stock prices was not uniform across all industries. these P/ E ratios are by no means out of line historically. THE ECONOMIC FUNDAMENTALS The total real income from 1921 to 1923 rose to 10. both then and now. electrical .4 percent per year. the price earnings (P/ E) ratio for 45 industrial stocks increased from approximately 12 to approximately 14. In 1929 the stock of money declined very slightly „as a result of the restrictive monetary measures arising out of the Federal Reserve SystemÊs concern with the contemporaneous stock market boom. then.‰5 For many. The stocks that went up the most were in industries where the economic fundamentals indicated there was cause for large amounts of optimism. It was over 15 in 1929 for industrials and then decreased to approximately 10 by the end of 1929. „the collapse from 1929 to 1933 was neither foreseeable nor inevitable. What Fisher saw was manufacturing efficiency rapidly increasing (output per worker). offers much data indicating that there was real growth in the manufacturing sector. telephone and telegraph.‰6 The stock price increases leading to October 1929. reflecting moderate. as was manufacturing output and the use of electricity. The evidence presented goes a long way to explain FisherÊs optimism regarding the level of stock prices. chemicals. utilities. could neither anticipate nor explain the decline of the market in the fall of 1929. agricultural implements. The remainder of this chapter will show that it is a myth that the stocks were obviously overpriced and that speculation determined stock prices. steel.8 although not low. leading economists. Values in this range would be considered reasonable by most market analysts. I discovered that I would have been caught by the 1929 debacle.‰7 Examining the manufacturing situation in the United States prior to the crash is also informative. in fact. department stores. There were also intelligent. stable growth in the money supply during a period of healthy real growth. Irving FisherÊs Stock Market Crash and After.5 percent per year.

1 percent. and divided that into the $6. The $5. Kendrick offers us estimates of productivity increases during various time periods. He took the $70 billion of stock value (as of April 1. In June the index was 125. for the year this figure was at 105. added $47 billion of bonds. and in September it increased to 123.1 percent. which was a performance second only to SeptemberÊs record measure. This is an annual growth rate in production of 3. we should attempt to understand the real economy for the period 1920 1929. In October the index dropped to 110. then climbed steadily (except for 1924) until it reached 118 in 1929. remember that government bonds in 1929 yielded 3. The factory employment measures were consistent with the payroll index. In October the loadings dropped to 118. Even in October the production index was 120. oil. in July it went down to 119. the stock market had little cause for fear. During 1929. 1929).12 We define productivity as output per unit of .10 of debt per $100 of farm property. each of the first six months showed production increases. In September unadjusted measure of freight car loadings was at 121 · also an all-time record. Factory payrolls in September were at an index of 111 (an all-time high).) In addition. During the period commodity prices actually decreased.4 percent.118 BEATING THE BEAR equipment.11 The index went down to 67 in 1921. These were reasonable choices for expectations of growth.8 billion of broker loans.10 PRODUCTION AND PRODUCTIVITY. Looking at this widely publicized measure of industrial production. thus the production record for the 10-year period was exceptionally good. paper. which beat all previous months and years except for September 1929. W. J. Farm product prices throughout the year were equal to or higher than 101. 1920 1929 To understand the stock market in 1929. To put the P/E ratios of 10 to 15 in perspective. and radio.9 Industrial bonds were yielding 5. The Federal Reserve Bulletin reported production in 1920 at an index of 87. Joseph Stagg Lawrence of Princeton University thought the stock market was not overpriced and that broker loans were not excessive. the prices of nonfarm products had gone down in 1929 compared with 1928. (In 1928.81 of debt per $100 of securities was much less than $9. it had been 106. this undoubtedly was disappointing to a market needing growth in order to survive. in August it was back up to 121. Building contracts awarded in August and September were down from a very good July. but only 99 in 1927 and 100 in 1926.

it is little wonder that those who buy stocks. Transportation was beaten by two time periods but was competitive with four other time periods. It is for them to judge and most emphatically not for a body in Washington.1 billion for the first nine months of 1929 · an increase of about 30 percent.4 billion. Lawrence also thought that the high level of stock prices merely reflected the high level of business profitability and growth. who.‰14 For the first nine months of 1928. Overall. compared with $278 million in September 1928 . while mining productivity was second to that for the period 1929 1937.7 percent. They may be in error. one of the most brilliant in fact of recent years. dividends were $399 million. but reasonable measures have been obtained by Kendrick. and that the federal government should not make judgments (and take actions) regarding the level of the stock market: 1929 Stock Values Justified With marked progress in individual industries. in terms of the economist. it is difficult to measure exact changes in productivity. Communications and public utilities did not do as well during the other time periods. The period 1919 1929 had the largest average annual rate of change in total factor productivity. the period 1919 1929 easily took first place for productivity increases.3 for 1919 1929 for the manufacturing sector was more than twice the 2.5 rate of the second best period (1948 1953). should be inclined to pay a rather high price. Dividends increased to $3.13 Farming productivity change for 1919 1929 was second to that for the period 1948 1953. This was outstanding economic performance · performance that justified stock market optimism. attended by singular good fortune in the expansion of foreign trade and achieving a dominant place in the firmament of international commerce and finance. These people are placing a high value upon future increments of income and subjecting them to a low discount. Lawrence concluded that the record for the first quarter of 1929 (the time of his manuscript submission) revealed „a prosperous state of business.15 In September 1929. with peace at home and abroad and with an administration in which the country has the greatest confidence.DISPELLING THE MYTHS OF 1929 119 input. With changing products and changing mixes of different factors of production. in an era of radical improvements in our economic life comparable to the Industrial Revolution. The annual rate of 5. are paying a present sum for an infinite series of future incomes. handily beating the six other time periods studied by Kendrick with an annual productivity change measure of 3. cash dividends were $2.

‰ recommended stocks of five different retail firms. issue of The Magazine of Wall Street had an article entitled „Yields below Carrying Charges. encouraging stock price increases. 1929 issue of The Magazine of Wall Street offered several interesting investment recommendations backed with persuasive stories. for September 1929 it decreased to 64 percent. One article entitled „Opportune Time of Investment in Retail Store Stocks. 1. it is not difficult to justify a P/ E of 27.3 shows the P/ E ratios for the five firms) showing the records of five „business appliance‰ companies. Today market appraisal. Table 10. The May 4.2. For September 1927 the dividend payout rate was 71 percent. IBM had a 10 percent growth in earnings in 1927 1928 and a 20 percent projected growth in 1928 1929. compared with 135 the year before. A second article cited the expansion in the use of tin cans and recommended for consideration the American Can Company and the Continental Can Company. With these growth rates. A second article dealt with the effect the tax on capital gains had on stock prices. These are dramatic numbers and a reasonable basis for optimism. dividend increases were announced by 193 firms. to judge from present ratios. In 1927.‰ The concern was the low dividend yield compared with the rate at which funds were being borrowed. and in 1927 it was 755. In the first nine months of 1929. For September 1928 this rate increased to 75 percent. IBM sold for a low of 53. The financial news from the corporations was very positive in September and October 1929.16 In September 1929. But if the above numbers for dividends merely reflected the distribution of a larger percentage of earnings. there would be cause for concern. 1929. In 1928. even . Not only dividends but also corporate earnings were increasing significantly in 1929. The theory offered was that the tax discouraged the sale of stock. depending on the character of the enterprise. P/ Es are frequently computed using projected incomes rather than the earnings of the most recent year. All the P/ Es are on the high side. The article included a picture of business equipment and a table (Table 10. A third article described how machinery transformed business practice. but except for Burroughs and Remington-Rand. has from force of circumstances passed into the limbo of comparative uselessness.120 BEATING THE BEAR (an increase of 44%). Also. is far less circumscribed. The June 1 issue also worried about the relationship of prices and earnings: „The accepted rule of thumb measure which placed the fair market value of a stock at from ten to fifteen times the earning power per share.‰17 The October 19. the number was only 955.436 firms announced increased dividends.2. they are not shockingly high for companies expected to exhibit high growth rates.

05 $0.13 0.70 Remington-Rand.00 240 21 $9.16 4.00 125 32 5. · Company now making fine progress. Burroughs Adding Machine Company 8.00 International Business Machine Corp.17 Underwood-Elliot-Fisher Company 5.21 3.80 94 08 Priced high on current (1929) earnings but sound for longterm holding. after merger troubles. Inc.Table 10. . 1929.80 · 53 4. October 19. Sales setting new records.23 $1. Excellent for investment purposes. Present price rise reflects good long-term outlook and strong position. 170 24 Steadily increasing earning power. One of the most attractive issues in the group.83 5.70 4.57 4.38 6. Good long term investment rating. 7.29 5. 1.67 National Cash Register Company 1.2 Records of Leading Business Appliance Companies Earned per Earned per Share Common Share Common EPS 1929 Dividend Recent Dividend Stock 1927 Stock 1928 (6 months) Rate Price Yield % Comment $8.00 Source: Adapted from The Magazine of Wall Street.

2 are low compared with the call loan costs of 6 to 10 percent.21 1.1 percent larger than for 1928.6 and 8 percent. But even National City Bank thought speculation was excessive and „a temporary slackening of the business pace. one could buy industrial preferred stock yielding between 5. in the first nine months of 1929.5 percent for 1929 compared to 1928. But the preferred yields were lower than the cost of call loans and thus could not be profitably financed with debt.‰ The earnings for the third quarter for 638 firms were calculated to be 14.6 Note: We are assuming the $94 recent price for Burroughs is after the stock split. the increase for the first six months of 1929 compared with 1928 was 24.13 6. but they went by a different name: „speculative‰). 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 percent increase compared with the first quarter of 1928. should be the very thing needed to keep business on a sound and enduring basis. If one wanted equity dividend yields that were higher than those of the common stock. it could have been bought at 150 (a P/ E of 14.15 BEATING THE BEAR Recent Price 470 240 125 53 170 Burroughs IBM National Cash Remington-Rand.122 Table 10.9 27. There is conclusive evidence that the general level of business activity and reported profits were excellent at the end of .28 8.8 27. Some investors were looking at fundamentals. industrial bonds had yields to maturity ranging from 5 to 7 percent (there were „junk‰ bonds in 1929.4 percent increase. In September the results were expanded to 916 firms with a 27.0 46.‰18 The November issue labeled the October decrease in stock prices as „the collapse of stock speculation. The August issue showed that for 650 firms. But on the same date.3 Price Earnings Ratios 1928 Earnings 8. which would have as its effect a sobering influence on speculative sentiment.2). The March 1930 issue showed that for 1. Inc. International PaperÊs preferred stock yielded a high 8 percent because its earning coverage was relatively low.2 24.509 firms the annual earnings had increased by 13. The dividend yields of Table 10. Underwood-Elliot-Fisher P/E Ratios Using 1928 Earnings 56. without the split the price would be $470.4 percent.83 5.

19 For 1929.20 If preferred stock is included. E. The dividend payout rate was 66 percent.3 billion on January 1. issue of The Magazine of Wall Street carried an article entitled „Untapped Reservoir of Future Expansion in Rural Electrification. he found a P/ E ratio of 29.8 using the high stock prices for the year and 12.‰ The article estimated that an $8 billion capital outlay was needed to electrify 6.1 billion. the closing price of 1929 as a percentage of the high prices of 1929 was 59 percent. This was the highest percentage for the three-year period ending December 31.8 percent.‰ The October 1 issue of Forbes carried an article with the following headline: Rail Earnings Break Records Improvements.‰23 . 1929. „Business so far this year has astonished even the perennial optimists. The market price as a percentage of year-end book value was 420 percent using the high prices and 181 percent using the low prices. the ratios of borrowing to market value of all listed stocks increased only from 8. 1929. and a larger average net income per share of stock than they ever have earned.7 billion. 1927.96 percent using the high prices and 5. M.‰22 Article after article from January to October in business magazines carried news of outstanding economic performance.5 billion on October 1. the value is $89. Although member firm borrowings increased from $3.6 percent to 9. 1929. Other articles in the same issue described growth opportunities in the South and far West. Operating Efficiency Responsible for Best Returns In Railroad History The first paragraph read as follows: „It seems certain now that in the entire year 1929 the railways as a whole will earn the largest percentage of return on their property investment that they have earned since 1916.165.3 million farms. For WigmoreÊs sample. Burger and A. and one reported „Stocks in Favorable Earning Position. The potential was vast. wrote in June 1929.21 The May 24. The dividend yield was 2. two staff writers of The Magazine of Wall Street. Leinbach.90 percent using the low prices. 1929. to be $82. K.4 using the low prices. The farmers would have a $12 billion equipment cost. the return on equity for the firms (using the yearend book value) was a high 0. to $8. (Appendix 1 shows the details of two National City Bank earnings surveys.) Barrie Wigmore researched the financial data for 135 firms. However. Wigmore computed the value of all stocks on the NYSE as of September 1.DISPELLING THE MYTHS OF 1929 123 September 1929 and the middle of October 1929.

71 Residential Structures 16.73 12.6) were strong all the way through 1929.55 14. J.79 17.47 16.58 21.20 192.27 23.124 BEATING THE BEAR The economyÊs healthy state is illustrated by the following Gross National Product (GNP) measures.66 16.40 15.14 19.29 20. Balke and R.79 15.24 16.17 103. Balke and R. There was little hint of a severe weakness in the real economy in the months prior to October 1929. the total production numbers (Table 10.‰ in The American Business Cycle (Chicago: University of Chicago Press.35 19.56 Nondurables 189.4 Gross National Product: 1925 1929 Year 1925 1926 1927 1928 1929 Nominal GNP 93.04 23.06 20. In the third quarter of 1929.‰ in The American Business Cycle (Chicago: University of Chicago Press.62 192. p.45 194. Gordon.23 Source: N.82 9.31 16.19 21. Only residential and nonresidential structures showed a sign of weakness in the third quarter of 1929 ( Table 10. Gordon.52 187.22 315.55 15.69 rate.50 Durable Goods 19. real GNP was being generated at a 323. Although all GNP measures are estimates based on assumptions and incomplete information. Table 10.69 Source: N.04 14.27 296.01 97.08 20.11 19.5).91 15.03 291. pp. J.4 is an attempt to provide information regarding the health of the U. Table 10. „Historical Data. All other productivity measures were strong. 782.72 195.56 193.16 21. Table 10. S.52 Quarter 1928 1 2 3 4 1929 1 2 3 4 Nonresidential Structures 19. 1986). economy.17 95.42 Real GNP (1972 Dollars) 276. 1986). 810 23.81 293. In fact. Real GNP was growing in a healthy fashion in 1929. S.06 14. „Historical Data. .87 19.05 21.30 97.5 Expenditures ProducersÊ Durable Equipment (1972 dollars) 14.S.40 196.51 20.

A NUMERICAL JUSTIFICATION OF THE MARKET LEVEL The October 19 issue of The Magazine of Wall Street reported that the average public utility bonds yielded between 5 and 6 percent. In conclusion.827 13. and changes in dividends and earnings all gave cause for stock price optimism. Conventional financial reports of corporations gave cause for optimism relative to the current earnings of corporations. U.7. P/ E ratios.526 14.097 14. and average public utility preferred stock yielded between 6 and 7 percent. „Historical Data. Leading economists were betting that common stock in the fall of 1929 was a good buy.585 125 Source: N.S.‰ in The American Business Cycle (Chicago: University of Chicago Press. J. dividend amounts. 842 43. we have: P= (1 − b ) E D = k −g k −g (1 − b ) k −g or P /E = .812 13. Treasury bonds as of the end of September 1929 yielded 3.048 13. 1986). 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.6 Total Manufacturing in 2009 January June July August September October November December 13.187 14.7 percent.24 It would not be unreasonable to estimate the cost of equity capital to be 8 percent. pp.DISPELLING THE MYTHS OF 1929 Table 10.219 13. Using the basic dividend discounted cash flow model and assuming constant dividend growth for perpetuity. Balke and R. The dividend payment rate in 1929 was approximately 0. S. Gordon.

7 0.7.8 percent and a growth rate for the first nine months of 1929 to be 20. the P/ E of 16 is easily justified. . With these assumptions.6 percent.126 BEATING THE BEAR where P = the expected price per share based on the values of b.10 − g g = 0. we obtain: P/E = (1 − b ) k −g and 16 = 0. Appendix 3 shows that with a discount rate of 0.08.08 − g The P/ E multiplier of 16 implies that the market expects a growth rate of only 3.08.3 percent.10 return on equity capital. industry in the period 1926 1929.05625 This again is well within the range of reasonable assumptions. and g E = the earnings per share P/ E = the expected P/ E ratio D = the dividends per share K = the discount rate (required return) used by the market for common stock G = the expected growth rate B = the retention rate (1 b) = the dividend payout rate If (1 b) = 0. solving for the implied growth rate in dividends. given the performance of U. The multiplier is very sensitive to discount and growth rate assumptions. If we assume that the market requires a 0. a P/ E multiplier of 23. and P/ E = 16. if we assume a 15 percent growth rate for five years and then a 3 percent growth for perpetuity. More complex models (such as two-stage growth or a different growth rate for each year) lead to the same magnitudes of P/ E multipliers.98 can be justified. The fact is that there were ample reasons to expect respectable growth in earnings and dividends and in stock values in the fall of 1929. For example. Although the assumption of any growth rate for perpetuity is extreme.03625 0. the necessary growth rate becomes: 16 = 0. k = 0. then. National Bank reported a growth rate in earnings for 1927 1928 of 14. k.7 and g = 0.S. the calculations illustrate the fact that an assumption of a large growth rate can lead to the justification of a large P/ E multiplier.

Malkiel states that „from early March 1928 through early September 1929 the marketÊs percentage increase equaled that of the entire period from 1923 through early 1928. 19) states. to prove the market was too high. . Beginning in 1928. to justify his position.485. but the average measures show that the prices are not typical for the time period but rather involved relatively unusual stocks that increased in value more than the market increased.302.625 ÷ 13.‰ Although history has proven these statements to be correct. it ignored the fact that real measures of value (earnings and dividends) had also gone up dramatically.96 and was therefore selling at 335.908 of 1928 to 2. Malkiel clearly accepts the assumption that the market was running wild: „Conditions could not have been more favorable for a speculative craze . .000 to 2.801 stockholders. In 1929. the company had earnings of $13.‰ No one has proven that there was dramatic excess speculation in the 1920s. The .256 annual growth rate. Burton G.25 ANALYSIS OF STOCK PRICES AND VALUE Starting with a total return index of 1. The price rises for the major industrial corporations sometimes reached 10 or 15 points per day.‰27 Let us consider one company cited by Malkiel. at the end of August 1929 the index reached 2. speculation accelerated to boost prices well beyond supportable levels. American Telephone & Telegraph.485 in a four-year period is a 0. other than the stock prices themselves.7 reveals a large stock price increase. it is very difficult to cite evidence. Thus Kaufman (2009. given the high growth rates in earnings and dividends that could be reasonably expected. . p. Growth in the index from 1. .26 Thus from 1925 to 1929 the funds invested in stocks more than doubled in value over the four-year period (the peak was reached on September 3. Table 10. Although large. Thus.7.485 one year later is 0. however.96 = 24 times earnings. 1929).DISPELLING THE MYTHS OF 1929 127 The conclusion that the market was overvalued was primarily based on the fact that stock prices had gone up dramatically. The annual return rate from the index measure of 1. without justification or explanation: „Then came unprecedented speculation in the 1920s. The tendency to focus on speculation for 1929 continues to the present. using the high price for 1929. The company had 469.000 on January 1926. it does not compare to the numbers shown in Table 10. . in more detail. The desire to end the „speculation‰ and to „get the New York speculators‰ had blinded many observers to the fact that the stock values in 1929 could be justified by reasonable economic analysis.

The dividend payout was 0. the wholly-owned subsidiary which manufactured most of the equipment used by the company.28 The stock paid a $9 dividend for a yield (using the high price) of 9 ÷ 335.‰ Note the use of the pejorative word „speculators.8 207.625 = 0. 2. so a reasonable analyst could correctly conclude that the 1929 earnings were $14. different investment analysts reached different appraisals of the stock. B.‰ Williams then states that „sober investors‰ would realize the minor importance of the invention compared to American TelephoneÊs regular businesses.7 Stock Price Increases Security American Telephone & Telegraph Bethlehem Steel General Electric Montgomery Ward National Cash Register Radio Corporation of America BEATING THE BEAR Opening Price March 3.4 151.0 146. Williams states that „speculators in the 1929 boom had become excited about the inventions of the Western Electric Company. 3. . assets and earnings had been growing at 9.9 percent per annum for the previous five years. The company was forecasting a 40 percent increase in plant construction over the next four years. 4.128 Table 10. growth will end. 1928 1791Î2 56 Î8 1283Î4 132 Î4 503Î4 94 Î2 1 3 7 High Price September 3. 1929 3355Î8 140 Î8 3961Î4 466 Î2 1271Î2 505 1 3 Percentage Gain in 18 Months 87.5 Note: High price is adjusted for stock splits and the value of rights received subsequent to March 31. At the end of 10 years.027. 1928.8 251. J. The rate of growth will continue as at present. The ratio of stocks to bonds will remain as at present.25 per share of Western ElectricÊs earnings that were not consolidated. The $13.2 434. because in connection with its scientific researchers on sound this subsidiary had perfected an apparatus for making sound motion pictures.‰ He then makes the following assumptions and concludes the stock was overpriced:29 1.21. Williams correctly observes that „starting from the same data.96 of earnings excluded $0.64 of earnings. The return on invested assets will remain as at present.

8.038 (equal to 0.20. Graham and D. Dodd also maintained that the 1927 1933 period should be regarded „more as an economic phenomenon akin to the South Sea Bubble and other isolated instances of abnormal gambling frenzy than as an indication of what the typical speculative cycle of the future will be. In 1934. For example.20 to $21.‰30 They also did not offer proof of overvaluation.36 of earnings. we obtain: P= dividend 9 = = $409 discount rate − growth rate 0. the stock will sell at book value. In 1929 there were 19 million telephones in use in the United States. as was the assumption that after 10 years growth would end and the stock would then sell at book value.36 × 0. Most central stations still used manual rather than machine switching.1061). The year 1929 was a good year for steel.06 − 0. According to Table 10. It is not that WilliamsÊs assumptions are faulty but rather that other assumptions are equally valid and would lead to different valuations.4 percent in 1927. as either dividends or appreciation. the investor shall receive 6 percent on purchase price. During the 10-year period. In 1929 the rate of operations was 86. and have a growth rate of 0.3 percent of capacity compared with 81.1061 on new equity capital. At that time. the 6 percent estimate of return on investment was conservative. Growth was still feasible.0 percent of capacity in 1929. 10 years hence.31 New bookings of orders were also strong.038 It is not that this calculation is better than that of Williams. it merely illustrates the fact that the $335 market price for American Telephone can be justified if the above discount and growth rate assumptions are made. will retain 0. Let us consider the case of United States Steel common stock.5 percent in 1928 and 77. and 1926. B. The industry as a whole operated at 87. Since the company was earning 9. 6. It is extremely difficult to cite objective evidence proving that the stock market prices in September and October 1929 were not justified by real economic performance. if we assume that the firm could earn 0.8 in 1925 to 9. using a conventional dividend valuation model.7 in 1929. 1927. a marginal decrease despite the excellent stock price growth record.DISPELLING THE MYTHS OF 1929 129 5. then. Williams shows that in 1929 unfilled orders for steel compared favorably with those of 1928.61 percent on book stock equity. But earnings per share went from $9. L. The P/ E ratio went from 9.04 percent on net assets and 10. the stock price more than doubled from 1925 to 1929. with the 6 percent discount rate specified by Williams. .

one can find illustrations where stock price increases were not matched by earnings increases. but the fact is that the total corporate earnings did increase from 1925 to 1929 and that generally the stock price increases during that period were justified by equivalent earnings increases. 615.130 BEATING THE BEAR In the case of Pennsylvania Railroad (Table 10. Graham and D. however.8 United States Steel Company Year 1925 1926 1927 1928 1929 Average Stock Price 90* 99* 144* 153 206 Earnings per Share 9. Table 10.2 9.4 Source: B. p. Obviously.8* 12. 1934).4 12. Graham and D.77 6. . The P/ E ratio increased only from 7.8 7.34 8.82 Price Earnings Ratio 7. we know that the increases did not take place. Security Analysis ( New York: McGraw-Hill.5 percent for 1928.2 Price Earnings Ratio 9. we find the stock price going up.2* 12. Security Analysis ( New York: McGraw-Hill. L. the increase reflects an increase in earnings. Could the economy sustain the profit and dividend increases in the future that took place in the past? Historically. 310.4.83 7. To a large extent.9 Pennsylvania Railroad Company Year 1925 1926 1927 1928 1929 Average Stock Price 49 53 63 69 92 Earnings per Share 6. But in the fall of 1929 there were good reasons for thinking that the economy would continue to be strong and that corporate profits would continue to increase.9 to 10.9* 8.8 9.7 Source: B. but in 1929 the growth rate in earnings per share was 20 percent compared with 7.23 6. Dodd. 1934). Dodd.9). *Adjusted for 40 percent stock dividend. Even among professional economists.7 16.32 Table 10. L. p.5 21.9 7. there were few who understood the forces then at work to deflate the general price level and produce one of the worst depressions in history.4 10.2 9.

when compared to distributions calculated on the assumption of a short rapid-growth phase. suggest that the marked overvaluation of stocks was not general. but was concentrated in a small proportion of stock.‰35 Sirkin does not claim to be able to justify all the high prices of 1929 with the dividend growth model.DISPELLING THE MYTHS OF 1929 131 THE SIRKIN STUDY Gerald Sirkin uses a two-stage growth model where firms grow at a high rate for a finite time period and then grow at a normal rate for perpetuity. they suggest that conspicuously unsound speculation was not general. The P/ E ratios for 1929 for his sample range from 11.3.‰36 Also.10).3 and a median of 20.4. with a mean of 24.10 Production Industrial Production Total Year and Month 1919 1920 1921 1922 1923 1924 1925 1926 1927 Unadjusted 83 87 67 85 101 95 104 108 106 (Continued) . he recognizes that an increase in the expected period of high growth would enable him to justify even more of the high prices of 1929 (Table 10. He does state that „the distribution of the peak price-earnings ratios.2 (for North American Corporation).33 He takes as his sample the firms in the Dow Jones Industrial Index in 1929.34 Sirkin uses each firmÊs highest price and 1929 earnings per share.3 (for American Sugar) to 65. but was concentrated in a fraction · in the neighborhood of one-fifth · of the stocks in the sample. Table 10. He then takes the five-year growth in earnings for the group as a whole to compare the actual growth in earnings with the earnings necessary to support the mean P/ E ratio of 24. He then concludes: „If the calculated distributions are roughly realistic.

The Federal Reserve Bulletin. p.3 National Income (billions) $59. For national income and real income per capita.2 Income per Capita (1929 prices) $522 553 634 633 644 678 674 676 716 Sources: For industrial production and wholesale prices.4 96.11 Economic Growth. 1919 1938 (New York: National Bureau of Economic Research.1 103.7 100. 1921 1929 Year 1921 1922 1923 1924 1925 1926 1927 1928 1929 Industrial Production 58 73 88 82 90 96 95 99 110 Wholesale Prices 97.1 76.0 95. Note: Index numbers: 1923 1925 average · 100. p.6 96. Simon Kuznets. August 1930.0 81.7 87.10 Production (Continued) Industrial Production Total Year and Month 1928 1929 January February March April May June July August September October 116 120 121 124 125 125 119 121 123 120 Unadjusted 111 Source: Adapted from The Federal Reserve Bulletin.Table 10. 137.7 71. Prosperity Decade.6 98. p.1 81. The term „unadjusted‰ refers to adjustment for seasonal variations.4 60.6 80. 153. This table was adapted from Soule. October 1945. Soule cities the above sources. National Income and Its Composition.6 72. 108. 1941). 1049. pp. 494. . Table 10.7 95.5 100.

Sobel states „There were few bears on Wall Street and fewer still on university campuses throughout the nation. CONCLUSIONS The extraordinary rise in stock prices from 1925 to 1929 can be justified by the extraordinary performance of the economy and of the companies whose stocks had risen.10 without concluding that investors in September and October 1929 were being given optimistic numbers concerning the economy. . Table 10. conservative investor could find good reasons for buying common stock in September 1929.11 shows the real prosperity of in the United States from 1921 to 1929.DISPELLING THE MYTHS OF 1929 133 PRODUCTION AND EMPLOYMENT Table 10. Commodity prices held constant from 1922 while farm prices were up (but down from 1920). Clear downturns were apparent after October. A reasonably well-informed. The best-informed observers thought that the economic prosperity would lead to even higher stock prices. factory employment and payrolls were healthy. It is difficult to inspect Table 10. The crash was not inevitable.‰37 It was only after the crash that academics became proficient at forecasting its inevitability. Up until October 1929.10 shows that the factory production numbers up until October 1929 were very good.

347 141.662 27.Appendix 1 Tables 10.759 68.528 4.345 6.648 32.0 +8.648 157.187 67.024 80.4 +11.2 +77.792 1927 8 +24.12 American Corporation Earnings (Net Profits) Percent Change No.096 73. misc Heating and plumbing Household equipment Iron and steel Leather and shoes Lumber and furniture Machinery Meat packers Merchandising Metals.2 +9. nonferrous (exc. Although 1928 was a high basis of comparison.209 18.595 348.178 11.3 +7.225 13.377 22.015 8.798 25.1 +19.403 26.4 +20. 7 8 23 12 24 3 25 36 11 7 19 9 13 24 9 8 29 9 6 27 7 33 14 6 7 Industry Agricultural implements Amusements Apparel.13 show earnings of U.194 135.325 2. 1929 was even higher.310 16.161 37. Automobiles Auto accessories Aviation Building materials Chemicals Coal mining Copper mining Cotton mills Electrical equipment Bakery and flour Food products. There was cause for optimism.003 27.1 +33.5 5.7 .583 28.12 and 10.076 10.499 294. copper) Office equipment Paper products 1927 $17.063 36.531 29.296 18.678 22.4 +6. corporations for 1926 1929.689 1.8 +35.612 41.282 150.1 +152 +7.4 +84.S.5 14.1 +1.636 104.13 shows the data available to analysts in the fall of 1929.12 shows the data available to analysts in March 1929.162 4.225 26.894 7.5 +18.2 +125 78. Table 10. Note the large increase for 1927 1928. Table 10.773 51.975 1928 $22.853 9.036 210.7 +0.530 30.032 7.091 22.2 +12.800 2.9 +32.218 39. Table 10.7 +99.2 +10.414 7.357 24.639 7. etc.

080 27. p.2 49.8 +14.400 4.823 49. misc Tobacco Wool Miscellaneous Manufacturing and trading Railroads Telephone and telegraph Other public utilities Grand total 1927 63.540.265 857.1 25.835 80.2 +27. *Deficit.957 *43 36.988 7.702 1.12 American Corporation Earnings (Net Profits) (Continued ) 135 Percent Change No.8 Source: Adapted from The National City Bank of New York Newsletter.901 13.250 1.9 22.192 5.193. . March 1929.177 3.324 13.713 5. Silk Sugar Textile products. 32 10 10 14 9 8 13 12 16 2 20 527 135 63 95 820 Industry Petroleum Printing and publishing Railway equipment Rubber Shipping.301 238 47.2 44.806 77.6 +9.729 16.758.064.5 +21.917 233.445.DISPELLING THE MYTHS OF 1929 Table 10.134 255.4 +10.848 1.6 +14.9 +9.488 15.970 6.189 7.085.231 1928 123.7 +3.7 13.0 +· +30.748 4.040 1927 8 +96.288 10.145 8. 35. etc.435 775.649 1.

081 38.3 2.6 +9. Industry Percent Change +65.6 18.476 4.033 4.13 American Corporation Earnings Third Quarter 1928 $4.4 +8.Table 10.293 23.4 +70.775 +23.0 · +35.2 +25.787 46.394 D-1.980 4.3 +34.2 30.6 +21.853 11.382 13.999 9.150 101.802 79.2 +11.481 58.8 +36.928 +100.399 3.223 +19.2 32.9 11 17 6 12 6 68.4 +19.399 533 327.216 93.237 39.656 6.221 28.7 17 16 23 2 12 Food products Household goods Iron and steel Leather Machinery 8 14 5 19 5 Merchandising Metal mining Paper products Petroleum Printing and publishing .2 6.772 7.666 78.137 1.125 1.554 120.981 49.096 15.2 +44.265 265.821 20.990 26.503 1929 Percent Change 1928 1929 Nine Months No.9 5 2 16 20 10 Amusement Apparel Automobile Auto accessory Building material 136 24.444 54.466 30.890 43.204 245 6.055 77.139 117.797 13.332 9.1 +91.543 +33.7 +42.8 +14.721 21.803 $20.267 8.516 732 318.727 14.068 23.347 184 111.873 Business equipment Chemical and drug Coal and coke Electrical Flour and baking 4.464 4.1 +36.4 +7.812 11.101 6.6 +45.9 +31.9 +11.4 +12.578 1.963 20.983 3.904 1.070 25.761 31.715 124 90.428 21.8 $12.5 +19.060 +7.5 +16.279 $8.605 21.554 4.5 +37.8 +13.5 3.3 +46.136 30.0 +33.971 10.505 138.019 8.484 33.400 3.3 10.3 60.726 618 5.127 12.142 6.3 +32.

4 +26.851 +8.491 1.495 3. p.8 +17.6 +25.645 398.7 +17.655 819.9 +17.288 22.826 $389.302 +14. .223. Other utilities 638 Grand total $1.4 +30.061 1.679.6 +100.934 $450.186 9.750 3.5 +20.7 +11.901 69.044 3.042 20.142. and tel.039.3 Railway equipment Real estate Restaurant chains Shipping Textile products 8.0 $1.8 +38.107 +11.928 3.308 +17.001.4 18.244 137 Source: Adapted from The National City Bank of New York Newsletter.698 4.398 357.507 2.6 0.620 3.3 5 5 2 5 2.830 63.4 +7.983 962.248 214.649 730.4 +180.933 7.240 +15.0 +22.1 5 21 Tobacco Miscellaneous 272 132 89 95 Mfg.216 $1.441 3.315.109 1.265 26. And tracking Railroads Tel.740 $3.258 100.758 $1.120 9.489 803 180 976 3.151 5. November 1929.516 223.982 +19.0 +· +97. D: Deficit.1 $2. 154.5 +9.855 199. Summary of new profits in published reported covering third quarter and nine months.0 +21.208 621.181 8.0 7.021 1.

10. 1955). and 10.72 3.S.73 4.16 are adapted from the Stock Market Study.9 158.73 Note: In terms of yields.6 124.Appendix 2 Tables 10. the comparison is between MoodyÊs 125 industrial stocks and MoodyÊs Aaa corporate bonds.8 105. 40. 1955.2 150.6 290. 111.82 3.88 4.40 5.6 104.S.37 5.5 72.0 95.84 Bond 5. pp. 1922 1929 Year 1922 1923 1924 1925 1926 1927 1928 1929 Stocks 5.0 Table 10.10 5.75 5.55 4. 110.24 4.57 4.4 137.00 4. New York Stock Exchange. Senate (Washington.12 5. The information for the tables in the stock market study was supplied by G.9 177.9 Dow Jones Industrials 91. Table 10. DC: U.9 94. hearings before the Committee on Banking and Currency. 41. U.15.9 76.14.15 Stock and Bond Yields. Keith Funston.3 200.25 4. Government Printing Office. . president.6 245.14 Two Stock Market Indices Year 1922 1923 1924 1925 1926 1927 1928 1929 Standard & PoorÊs Composite (1935 39 100) 71.

.5 14.16 Price Earnings Ratios (1922 1929) Year 1922 1923 1924 1925 1926 1927 1928 1929 Ratio 13.3 10.9 10.3 139 Note: MoodyÊs industrial stock price earnings ratios for the same periods (annual averages).5 13.DISPELLING THE MYTHS OF 1929 Table 10.2 16.8 9.7 8.

.

‰ ·New York Times. chairman of National City Bank and Albert H. was reported on July 4.S. as saying that the Senate investigation was „in charge of a clever prosecuting attorney from New York who knows nothing of economics and whose purpose appeared to be to discredit all bankers and to make things appear wrong that are not wrong. In the 1930s. . More about Pecora later in this chapter.Chapter 11 THE U. Edmund Platt. July 4. Ferdinand Pecora. 1933. Mitchell. Mr. . Wiggin. chairman of Chase National Bank.1 . It would have been satisfying to those who suffered losses if the government could have named and punished the persons responsible for the 1929 stock market crash. These were: Charles E. 1933 In the above statement. Platt was referring to the attorney. These are the two names one finds in Galbraith (1961) and other similar exposés of the „evil excesses‰ of Wall Street in 1929. We will review two important executives of 1929 attacked by the powers in Washington. Wiggin. This chapter will focus on Mitchell and Wiggin. Pecora aggressively questioned Wall Street bank executives including both Charles E. Mitchell and Albert H. GOVERNMENT ACCUSES . The former vice governor of the Federal Reserve Board and then vice president of Marine Midland Corporation of New York. attempts were made to do this.

On March 26. Charles E. Senator Carter Glass blasted Mitchell: „He avows his superior obligation to a frantic stock market over the obligations of his oath as a director of the New York Federal Reserve Bank‰ (New York Times. Failing to find any indictable offense for his March 1929 managerial actions. The bank announced it was ready to lend $25 million on the call market. the market dropped 9. A newspaper carried an article that quoted Mitchell as telling the Federal Reserve Board to „go to hell.6 percent on a volume of 8. „If you had let it collapse in March. it is necessary to review briefly events of March 1929. MitchellÊs National City Bank stepped in and made loans available to brokers. 1933). 18 –19). the U. 1929. For example. Senate Committee on Banking and Currency held hearings on stock exchange practices. Senate Committee on Banking and Currency studying stock exchange practices in 1929 attacked MitchellÊs March 1929 actions in helping prevent a crash at that time. CHARLES E.3 In order to better understand the Mitchell case.‰ Mitchell later denied the quote. was blamed for the severity of the October crash (Stock Exchange Practices. p. 1). It looked as if a crash was in process. 1929.142 BEATING THE BEAR In 1933. Senator Glass carried this view of Mitchell well into the thirties. Mitchell and Albert Henry Wiggin. 1929.S. Senator Brookhart stated to Mitchell. who helped avert a selling panic in March.S. Mitchell was the president of the National City Bank in 1929.2 Two of the major targets were Charles E. the subcommittee sought to find evidence of stock manipulation . the Federal Reserve had discouraged its member banks from making loans to finance securities. Ferdinand Pecora was the counsel of the subcommittee conducting the hearings and later the author of a book (1939).246. March 29. when the crash did not occur. but Congress believed it. On March 26. Starting in February. stock prices were down drastically and call money had risen to 20 percent. that would have saved hundreds of thousands of dollars to people who invested later on.‰ Thus Mitchell.000 shares (the volume was much greater than the 6 million shares traded the day before and the day after). pp. later writing that Mitchell „issues a defiance and engages in an attempt to mitigate the policy of the Federal Reserve Board‰ when the board was seeking to „abate‰ the „menacing spectacle of excessive stock gambling‰ (Hoover. President Hoover also disapproved of MitchellÊs actions. 1952. The loans were to be made at rates of 16 percent and higher. MITCHELL On March 25 and 26.4 The subcommittee of the U.

. The testimony at the hearing then shifted to a topic where Mitchell was more vulnerable. „For the proud privilege of owning these shares.THE U.‰ But there were no troubles at National City Bank. the sale of stock to his wife for tax purposes.000 at their highest book value.300 shares. Senator Brookhart questioned Mitchell about his National City Bank stock transactions.000. They would like to have shown that Mitchell profited from the tremendous run-up in price of National City BankÊs stock. . leaving him a net ownership of 53. worth $140. It becomes obvious to an impartial observer that Mitchell deserved praise for the ethics of his market transactions in his bankÊs stock. Pecora does not reveal who pushed up the stock price. but they chose the wrong battle. The implication was that Mitchell „pushed up‰ the price of the stock.‰ The reference to par value indicates that Pecora was not a student of finance (he was legal counsel of the subcommittee).000. There was a disagreement with regard to MitchellÊs tax return but not a problem that had to be resolved in federal court in a criminal case. pp.‰5 Senator Brookhart also found out that Mitchell bought at $375 a share (the stock went down to $16 in 1933). GOVERNMENT ACCUSES . not censure. Galbraith (1961. Rather than proving that Mitchell was manipulating the market.‰ In answer to „Before or after the collapse?‰ Mitchell responded „In the midst of the panic. 1939. Unfortunately for Brookhart. For example. He also writes.000. which had a par value of $100. the public paid the stupendous sum of $650.‰ The reference to the book value of a bank stock with the bank heavily engaged in investment banking activities does not enhance our confidence in PecoraÊs financial sophistication. In 1933 when the stock fell to $16. Brookhart and Pecora extracted from his testimony that he was the number one victim of the stock market increase (buying at $375 and higher) and then the decrease in National City Bank stock. Pecora asked whether Mitchell had sold any substantial portion of his holdings of National City Bank stock in 1929. and the high market value was in some sense morally or criminally wrong. . 155) writes. Mitchell had purchased 28. he held more than 53.300 shares in October 1929 and sold 10. Mitchell responded to the question „In what years did you buy?‰ with „I bought the largest amount of stock in 1929. a criminal trial. „National City Bank stock. „By comparison with the National City the troubles of the Chase were slight. 110 –11) writes. The stock reached a high of $580 in September 1929 before it began its slide.S. was pushed up and up until it reached dizzy heights. the investigating committeeÊs counsel Ferdinand Pecora ( Pecora.300 shares.000 shares. Here the government had a worthwhile target. 143 by Mitchell. p.

he was 51 years old. Sold Out the Customers.‰ There were 100 officers so protected. If only the three of them could have gone to a pub for a couple of beers rather than performing their sad dramas in court and public inquiries. On February 2 the Times ( p.000 in 3 Years. Times ( p. On January 30. Bank Charged Them No Interest. subpoenaed Charles E. It is interesting that three of the major characters in this drama had lived the American dream up to 1929. 1933. 25) reported that the Senate inquiry aimed to show that the banks caused the boom and that the marketing of their own stock contributed to inflated stock prices. This list would soon get larger. Mitchell was particularly at fault since he „took a go-to-hell‰ attitude toward the Federal Reserve Board in March 1929. The subcommitteeÊs chairman. He then went to work at a law office to help support six young siblings while attending law school part time.‰ MitchellÊs testimony led to the front-page headlines (Times) on February 22. p. The salary was $255 a month (a good salary but not comparable to the wages of the people he was to question). and then left for private practice. Stephens College. working as a district attorney. Senator Norbeck. but not . stated.000 Loss‰ and „Got $3. 1933. came to the United States at age 5 and at age 15 had to stop his full-time education. Mitchell to testify. 1933: „Mitchell Avoided Income Tax in 1929 By $2. In 1909 he was accepted to the bar at age 27.500. His full-time college education consisted of one year at St. He went to work as a clerk on graduating from high school. He had a fine record of public service. Pecora. Ferdinand Pecora. In 1933. The February 23. 12) described Mitchell as „a better salesman than a financier‰ without implying that he was a bad financier but acknowledging his appealing personality. Ferdinand Pecora. January 31. was born in Sicily and was brought to the United States at age five. It would appear that someone did not like him. Wiggin was chairman of a bank that was soon to be the worldÊs largest bank. „Some of the large banks were highly responsible for the wild stock market boom‰ and „It was just a polite way of robbing the public. when the board attempted to restrain the boom. 1933 (New York Times. 1) revealed that „National City Lent $2. counsel of the Senate subcommittee of the Committee on Banking and Currency. In January 1933. there were published reports („innuendoes‰) of „slurs on Pecora‰ but nothing of significance was ever revealed. He went to work as an apprentice clerk at age 14 in England. Sam Insull controlled a $3 billion public utility empire. 11).800. 1933. he was approached by Chairman Norbeck to act as counsel for the Senate committee.144 BEATING THE BEAR The counsel for the subcommittee. It is noted above that the prosecutor.400. Senator Couzens (p.000 were bonuses received by Mitchell from the bank.000 to Save Stock of Officers.‰ The $3. In May 28.500.

THE U.S. GOVERNMENT ACCUSES . . .

145

Mitchell. He borrowed from J. P. Morgan & Co. The same paper ( p. 27) had an article in which Senator Wheeler of Montana „assails Mitchell.‰ On February 25, 1933 there was another front-page headline, „Federal Inquiry on National City and Insull Starts. Law Violations Sought.‰ Given the 1929 stock market crash, somebody had to be guilty of something. On February 27, 1933 (again p. 1), „Mitchell Offers to Quit National City Bank. Letter of Resignation Up for Action Today.‰ The next day the resignation of Mitchell was accepted by the bankÊs board. Presidentelect Franklin Roosevelt advised the banker to retire. A Times editorial ( p. 18) with the heading „Better Banking‰ said the „resignation was inevitable.‰ Thus with no crime, even hinted at, other than differences of opinion regarding MitchellÊs tax bill, Mitchell was driven from his position by vague accusations that he and his bank caused the stock market boom and bust. Pecora released a statement to the press that „any public misunderstanding created by Mr. MitchellÊs testimony was due to Mr. Mitchell himself.‰ Next Pecora went after the marketing by National City Bank of $90 million of Peru bonds issued in 1927 and 1928. National City had a net gain of $687,000 on the transactions, and in 1931 the investors lost when the bonds stopped paying interest. The accusation was that the bank had acted contrary to advice given by South American experts against participation in Peruvian bond flotations. In 1921, the vice president in charge of the Lima branch (Claud W. Calvin) of National City Bank described the Peruvian financial situation as being „positively distressing‰ and said the countryÊs treasury was „ flat on its back.‰ In May 1923, National City rejected participating in a $6 million Peruvian bond issue proposal because there was too much risk. In July 1923, the bank again rejected a Peruvian bond proposal because of risk. In 1925, Mr. Calvin (see above) sent a letter to the bankÊs New York office saying that there was so much progress under President Leguia that he felt the underwriting should be reconsidered (Times, February 28, 1933, p. 6). National waited two years before it joined the Seligman syndicate. The factors that swung the decision were CalvinÊs report and the fact that the bonds were to be secured by a tobacco monopoly. In 1927 National City Bank agreed to join a syndicate to market a $15 million issue (NationalÊs share was $5 million). The syndicate was headed and managed by J. W. Seligman & Co., a leading Wall Street firm. The stated purpose of the issue was to refinance outstanding binds (these bonds had not been marketed by National). Thus, if the new bonds had not been issued the holders of the old bonds would have suffered an equivalent loss.

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BEATING THE BEAR

One factor cited by Pecora as evidence of excessive risk was that the Peruvian government budget had been balanced in only 3 of the 10 years from 1914 to 1925! What would Pecora have said about the last 40 years of U.S. federal government budgets? PeruÊs president wanted a consolidation of the countryÊs external debt, and he promised the underwriters a stabilized currency and a balanced budget. In 1931, there was political unrest and a major revolution in Peru, and the Peruvian bonds failed to pay interest in May 1931. In 1933 Peru was at war with Colombia. The bonds went down further in price. National City admitted to „an honest mistake.‰ The implication that National City Bank (and Mitchell) were culpable is unfair. It was not unreasonable for National City to market Peruvian bonds in 1927 and 1928. If there were criticisms they should have been made in 1927 and 1928 at the time of the deals rather than in 1933 based on the wisdom offered by hindsight. There is no question that the bonds were risky at the time of issue, but an optimist could rationally buy the bonds based on the reports that were available. The Times, October 9, 1929 (p. 53), had an article with the heading „Loan Record Made by Latin America.‰ The total borrowings by Latin American countries in 1928 were $344,598,000 of which $106,400,000 was refunding of loans held by Americans. The article cited the Bolivia–Paraguay boundary dispute and the credit situation in Brazil and stated, „These developments detracted somewhat from the yearÊs generally favorable trend.‰ As part of the favorable trend it said, „A law was enacted in Peru creating the Mortgage Bank of Peru.‰ On March 3, 1933 ( p. 25), the Times reported „Profit in Mergers.‰ A merger leading to the combination of several airplane manufacturers into Boeing Air led to a National City Bank fee of $2,499,250. The common stock was issued to friends and officers of the National City Bank. Mitchell indicated that the offering was „ too speculative‰ for a public offering. If the stock had been offered to the public and had gone down. the hearings would have been more productive. The hearings did bring out that in violation of Federal Law, National City Bank did hold bank stock for a short period of time ( p. 25 of the March 3, 1933 Times). In his inaugural address, Roosevelt stated ( p. 1, March 5, 1933), „Practices of the unscrupulous money changers stand indicted in the court of public opinion, rejected by the hearts and minds of men.‰ He did not identify who was „ unscrupulous,‰ but Mitchell was the man making the front page of the Times during the moment of RooseveltÊs taking office. President Roosevelt, newly inaugurated, gave the stock practices hearings new vigor with a statement upholding the banking inquiry with an objective to eliminate „ bad banking practices.‰

THE U.S. GOVERNMENT ACCUSES . . .

147

On March 17, 1933 the Times had an article dealing with a report to the Senate Committee on Banking and Currency. The report concluded that pools can control prices and that one of the techniques used by speculators was „selling against the box.‰6 The report said corrective legislation was required. The Times ( March 18, 1933, p. 1) reported that Attorney General Cummings was „Hunting Law Violations.‰ President Roosevelt was quoted as asking him „vigorously to prosecute any violation of the law.‰ The next dayÊs headline ( p. 1): „Mitchell Will Face Grand Jury Inquiry.‰ The accusation was that he illegally evaded an income tax payment in 1929. In 1929 Mitchell purchased 28,300 shares of the National City Bank stock at prices of approximately $369 a share (Times, March 19, 1933, p. 1). His motivation was either to support the stock price (his position) or to take advantage of the drop in price (from its high of above $580). Also in 1929, he „sold‰ 18,300 shares to his wife at a price of $212, thus he had a loss of $2,872,306 that he then took as a deduction on his 1929 tax return. Since he reported a gain on sale of other stock of $1,388,238, the $1,484,068 net loss resulted in a deduction against salary and other incomes. Three days after the grand jury inquiry was announced there was the headline „Mitchell Arrested as Tax Evader‰ (Times, March 22, 1933, p. 1). The government wanted a $657,152 payment. An interesting sidelight is that the Federal Marshall (Mulligan) had to borrow a car from his brother to drive the arrested Mitchell to the court house. Bail was set at $10,000. The assistant U.S. district attorney directing the arrest was Thomas E. Dewey. On March 23, 1933 (p. 1), the headline was „Mitchell Evidence Goes to Grand Jury‰ and on March 25 (p. 1) „Mitchell Indicted.‰ On April 14, the indictment was changed to include MitchellÊs 1930 tax. On April 22, there was a second change. The tax total was reduced by $40,000 (the government had calculated wrong). On April 26, a third change was made. The government claimed Mitchell had $666,666 of additional income (Mitchell said he owed the money, thus it was a loan and not income). On May 12 (p. 1) the trial began. Max D. Steuer, MitchellÊs lawyer, described Mitchell as a „ruined patriot‰ and noted that he „lost $25,000,000 protecting bank and country‰ (May 17, p. 1). Mitchell owned 53,300 shares of bank stock at the end of 1929. A price drop of $469 would lead to a $25 million loss. National City BankÊs stock dropped more than $469 from its 1929 high to its 1933 low ($580 –16 = $564). The 18,300 shares „sold‰ to his wife by Mitchell were pledged with J. P. Morgan & Co. as collateral for a loan of $6 million (at times the loan exceeded $10 million) to finance the stock purchases. In addition, Mitchell

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BEATING THE BEAR

had mortgaged his three homes to help pay for the stock purchased in 1929. As evidence that there had been a sale, the defense revealed that:
1. Mitchell and his wife both wrote letters indicating a sale and purchase. 2. The internal revenue agent was shown the letters and knew the nature of the transaction. The agent approved MitchellÊs tax return. 3. A tax lawyer advised Mitchell that the transaction was valid.

As evidence that there was not a sale, the prosecution revealed that:
1. The letters did not have on them a stamp indicating a transaction had taken place. 2. The wife (Elizabeth Rend Mitchell) did not pay any cash for the stock, though she had considerable wealth. 3. Mitchell sold the stock to his wife for $212 and bought the shares back at $212 when the stock had dropped to $421Î2 in 1932. 4. J. P. Morgan & Co. was not told of the sales ( May 18, p. 1), even though the stock was collateral for MitchellÊs loan.

Obviously, there was sufficient reason for the government to reject the tax loss deduction. However, given the fact that the nature of the transaction was known and approved by the internal revenue agent, there was no valid reason to bring criminal proceedings against Mitchell. One interesting (p. 1) headline (May 24, 1933) was „MitchellÊs Wife Missed Big Profit.‰ She could have made $800,000 by selling in 1930. On February 14, 1930, the stock was selling at $256. Thus she could have made $44 profit per share if she sold. All she had to do was sell at the stockÊs post-1929 high! This revelation to the Times came from U.S. Attorney Thomas E. Dewey. MitchellÊs lawyer made clear that MitchellÊs 1929 tax return had been approved by the Internal Revenue Service and that „the agent looked at copies of the ÂDear CharlesÊ and ÂDear ElizabethÊ letters defining the stock sale and asked for the originals‰ (June 1, 1933, p. 1). Was the $666,666 received from National City income? While the $666,666 had originally been intended as income, „the company had formally notified Mr. Mitchell that the payment had been rescinded and that the amount was to be repaid later‰ (June 1, 1933, p. 11). Later it was established that the amount was to be paid out of his future earnings, and Mitchell did not have to repay it out of his depleted assets. The 18,300 shares of National City Bank stock sold to his wife had been bought October 29, 1929 (June 6, 1933, p. 18). Mitchell said he

Forbes testified that he did give the advice (June 9. GOVERNMENT ACCUSES . The circuit court decided the $666. but he did not because the market was thin and the sale would „accentuate decline. 3). p. Steuer said „Mitchell Is Victim‰ (June 20. the federal government sued for delinquent taxes. In closing testimony.‰ The recipients were not obliged to pay. and Medalie described MitchellÊs position as „Sanctimonious Rubbish‰ (June 21. the penalty did not have to be paid. Most of the observers (including the Times reporter) expected a conviction.384.‰ Mitchell justified the exclusion of the $666.666 as taxable income since another bank officer. Mitchell lost 25 pounds during the trial (thus some good came of the trial process). p. . and Mitchell thought he had to pay it. p. 1937. the headline was „Mitchell Cleared. There was no immediate payment by the purchaser (his wife). the defense two. thus Mitchell concluded that he could do the same as Russell. p. .223 was filed by the government (June 29. The tax court and the circuit court agreed the stock sale was „not genuine‰ (May 11. On June 4 the jury debated 10 hours without reaching a verdict.354 plus interest.‰ He consulted with Harry Forbes. A tax lien of $1.223. 1936. and a penalty for failure to pay. The next day Mitchell left for a long rest.666 included as income. 8). 3) decided that Mitchell should pay the tax that would have been paid without the tax loss from the sale.‰ The verdict was reached after the jury was out for 25 hours. but not the penalty (because of the previous criminal acquittal). and they never attempted to do so. 1937. This included a penalty of $364. On June 23. 1933.000 created by the same transaction approved by the Internal Revenue Service. The Second Circuit Court of Appeals (May 11. However.666 was income since the amount could be paid „from amounts that should become due to them in the future. Mitchell. The tax court (Board of Tax Appeals) decided that Mitchell should pay $1. 1933.666 was not income if it had to be paid or if it was to be paid out of future incomes. 11). faced a 10-year prison term (June 22. The judge had told the jury that the $666. Immediately after the acquittal. Weeps at Verdict. page 1. 1933. p. 3). 1933. if found guilty.THE U. 12) as long as the sale was „unconditional and in good faith. Ovation in Court. Stanley A. a tax lawyer. p. the $666. The trial had lasted almost six weeks. had an exclusion of $170.S. . and three days were spent selecting the jury. 149 considered selling in the market. The prosecution had taken three weeks. p. It wanted the tax loss from the „sale‰ to MitchellÊs wife rejected. who indicated that the sale to his wife was proper. 1933. 1). the interest on the taxes that should have been paid. Russell. since Mitchell had been acquitted of criminal charges by the jury.384.

In October 1937. In October 1929. and the outcome of the criminal case did not determine the amount of the tax to be paid. Mitchell a good break.222 lien was settled for undisclosed sum. and the „$1. 1938. despite the severity of his financial difficulties. 1938.354 that had been disallowed by the Second Circuit Court of Appeals had to be paid. He ultimately paid off his loans to J. It is also clear that he thought the stock was a good buy in October 1929 (he bought). Mitchell refused to go into bankruptcy. p. In 1935. Mitchell obviously was close to going over the line with his tax manipulations. It can also be said that he paid his taxes (we do not know the amount). On December 28. MitchellÊs counsel told the Supreme Court (January 15. The $666. The government evaluated his assets. assuming the „sale‰ to his wife did not actually take place. Finally. he made statements for the press that the market was not too high. He seemed to believe what he said. Mitchell should not have been forced from his position as chairman of National City Bank because of these tax payment disagreements. Most people will conclude that Mitchell should have been asked to pay the tax. The Court decided that there was no double jeopardy (March 8. his prospective incomes would be sufficient. Mitchell settled his income tax bill for 1929. the Supreme Court decided that Mitchell had to pay the $728. and on March 8. 1938. Morgan & Co. but its omission was not a criminal offense. and was earning enough income so that he would obviously be able to pay his tax debts if given sufficient time.384. It is clear that Mitchell did not have a strategy for manipulating his bankÊs stock.ʉ The government called him a „tax evader‰ and wanted compensation for investigating fraud.709. it decided that the 50 percent fine of $364. but he deserved praise for his handling of his investments in 1929 from an ethics viewpoint.150 BEATING THE BEAR The tax case went to the Supreme Court. His investment strategy was flawed from . 1938.‰ There were many faults with the process followed by the government. the government should not have settled for less than the amount that the Supreme Court decided was the appropriate amount. p. The penalty verdict was handed down by Judge Louis Brandeis (there was one dissent).666 of income (or loan) was a judgment call. P. Mitchell was appointed chairman of the investment banking firm of Blyth & Co.‰ A government official said that the deal was „a compromise that gave Mr. My preference would have been that he pay all except the penalty (the jury said he was not guilty of fraud). To his credit. 4) that „he gave up 30 million in Ê29 to Âstem [the] tide. While MitchellÊs assets may not have been sufficient to pay the tax lien. 2). given that there was precedent for excluding it. (they did not press him during his period of difficulties).

p. at the age of seventy-eight. He died on December 17. ALBERT H. . In 1933. 37). In 1935. On graduation. It is not obvious that his testimony should have affected the passage of this act. C. Thus he implicitly supported the Banking Act of 1933.000 in income taxes.THE U. he was elected chairman of Blyth & Co. Mitchell talked to New York CityÊs Board of Estimate. 2) carried a glowing article on MitchellÊs attempt to instill fiscal responsibility in the board.S. p. VIII. The New York Times (October 23. GOVERNMENT ACCUSES . a subsidiary . He resigned (under pressure) from the National City Bank in 1933. he went to work as a clerk for Western Electric for $10 per week. testifying before the Senate Finance Committee. In 1932. which prohibited banks from continuing in the business of underwriting new security issues‰ (Times. Mitchell received a bachelor of arts degree from Amherst College in 1899. p. The New York Times obituary included the statement. 151 a theoretical viewpoint (not enough diversification and bad timing). December 18. but it was not. Wiggin was the president of Chase National Bank in 1929. MitchellÊs criminal trial was a sad example of excessive prosecutorial zeal on the part of an agency of the federal government. there were at least 19 New York Times first-page articles dealing with Mitchell. The attention received by Mitchell should have been motivated by a real revelation as to the causes of the 1929 boom and crash. 1955. 1939. He did three very strange things in 1929 or before. He then studied banking and became a vice president of National City Bank in 1916 and chairman of the board in 1929. 1955. 39).‰ A jury said he did not. Mitchell warned about dire consequences in Germany unless the debt payment schedule resulting from the World War was drastically revised. after a year as an independent financial consultant. WIGGIN Albert H. he „defrauded the Government of $850. it would have achieved a monopoly position. Mitchell testified as an expert witness on the investment banking industry before the Temporary National Economic Committee of Congress. but there is not a hint of manipulation or self-serving trading.. 1932. He denied that there was an investment banking monopoly in 1929 but admitted that if the National City Bank had not been forced to divest itself of its investment banking unit.‰ This was a very respected person. First. In 1931. His testimony was a „factor in the passage of the Banking Act of 1933. it stated. With reference to Mitchell. five days after testifying before the Senate committee. „He had the reputation of being one of the frankest straight-from-the-shoulder talkers of all the financial executives whose opinions are worth quoting. C. In December 1939 (December 15. .

506 shares of Chase stock and made a profit of $4 million.000. Second. The total profit was less than $160. Times ( p. In 1932. he was elected club president by his peers. he had much larger losses from the shares he owned. Pecora. Chase cut its dividend from $4 to $2. Between September 23 and November 4. Wiggin was long many more shares than were sold. Malkiel. 5) reported that „Wiggin Heads Banker Club.25 per share. During the period of short sale. 1933.‰ At the same time that he made a profit of $4 million from selling short. 1933. Third. between September 23 and November 4.‰ His views were sought and respected.152 BEATING THE BEAR of Chase (Metpotan Securities Corporation) engaged in frantic trading activities that made little profit from 1928 to 1932. . However. and the stock dropped to below $20. He was „selling against the box. the facts are more involved. Wiggin sold short 42.‰ Even retired. Selling short the stock of the company of which you are president is obviously in bad taste (at a minimum). retired from Chase. On October 18. In January 1933 Wiggin. 1929. 5) had a heading „Retiring Chase Head Sees Credit Restoration and Recovery Nearing. not including the opportunity cost on the capital used. 1929. Galbraith. who was to be 65 years old on February 21.506 shares of Chase stock. the Times ( p. The January 9. I disagree. Wiggin sold short 42. and the 1933 New York Times all cite the selling short of his own bank stock as an outrageous action. three corporations owned by Wiggin or his family engaged in longer term investing in Chase stock and made a gain of over $10 million.

changes in the mix and number of customers. There can be time periods in which the utility can earn more (or less) than the allowed return. The present value of the equity is equal to the present equity rate base. and . The general rule applied by regulatory authorities is to allow utilities to earn a fair return on an allowed rate base. The return required by the market is r. ·„20 Utility Stocks Hit New Low Mark. but the target set by the regulatory authority is the weighted average cost of capital.Chapter 12 THE PRIME CAUSE OF THE 1929 CRASH: THE PUBLIC UTILITY SECTOR The utility shares again broke wide open and the general list came tumbling down almost half as far. the firmÊs equity will be worth X + rX or (1+r)X with a present value of X. There are several reasons why a public utility can earn more or less than a fair return. The fair return is defined to be equal to the utilityÊs weighted average cost of capital. Thus the market value of a properly regulated public utilityÊs stock should normally be reasonably close to the book value per share. regulatory lag. and the stock price should be equal to the equity rate base per share. as well as the allowed return. If a public utility has an allowed rate equity base of $X and is allowed to earn a return of r (rX in terms of dollars). and the stock price should be equal to the present equity rate base.‰ Washington Post Intrinsic values are reasonably well defined for regulated public utilities. after one year. changes in efficiency. changes in the weather. The reasons for this include regulatory practices that differ from the above.

17 198. 1985. Sooner or later this price–book value relationship would have to decrease unless the regulatory authorities continued their past practices or there existed a stream of investors who would buy the utility stocks even at their high prices. The decision made by the Massachusetts Public Utility Commission in October 1929 applied to the Edison Electric Illuminating Company of Boston. The Washington Post (October 17.C. The October 19 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 Public Utility Commission to allow Edison Electric Illuminating Company of Boston to split its stock. public utility stock prices were in excess of three times their book values. „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. we would not expect the stock price to be very much different from the book value per share for very long if the regulatory process is as described.72 . There should be a tendency for the stock price to revert to the book value for a public utility supplying an essential service where the rate commission is effectively allowing a fair return to be earned. Although the Federal Power Commission v. and the stock market reaction to the decision made clear that neither of these improbable events was going to happen.07 Utilities 144. The Boston Daily Globe featured this story on both October 12 and October 16.154 BEATING THE BEAR prospects of deregulation.69 Railroads 189. The explanations offered by the commission made the situation worse (the stock was not worth its price and the companyÊs dividend would have to be reduced). 637): 1929 High Low Industrials 381.61 64. p. the cost of equity may be different from the allowed return because of inaccurate (or incorrect) calculations or changing capital market conditions. Thus in 1929 there were limits on abnormal profits for a regulated firm. Hope Natural Gas Company case (1944) had not yet been decided. Although the stock price may differ from the book value. (1923) was a historical fact in 1929. stated. Consider the following values for the Dow Jones Stock Indices (month ends) for 1929 (Wigmore. In the year 1929. 1). the Bluefield Water Works v. in explaining the October 16 market declines (an Associated Press release).‰ This news release was widely circulated. P.S.11 128. Also. Bluefield is one of the primary cases defining the regulatory process for determining a fair return on regulated assets. p.

1929. reached a maximum of 330 (a 65 percent increase) . Public utilities helped fuel the large stock price increases from January to October 1929.17 Railroads 158.54 189.11 Utilities 97. the investment trusts were heavily invested in utility stocks.61 January 1929 1929 high The high prices as percentages of the January prices and the growth in the value percentages were: Ratio Industrials Railroads Utilities Growth 120% 119% 148% Percentage 20% 19% 48% The growth in value for utilities during the first nine months of 1929 was over twice that of the other two groups.51 381. January 1. A comparison of the beginning of the year prices and the highest prices is also of interest. we have the beginning of a viable explanation for the crash. 976–77) computed an index for 34 public utilities. Industrials 317. Picking on the utility segment of the market as the cause of a general break in the market in October is not a sufficient explanation of the stock market crash. pp.THE PRIME CAUSE OF THE 1929 CRASH 155 The highs were all in September and the lows in November 1929.92 144. 1930). The index was 200 at the beginning of the year. The low prices as percentages of the high prices were: Industrials Railroads Utilities 52% 68% 45% In 1929. The Economist (November 23. All the companies listed lost at least 52 percent of their market value. Remember. The following high and low prices for 1929 for a typical set of public utilities and holding companies is illustrative of how severely public utility prices were hit by the October 1929 crash (New York Times. But if we combine a besieged utility segment with leveraged investment trusts that had been purchased on margin. the utilities dropped the furthest from the highs for the three groups.

The heading said: „Bars Stock Split by Boston Edison.29 0. October 12. The Dow Jones Utility Index was 97.156 BEATING THE BEAR 1929 High Price 1753Î8 71 Î8 2481Î2 128 681Î8 1831Î4 189 91 303Î4 673Î8 1 Firm American Power & Light American Superpower Brooklyn Gas Buffalo. Criticizes Dividend Policy.37 0. a 39 percent decrease. there is no question that utility stock prices were explosive in 1929.21 0. 1929. The stockÊs high for the year was $440 and the stock had closed at $360 on Friday October 11. 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. of N.92 at the end of January and reached a high of 144. Electric Bond and Share Long Island Lighting Niagara Hudson Power Transamerica 1929 Low Price 641Î4 15 99 611Î2 20 801Î8 50 40 111Î4 201Î4 Low-Price Dividend by High Price 0. Although the exact measures of percentages of increase and decrease depend on the dates used and firms making up the index.27 in December. and then fell to 170 by the end of October (a 48 percent decrease from the high). Prices then fell to 88.48 0. This was a 48 percent increase.26 0.44 0. 27) stated that it did not want to imply to investors that this was the „forerunner of substantial increases in dividends. THE MASSACHUSETTS TRIGGER On August 2. Holds Rates Should Not Be Raised Until Company Can Reduce Charge for Electricity. the Times reported ( p. p. On Saturday. October 12. They offered .44 0. 27) that the Massachusetts Public Utility Commission had rejected the stock split.61 in September. The Massachusetts Public Utility Commission (New York Times. both on the upswing and on the collapse. Niagara & Eastern Power Cities Service Consolidated Gas Co.Y.44 0.30 in September.‰ Boston Edison lost 15 points for the day even though the decision was released after the closing.37 0.‰ They stated that the expectation of increased dividends was not justified.

losing 15 points before the rejection announcement was released.‰ One major factor that can be identified leading to the price break for public utilities was this ruling by the Massachusetts Public Utility Commission. and on October 19 it set the dates for the inquiry. the Boston City Council advised the mayor to initiate legislation for public ownership of Edison. It dropped 61 points at its low on Monday (October 14). The decision is a far-reaching one and Wall Street expressed the greatest interest in what effect it will have. including „dividends. p. . 1929 Date (October 1929) 1 2 3 4 5 6 7 8 9 10 11 Volume (Shares) 34 109 68 63 33 Sunday 155 535 76 207 247 360 395 390 380 3751Î2 358 360 380 375 360 360 390 380 375 360 High 365 365 365 362 360 Low 365 360 360 360 360 Close 365 360 360 360 360 . if any. a loss of 32 points. On October 16. the first trading day. but closed at 328. The only specific action was that it refused to permit Edison Table 12.‰ It „excited intense interest in public utility circles yesterday and undoubtedly had effect in depressing the issues of this group. On Tuesday October 15. . October 1–11. the Times ( p. depreciation. 42) that „The public will take over such utilities as try to gobble up all profits available. upon commissions in other States. there was a discussion in the New York Times ( p. On October 16. 42) and concluded (p.1 Edison Electric Illuminating Company of Boston Trades before the Decision.THE PRIME CAUSE OF THE 1929 CRASH 157 „scathing criticisms of the company‰ (October 16. 42) reported that Governor Allen of Massachusetts was launching a full investigation of Boston Edison. the department announced it would investigate the rates being charged by Edison.‰ Boston Edison had closed at 360 on Friday October 11. and surplus. . 41) of the Massachusetts decision in the column „Topics in Wall Street.‰ On October 15.

the Financial Times ( p. and the stock split should have been easy to grant. The Boston Daily Globe (October 16) reported on page 1 that a $600. The next day (October 17).085 per kilowatt hour and Cambridge only $0. For example. The largest amount of trading was 535 shares on October 8 (Table 12. p.265 617 289 Sunday 896 226 624 295 298 293 285 292 280 293 296 280 330 324 309 304 303 299 Î2 1 High Low Close 299 310 Î2 290 290 300 290 1 328 310 1Î2 290 303 300 290 .982 2.‰ and the article heading read „Electric Issue Hard Hit.000 rate cut was planned. the Financial Times (October 16. 1929 Date (October 1929) 12 13 14 15 16 17 18 19 20 21 22 23 Volume (Shares) A Holiday Sunday 7. 1929.‰ EDISON ELECTRIC ILLUMINATING COMPANY OF BOSTON During the first 11 days of October. thus leaving the total stock equity value unchanged. There was also talk.158 BEATING THE BEAR Electric Illuminating Company of Boston to split its stock.2 shows the trading for the next 11 days. 7) reported that the commission advised the company to „reduce the selling price to the consumer.1). The high for the Monday after the news of the commissionÊs decision Table 12. Table 12.055. But the commission made it clear it had additional messages to communicate.241 1. 3) reported.‰ Boston was paying $0. Most finance academics would argue that the primary effects of a stock split would have been to reduce the stock price by 50 percent and double the number of shares outstanding. October 12 – 23. as well as news reports. Boston Edison stock closed at between 360 and 390.850 1. of public ownership and a shifting of control.2 Trades after the Decision. „The worst pressure was against Public Utility shares. The event was not economically significant.

3 Trades during the Crash. On October 23.0 percent. There is no question that the stock price of Edison Electric Illuminating Company of Boston was greatly affected by the Massachusetts Public Utility CommissionÊs decision and pronouncements.‰ The article then referred to the decision by the Massachusetts Public Utility Commission: „It was pointed out in some quarters that the stand taken by the commission held possibilities of changing the public attitude towards the utility shares. Table 12.9 percent. which it has been recognized have been discounting prospects to an unusual degree. The stock fell from $280 on October 23 to $250 at the end of the month (the low for the month was $240). 1929 Date (October 1929) 24 25 26 27 28 29 30 Volume (Shares) 1. from October 10 to October 16. American Power & Light fell 14. Thus the largest amount of Boston EdisonÊs price decline preceded the market crash (there was a $115 price drop. American Superpower fell 12.840 1.‰ The article concluded that the events would harm utility expansion plans. Other public utilities were also affected.5 percent drop. of which $85 or 74 percent took place before the crash). Remember that Black Thursday was still a week away from the closing prices on October 16. For October 1 to October 23. 1) identified the October 16 price drop as a break in utility stock prices. it closed at 280. October 24 – 31. and Electric Bond and Share fell 12. The total price drop from the October 1 price of 365 to 250 on October 30 was a 31.3 percent drop.290 365 232 Sunday 473 1.THE PRIME CAUSE OF THE 1929 CRASH 159 was 30 points lower than FridayÊs close. 1) on the unfairness of the Massachusetts Table 12. there was a 23. During the day the stock went as low as 299 (a 61-point day) and closed at 328. The October 17.3 shows the stockÊs performance through Black Thursday (October 24) and Black Tuesday (October 29). the Wall Street Journal ( p. For example.7 percent. „The price structure of several leading active utility issues crumbled under a combination of professional attack and liquidation yesterday.547 278 250 250 240 240 240 240 250 250 High 285 280 280 Low 276 275 275 Î2 1 Close 273 275 278 . On October 18 there was an editorial in the Wall Street Journal ( p.

The Federal Trade Commission. 18): „This inquiry is likely to have far-reaching effects and may lead to similar action in other States. 38). described the existing process as a „vicious system‰ (October 19. 1) was highly critical of BonbrightÊs jump to a conclusion. 21) and said that consumers were ignored. wanted more control over utility holding companies. especially the commissionÊs criticism of the utilityÊs depreciation accruals (the Journal pointed out they exceeded the requirements of the commission). after the study had barely started and his „impatience to arrive at predetermined results. 18). New York City. On October 17. October 22 ( p. and New York concerning public utility regulation.‰ Both the October 17 and October 19 issues of the Times carried articles regarding the New York investigative committee. 18) reported that the Committee on Public Service Securities of the Investment Banking Association . with his „vicious system‰ comment. and „their influence has become very important‰ ( p. accused of graft. October 17. thus „proving‰ that he had not accepted bribes (New York Times. p. They conjectured that the trusts had $3. p. although the head of a New York Stock Exchange house had a simpler explanation: „More sellers than buyers‰ (New York Times. The committee stated (New York Times. It is reasonable to conclude that the October 16 stock market break was related to the news from Washington. The New York 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. p.160 BEATING THE BEAR ruling. October 23). OTHER REGULATORY FACTORS Massachusetts was not alone in challenging the utilities. testifying before the committee. The New York governor ( Franklin D. The Wall Street Journal of Tuesday.‰ This was down from 35 in July and August. the New York Times (p. Professor James C. October 17. Mayor Jimmy Walker. 1929. The chairman of the Public Service Commission. October 17. Bonbright of Columbia University. Massachusetts. a Roosevelt appointee. and New York State were all challenging the status of public utility regulation.‰ On page 3 it was noted that „Utilities Sell 24 Times Net. especially management fees and other transfers. to investigate the regulation of public utilities in the state.5 billion to invest. In New York City. Roosevelt) appointed a committee on October 8. was fighting back with statements that his administration would fight aggressively against utility rate increases. 18). p.

8/82.30 35 3. and utilities were 14.‰ On Black Thursday. The utilities industry represented $14. Market Price / Book Value 35 3. The declines were „led‰ by the motor stocks and public utilities. 1985.1 billion.‰ we would have to conclude that public utilities at the beginning of October 1929 were overpriced.1 = 18 percent of the value of the outstanding shares on the NYSE.THE PRIME CAUSE OF THE 1929 CRASH 161 had warned against „speculative and uninformed buying. inconsistent with logical regulatory policies and theories. or 11 percent) and closed at 299. all common stock listed on the New York Stock Exchange had a value of $82. THE PRICES OF UTILITY STOCKS At their September price height. As of September 1.32 (a 34-point drop. the market panic accelerated.87 to 272. October 24.Y. public utilities were very aggressively priced.‰ The committee published a report in which it „asks care in buying shares in utilities. Volume was 12 million shares on the NYSE and 6 million shares on the Curb. 39) for five operating utilities.06 28 3. The market dropped from 305. Given that the above firms were all regulated utilities. Detroit Edison Pacific Gas & Electric Public Service of N. The public utilities in September 1929 were very aggressively priced. investors are expecting the firm to earn massive abnormal profits. Utilities were a significant fraction of the stock market. if they were allowed to earn no more than a „fair return. 1929.8 billion of value. Consider the following measures (Wigmore.47. and · given the announcements from the regulatory authorities and political figures in October 1929 · a prudent investor would have had a difficult time justifying an investment in these firms at the September 1929 prices. which were typical: 1929 Price–Earnings Ratio High Price for Year Commonwealth Edison Consolidated Gas Co.14 Public utility holding companies had even larger price–earnings ratios and market-to–book value ratios than did operating utilities.31 39 3. A public utility allowed to earn a fair return should sell approximately at its book value (rate base) if the market expects it to earn a fair return. When a public utility is selling at over three times book value. p.J. . of N.34 35 3.

50 market price premium over book value and the investment trustÊs premium over market price of the stock. any change in public utility stock values resulted in larger changes in the equity wealth of investors. we also assumed that no debt or margin was used to finance the investment. p.162 BEATING THE BEAR THE PUBLIC UTILITY MULTIPLIERS Public utilities were a very important segment of the stock market. For simplicity.44 times book value) for the holding company stock Market price of investment trust holding stock (assuming 100% premium over market value) $ 50. 43). even more important.50* Market price of investment trust holding stock (assuming a 100% premium over market value) $325. The effects shown would be reduced if the trust held only a fraction of the stock.50 loss in underlying stock value and the $275 reduction in investment trust stock value.00 If we were to eliminate the two premiums over book value.00 $444. Consider the following hypothetical but representative values for a public utility: Book value per share for a utility $ 50.00 *Based on a price-to–book value ratio of 3. the market price of the investment trust would be $50 without a price premium.00 $222.50 is equal to the $112. the loss in market values of the underlying stock and the investment trust stock would be $566. Assume the individual investors invested only $222 of their . If we were to eliminate both the utilityÊs $112.44 (Wigmore. 39). p. since their ratio of price to book value averaged 4. In 1929 there were three important multipliers meaning that any change in a public utilityÊs underlying value would result in a larger value change in the market and in the investorÊs value. The loss in market value of the stock of the investment trust and the utility would be $387.50 (with no premiums). The $387. Assume the following situation: Book value per share for a holding company Market price per share (4.00 Market price per share of utility $162. The public utility holding companies were even more vulnerable to a stock price change. However.25 (Wigmore. we assumed the trust held all the holding company stock. This assumes the trust lost its premium and traded at liquidation (net asset) value.

22 times book) and the trust still sold at a 100 percent premium. If the holding company stock went down from $222 to $111 (selling for 2. Consider the following example. The $1 million of stock is owned by a holding company with $700. Thus $50. A DIFFERENT INTERPRETATION One conclusion to this point could be that public utility stocks were overpriced prior to October 1929. Remember. it was rational for the investors to pay more than book .000 holding company stock value all goes to the preferred stock). each layer introducing more leverage.000.000 of preferred stock.000 of investor equity funds. since the investors have a $222 asset and owe $222. It was not any one layer of leverage that was excessive but rather the cumulative effect of the leverages at all levels. The $100. The value of the investment trustÊs common stock is reduced to zero (the $200. In 1929 there were frequently several layers of holding companies and investment trusts. The vulnerability of the margin investor buying a trust stock where the asset is utility holding company stock is obvious.22 times book value. If the $1 million of utility stock decreases $100. the value of the holding companyÊs stock becomes $200.000. since utilities paid relatively high cash dividends and enabled the investment trusts to pay dividends. the holding company would still be selling at an inflated 2.000 in value to $900. Assume that a utility with assets of $2 million has $1 million of stock equity and $1 million of debt. This implies a lack of rationality on the part of the investors. since there is $700. Investment trusts liked to invest in public utilities. The $300.000 of investor equity funds is supporting $2 million of operating assets owned by a public utility. the trust would sell at $222 and the investors would have lost 100 percent of their investment.000 of debt and $300.000 of stock. In this example. At a price of $111.000 of common and $200. Let us consider a different interpretation. a 5 percent ($100.000 of debt. The impact on the several layers of leverage was enormous. Only a very small change in the value of the public utilityÊs stock is required to wipe out the investor in the investment trust if one considers all the layers of leverage. the trust can also be highly leveraged (primarily by the use of preferred stock).000 of holding company stock is held by an investment trust financed with $100.000) reduction in the utilityÊs asset causes the equity investors to lose 100 percent of their investment.000 of common is financed by the individual investor with $50. As long as the regulatory commissions allowed stock investors to earn abnormal returns.THE PRIME CAUSE OF THE 1929 CRASH 163 money and borrowed $222 to buy the investment trust stock costing $444.000 of margin debt and $50.

The utility holding company has $720. 1929. but the common stock has a $1. The investor $96. p.000 of equity capital. 32) had all listed stocks at $63.000 of debt and $400.7 percent of the stock market. and the investment trusts. Actually. 17) advertised the issuance of 1 million . When the large amount of leverage is combined with the inflated prices of the public utility stocks. when it became obvious that the new Democratic administration in Washington was going to be unfriendly to utility investors and would protect the interests of consumers with a great deal of zeal.164 BEATING THE BEAR value for the stock of the utilities. Thus the $1 million utility asset is financed with $32.000 in the stock.6 billion and gas and electric operating companies at $3. Continuing the above example. The $1 million asset is supporting $1. Assume that a utility purchases an asset that costs $1 million and that asset is financed with 40 percent stock ($400.58 billion (as of December 1929). The investorÊs $96. Some of the drop in utility prices occurred in 1932 and 1933. The investment trust has $288. THE LARGE AMOUNT OF LEVERAGE The amount of financial leverage (both debt and preferred stock) used in the utility sector was enormous.000 of margin debt.2 million market value. A tombstone (a published advertisement listing the involved investment banks and relevant facts regarding the securities) published in the Wall Street Journal (October 1. An investor buys the investment trustÊs common stock using 50 percent margin and investing $32. and the market value of the holding company stocks was approximately as large in total as that of the operating companies. the holding company stocks. the problem is even more dramatic.000) and 60 percent debt.704.000 of equity is very much in jeopardy.000 of debt and $480. the Times ( p.83 billion and gas and electric holding companies at $3. 1929.000 of common stock.000). Together these utilities were then 11. and Washington that the regulatory commissions in the future would allow only a fair return on the capital invested in the utility. An investment trust owns the holding companyÊs stock and is financed with 40 percent stock ($64.000). A utility holding company owns the utility stock and is also financed with 40 percent stock ($160. reflecting both an overreaction on the part of the investing community to the events of the fall of 1929 and a changed economic environment. assume that the $1 million asset is again financed with $600. the utility stock prices fell far below book value.000 common stock. by 1933.000 of common. New York.000 of debt and $192. As soon as there were indications in Massachusetts. the stock prices had to fall to be closer to book value. On December 27.000 of debt.

and the investors. the downward movement in real estate prices triggered a financial crisis. The tombstone showed that this investment trust owned 74 different utility securities. A small change in market price of a utility stock would trigger a massive change in the value of the equity securities held by individual investors. or the financial institution would be in severe financial difficulty. In 1929. Neither the earnings nor the prospective regulated earnings (represented by the book value per share) would have justified this price increase unless the regulatory commissions were very friendly to utilities. In 2008. Compounding the problem was the leverage used by the utilities. CONCLUSIONS Assuming that they were to be allowed to earn only a fair market return. 1985. Although this trust had wide diversification within the one industry as described above. In October. The debt had to be rolled over. 637) was 97. Without governmental assistance and without the ability to roll over the credit. In 2008. . Lehman Brothers). p. investors were bombarded with news reports indicating an adverse change in the regulatory environment. The values of the utility holding companies and the investment trusts (heavily invested in utility stocks) were also hit very hard.92 in January and had gone up to 139. the holding companies. even if the financial markets were not receptive. the result was likely to be bankruptcy (for example. the excessive use of debt leverage was made more dangerous by the extensive use of short-term debt. the investment trusts. The causes of the stock market crashes of 1929 and 2008 were shockingly similar.61 by the end of September (a 43 percent increase). a change in the attitudes of the regulators of public utilities triggered the October 1929 stock market crash. and the prices of utility stocks fell like a rock.THE PRIME CAUSE OF THE 1929 CRASH 165 shares of stock at $58 a share for the United States Electric Light & Power. the investors had a large amount of risk. The Dow Jones Utility Index ( Wigmore. utility common stocks were overvalued at the beginning of October 1929. The use of excessive financial leverage was common to both crashes.

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well-informed people) leading us to conclude that the high level of the stock market before the 1929 crash was not the result of excessive speculation by gamblers but rather due to a well-founded optimism on the part of a well-informed investment community. and 1932? It is clear that the drop in real prosperity in the business community was the ultimate factor that caused subsequent drops in stock market prices in the years 1930–1932. . it is a sort of customersÊ manÊs chantey to encourage customers to step into and out of the market a little livelier.. ·Forbes. then why did it fall drastically in October 1929 and then again in 1930.Chapter 13 LESSONS TO BE LEARNED I have known bulls to make money and I have known bears to make money. The Memoirs of Herbert Hoover There is a great deal of evidence (including the investment decisions of some very bright. December 15. . Jr. 1929 „.‰ ·Fred Schwed. 1931. . And if the market was not too high. but I never knew of a hog making money. Where Are the CustomersÊ Yachts? We Attempt to Stop the Orgy of Speculation ·Title of Chapter 2.

g. 3. The various actions by the Federal Reserve Board and member banks to restrict credit had taken hold. 9. If one removes the prospect of price appreciation. the investment in common stock was not attractive compared with alternatives. including the secretary of the treasury. New broker loans were becoming scarce because of the New York BankÊs awareness of the relentless pressure from the Federal Reserve Board to restrict loans to finance speculation. increased nervousness. Some businesses (e. The statements by important people. The Hatry scandal triggered the recall to England of funds invested in the United States and. There was bound to be a change in market psychology sooner or later.. 5.168 BEATING THE BEAR What caused the October 1929 stock market drop? Let us consider the various events that are likely to have contributed to it: 1. in addition. The increase in the persistent gap between the borrowing cost to finance common stock investments and the dividend yield of stocks relative to the increase in the discount rate. 8. The stock fell by more than $100 a share. 2. The increase of the discount rate from 5 to 6 percent in August by the Federal Reserve Bank of New York in a situation where the interest rate–sensitive construction industry was already weak. The Bank of England raised its discount rate from 51Î2 to 61Î2 percent on September 28. Even the turndown in construction activity could be attributed to higher interest rates and more restrictive credit. 6. and in October 1929 there was a major change in the sentiment of the market. This is my number one choice. It had already been raised from 41Î2 to 51Î2 percent earlier in the year. 4. but they also got both the small investors and the large investors. given the war on speculation. 7. If it could happen in England. they declared that the stock was not worth its price and predicted a decrease in the companyÊs dividend. All the reasons were manufactured by government decision makers except for the Hatry scandal. The Massachusetts Department of Public Utilities denied the Edison Electric Illuminating Company of Boston its request to split its stock. There were a lot of reasons why one could expect the market level to decrease. construction) were reporting signs of weakness. The people who wanted to „get the speculators‰ finally got the speculators. . More important. This decreased the relative attractiveness of investments in the United States. it could happen in the United States. The Federal Reserve was acting effectively to remove the prospect of future price appreciation. that stocks were too high and there was excessive speculation.

Members of Congress exerted pressure to bring down the New York speculators. With your help and wide influence. S. Anyone who desires to buy for income finds to-day few suitable stocks among those which have been most in the limelight. I donÊt pretend to be able to analyze the whyfor and wherefor of all that has happened. rather. there was general agreement (existing to this day) that speculators had driven up the stock values excessively and a fall was inevitable. follow Mr. president of the Investment Bankers Association. and they succeeded. it has seized its scepter of power. however. addressed his group in New Orleans. He chose to take the obligatory crack at speculation. Fortune magazine in February 1930 blamed the bust on the extraordinary industrial activity and profits of the first six months of 1929. and as investment bankers we can do our part to direct the savings of the country into constructive and dependable lines. J. A few of the „bear crowd‰ sold short and became extremely wealthy. The view had become pervasive that speculators were driving the market: „The stock market continues to prove more attractive to speculators than to investors. normal . Old-fashioned standards for judging values are again back in vogue. Animated by a wholly righteous zeal. Old-time reasoning can no longer be applied · except with unhappy consequences.‰1 An important banker was quoted as saying: „I have scrapped every theory I used to hold. Trowbridge Callaway.‰2 This implies that even the important banker had now become a speculator.LESSONS TO BE LEARNED 169 foreign and domestic. Before the 1929 decline.‰ He also maintained that the boardÊs direct policy was „based upon nothing more substantial than provincial prepossessions against Wall Street and a Calvinistic repugnance to gambling. Irving Fisher lost $5 million and his house.‰3 After the collapse of the market. He must.. . Conventional wisdom in 1929 in Washington. . MellonÊs advice and buy bonds. „The orgy of speculation which clouded the countryÊs vision has passed and clearer thinking is now the rule rather than the exception.C. In October 1930. For example. There were some weird explanations. D. Nor do I pretend to know what the outcome is going to be. . was that the market level was too high and had to come down. Lawrence stated: „we come to the ugly conclusion that the Board either shares or has been moved by the unreasoning prejudice against the stock market and that it feels that the prices at which most stocks are selling to-day are too high. ceased to try to go contrary to existing realities but am now governed by them and not by theory. I have.

Taylor. before and after he took office. Our banking position is extraordinarily strong.8 Hoover quoted Adolph Miller. Steel Corporation. . Hoover publicly warned of the dangers of speculation.‰4 Even the president of the New York Stock Exchange. and it was safe to do so then because the Board knew that Mr. and his every influence in the Presidency was in that direction.‰9 Hoover not only launched the Federal Reserve attack on speculation (by way of Adolph Miller) but also did much more: I. not burdened by excessive inventories. He wanted to deflate the utter extravagance then rampant. As early as 1925. Industry. . He indicated that stocks had risen excessively and then fell excessively in October: „Second only to the folly of the speculative frenzy that lifted securities to levels far beyond any warrant of supporting profits to the industry or of yield to the investor. Hoover was about to take office. agreed with Taylor that in November 1929 the market was oversold: Those who voluntarily sell stocks at current prices are extremely foolish. .7 Most important for the health of the stock market. head of the U. from 1926 on. resolved to attack the problem from several directions in addition to securing cooperation from the Federal Reserve System. declared that „the primary cause of the panic was undoubtedly the high level of prices which so many American share issues had attained. the newly elected president of the United States. is in excellent shape physically and financially. Herbert Hoover. if the frenzy in the stock market should be carried much further. It is obvious. in a speech given on January 25. Hoover. Young. But there is no reason in the world why it should be carried further. was struggling desperately to curb credit extravagance.‰6 Owen D.170 BEATING THE BEAR confidence can be more readily restored and the fundamental law of supply and demand be brought into balance. spoke on the subject of the stock market decline to Carnegie Institute students. however. Hoover.‰5 Myron C. when another evil effect of mass psychology overwhelmed the nation. . It has already been carried nonsensically far. Mr. Our general financial conditions never were sounder.S. therefore. has been the crisis through which we have just passed. it will inevitably injure business. chairman of the General Electric Company and probably the most outstanding industrial statesman of the decade. that the high level of share prices last August rendered the stock market vulnerable to a considerable price decline. had been protesting that the money policy of the Reserve System was certain to bring about disaster and calamity. 1930. declared war on speculation. who approved of HooverÊs positions: „The Board only began issuing warnings when Mr. Of course. General business has been prosperous.

announced that in this emergency his bank would furnish the deficient credit. Most of them responded with strong editorials. Secretary of the Treasury Mellon and others. after October 1929. There is no question that if stocks had fallen and nothing else had happened. and the market. intended to turn back the flow of gold from Europe to the United States. was mainly responsible for the speculative rise in the stock market. This also had no effect.‰13 MYTHS OF 1929 The first and most important myth in 1929 was that the stock market was obviously too high.‰12 There are many other examples in HooverÊs Memoirs of his war against speculation. Distressed farmers had been clamorous for years.‰11 Hoover had an obsession with stopping stock market speculation: „We did at one time almost secure a stranglehold on the stock market when the Reserve Banks had so tightened the call-loan situation that a moment arrived when there was no money available to the market. No one was to claim credit for what happened to the U. The collapse of that market in October 1929. issued repeated statements urging the public to convert their stocks into bonds and advising other forms of caution. Since the market went up. A break seemed inevitable. however. at my request.10 Hoover had a conversation with Governor Roy Young. Unfortunately. which had been oversold in the fall of 1929. however. This had no appreciable effect. driven up by speculators. I sent individually for the editors and publishers of major newspapers and magazines and requested them systematically to warn the country against speculation and the unduly high price of stocks. in which Young „agreed to use the full powers of the Board to strangle the speculative movement. the speculative boom had obscured downward tendencies in production and prices of manufactured goods and raw materials.S. There was little effort (other than by Fisher and by Lawrence) . Hoover would appropriately have claimed credit for stopping speculation.LESSONS TO BE LEARNED 171 To create a spirit of caution in the public. Historians have tended to focus on the speculative boom in the stock market. ignoring the real prosperity of the period from 1925 to 1929: „ The easy-money policy of the Federal Reserve System after 1925. it was too high. is ordinarily taken as the beginning of the world depression. In fact. Mitchell. But Charles E. In the United States construction had fallen off from the summer of 1928. President of the National City Bank of New York. economy after October 1929. facts regarding the economy were about to turn bad. would be hit hard in the coming three years as business activity slowed to a crawl.

but unfortunately the empirical evidence is not available for proving or disproving its importance. There was a great deal of focus on broker loans. and thus it was inevitable that it would decline drastically. Although speculators were broadly attacked. One continuing myth is that evil (dishonest) manipulation fueled first the upswing and then the collapse. It is far from obvious that broker loans were excessively high. If we had to choose a possible culprit from among these three. The myth was that the speculators were a significant factor in setting the level of the market and that they harmed the other people. few defined what they meant by „speculation‰ and why it was bad. investment trusts. The effect of Wall Street credit on real components of the economy was assumed to be a negative factor that had to be controlled. There was also considerable worry that Wall Street was stealing credit from farmers and industry. but it is possible that the decline was caused by the actions of the federal government (including the Federal Reserve Board) and statements by its officials. The second myth is related to the first. It was a myth that the high level of stock market prices jeopardized the nationÊs prosperity. It is far from obvious that the market was too high in October 1929. Concerns regarding the safety of broker loans was a myth. it would be short selling. Both investors and speculators were buying stocks. They proved to be safe loans from the viewpoint of the lenders. There is no evidence that any of these three factors contributed to the October decline. The biggest myth was that speculators had to be taught a lesson and that this lesson became the primary economic objective of both the Federal Reserve Board and the president of the United States.172 BEATING THE BEAR to evaluate the level of the market compared with the profitability of the corporations and the growth in that profitability.14 This issue was completely misunderstood by the Federal Reserve Board. The lenders required sufficient „margin‰ to make them safe loans. Short selling. and pools all received credit for either causing or accelerating the stock price decline. The market did decline.‰ . Although it can be shown that there were practices which either exhibited bad judgment or else were not completely ethical. namely. Congress did not disagree with the objective of „getting the speculators. because they fueled the speculators who were driving up stock prices with margin buying. it cannot be shown that these practices were significant either in setting the level of the market or in causing the market turn in October 1929. and it was difficult if not impossible to distinguish between the two types of buyers. that the market was too high.

testifying before a senate committee. Maintain higher lending standards for real estate loans so that fewer subprime mortgages are issued. 1. The Federal Reserve Bank had been more generous regarding the money supply. That is one who observes the future and acts before it occurs. HOW THE 1929 CRASH COULD HAVE BEEN AVOIDED The 1929 crash might possibly have been avoided if: 1. The President and Congress recognized that verbal attacks on speculators were not justified. the constant attacks did make investors in stocks nervous and vulnerable to any bad financial news. given the healthy state of the real economy. The public utility commissions of each state had made it clear prior to 1929 that electric rates were not to be raised solely to justify stock prices that far exceeded a utilityÊs book value. ÂProfessor. what about so and so?Ê And these men can take facts and figures and bring them together. but their predictions are not worth any more than ours. 2. but I have my own definition of a speculator. I was what you would call a speculator. but it includes measures that were not easy to implement in 2007–2008. offered a friendly definition of speculator: „I was very active in the stock market before World War I. However.‰ He also offered an evaluation of the predictive capability of economists: „The only economic doctor is an economist and they go to him and say. Bernard Baruch. If they were. most of the stock price losses took place in 1930 and 1931. . Have the credit rating agencies do a better job of defining very risky loans. 2. HOW THE 2008/2009 CRASH COULD HAVE BEEN AVOIDED The list of changes that could have resulted in no stock market crash in 2008 / 2009 is somewhat longer. they would have all the money and we would not have anything. In fact. 3. those that invested (speculated?) on the New York Stock Exchange.LESSONS TO BE LEARNED 173 Why was it such an obsession to „get the speculators‰ of the New York Stock Exchange? The need to „strangle‰ the speculative movement bordered on a hatred of a portion of humanity.‰15 One relatively minor myth is that the Great Crash occurred in October 1929.

Counterparties who pay in case of default swaps evaluate the creditworthiness of the other counterparties who are assuming different levels of defaults. The collapse of the mortgage market (defaulting of the mortgage payments). which is not guilty of facilitating these errors. the optimism was steadily eroded by negative . there is a need to find explanations for these failures. LESSONS TO BE LEARNED (1929) First. 4. and the resulting failure of AIG (insurance). measures such as those outlined above are not easy to implement. authors soon seek the causes of the disruption in economic activity. and commercial banks resulted in a drying up of business credit. Have investors refrain from relying solely on the loan ratings but instead actually evaluate the quality of loan packages by looking at the underlying loans. Have investors in risky mortgage bonds control the amounts of loans and also limit the amount of debt they use to finance the investments. For example. THE ACCUSATIONS HAVE STARTED (2009) Once a boom has gone bust. Was there excessive stimulus? 7. Also. A general theory of human beings seeking excess returns and satisfactions is likely to be a more satisfactory path. 6. In 1928 and 1929. Faster and more effective action by the Fed might have decreased the consequences to the overall economy.174 BEATING THE BEAR 3. Given the failure of credit agencies and investors to evaluate correctly the riskiness of sub-prime mortgages. requiring continuous roll-over (frequent borrowing to stay afloat). 5. use long-term debt and not short-term debt. As the opening sentence of this section states. the use of excessive short-term debt to finance these risky investments and the failure of government agencies to regulate these credit markets. the balance between stock market optimism and pessimism is very delicate. Have the Federal Reserve refrain from encouraging too low a set of interest rates. This theory states that the prices of widely traded securities reflect all readily available information. investment banks. But there is also a need to look further than the EMH theory. the failure of credit default swaps to ensure risk free investing. It does not state that todayÊs price will also be equal to tomorrowÊs price. real estate activity is stimulated by low long-term interest rates. several authors (best unnamed) picked the villain to be the widely accepted efficient market hypothesis ( EMH ). In 2009.

but the attempt „to get the speculators‰ might well have helped cause the Great Depression of the 1930s. Second. This is a strong lesson for diversification of investments. There are likely to be too many emotions and political considerations tied to the investigations for them to be useful. Finally.LESSONS TO BE LEARNED 175 statements regarding speculation. and then other events triggered the start of the decline. Third. which were made by important people and government bodies. Finally. Fourth. They were not wrong in their analysis but rather in their forecast of future market prices. Irving Fisher and John Maynard Keynes were both completely wrong in the fall of 1929. Objectivity is lacking and justice and understanding are likely to prevail only after a long period of time. They could not predict the marketÊs psychology. A shifting investor sentiment is catching and there is a snowball effect. Sixth. Seventh. building a very strong defense establishment might guarantee peace. . the period of 1929 to 1932 and beyond indicated that there could be long periods of time during which common stock would prove to be undesirable investments. The failure to anticipate the results of actions is always present. Fifth. So it is with optimism and pessimism when the optimism is met by only persistent announcements of coming doom. The investigators are too close to the events to see the causal relationships. It is possible that the market was too high when the Federal Reserve decided it was too high. major events can occur that are distorted by reporters of history to be something that they are not. thus the forecast of the next market turn is uncertain. For example. one straw will cause the light side to become the heavy side. The 1920s were not an orgy of speculation. there is the problem of mob psychology. and today it is not likely to be taken seriously as an important factor in a stock market price decline. even the best and the brightest minds can be wrong as to what is going to happen next in the stock market. but it might also wreck the competitive economic position of the country. Why is there a snowball effect on one day and not another? We do not know. This widely accepted belief was not proved. Consider a balance scale that is almost in balance while pieces of hay are being added to the high (light) side. margin buyers and speculators (including the short sellers) were blamed for the overpriced market and the resulting collapse. a major event such as a stock market crash gives rise to investigations and recommendations. A conclusion that the stock market was too high in September 1929 and thus crashed is much too simple an analysis and is not based on the facts. the attempt to use the money supply to control the stock market affected real business activity in ways that were not anticipated.

the Hatry scandal in England received a large amount of press and there began an outflow of foreign capital from the stock market. Most of us would not have predicted the market turn in October 1929. Although we can explain many of the statements and actions of the participants in terms of the „normal prejudices of the period. First NationalÊs observations of the economic scene at the end of 1929 are of interest: „The essential fact. The facts are that it is not obvious that the market was too high in October 1929 (or October 1987 or March 2008) or too low in 1933. stated that there had been excessive speculation. In addition. Simmons.5 billion. and this received a lot of attention (excessive speculation had to be stopped). actual measures of production output were turning down. In September. the nonbank broker loan money melted away and the price decreases fed on themselves as investors were sold out by their creditors. we probably would have bought in November and December 1929 and would have been ill prepared for the additional collapse in the spring of 1930. In the spring of 1930. while it may cause business a severe headache. the reports of real trouble in American industry gave stock market investors a valid reason to change their expectations and for the market to fall.176 BEATING THE BEAR which was accelerated by the withdrawal of nonbank loans from the broker call loan market and the relatively high cost of loans compared to dividend yields. Once the market turned down. broker loans reached a high of $8. and the business press all declared that the market was too high and that speculation needed to be controlled.H. the president of the NYSE. the action and statements of the Massachusetts Public Utility Commission received a lot of attention (discouraging investment in public utilities). wherein the present differs from most periods of great stock market declines in the past. But even if we had predicted that turn.‰ that is not an excuse for the actions taken in 1929. But one needs a heavy case of 20 – 20 hindsight to be able to define the market as being overvalued as of October 1929 or November 1929. should not seriously cripple the patient.‰16 But the Federal Reserve. In September.H. the Senate. Even E. There were voices of reason that could have been listened to and which might have changed history. Also in October. Also. In that . The obviousness only occurs after the fact. we would probably not have bought common stock in 1933 and would have missed the largest upturn in the history of the market (in the depths of the Great Depression). is that business itself is healthy and has not been involved in over-expansion with the stock market · which means that an attack of acute indigestion in securities.

600. that there was no real cause for the slump in value which they had suffered. AA. We will know more about that in another six months. nationwide banking should be authorized ( p.000 bad credit mortgages and by redefining the allocation of the cash flows from these 10.000 mortgages (the priority of payment) the financial institutions would be able to sell AAA.‰ On the same day Professor Irving T. And anyone who has purchased stocks on margin at any time during the last eight weeks is also in an unhappy position. The last hour was the worst. head of the department of economics at Yale University. declared that the prices of stocks were low. The big crash came yesterday. President Mitchell and Professor Fisher may both be right. But it must be obvious that anyone who bought stocks on their say-so with the expectation of immediate profits has been grievously disappointed. and that quotations were far behind real values.000. The financial community would take 10. 2. Brooklyn Daily Eagle: Predictions That Fail On Tuesday Charles E.18 Kaufman also believes in a separation of banking and commerce. No banking operations for Walmart. A (etc. CONCLUSION The development of the securitization process for mortgages facilitated the process of expanding the subprime mortgage market from 1990 to 2009. expressed the opinion that the stock market decline „had gone too far.000.‰ recent experience should provide it. If anyone wants proof that the market is „unpredictable. This morning the aggregate value of stock market issues stood several billions below what it was when these experts made their optimistic statements. 1929. On the other hand. Fisher.000. Mitchell. it should be strictly regulated ( p. president of the National City Bank and a high authority in financial matters. 126).LESSONS TO BE LEARNED 177 spirit consider the following enlightened editorial from the October 24.000 shares being thrown overboard for whatever they would bring. 115). The time may soon be here when the investor who buys stocks outright can get them at bottom prices. when paper values slumped by about $4.17 HENRY KAUFMAN (2009) Henry KaufmanÊs The Road to Financial Reformation makes the point that if a bank is too big to fail.). But for the next few days the high authorities who venture predictions will make it plain that they are not saying what may happen from one day to the next. investment-grade securities derived from the bad . another expert of wide repute.

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credit mortgages. Of course, the residuals (to receive payment after the investment-grade securities had received their contractual flows) would be much worse than the cash flow from the average of the overall portfolio. One could argue that this was merely equivalent to rearranging the chairs on the deck of the Titanic as it sailed the North Atlantic. But if the investors were attracted to the investment grade tranches and they could still be sold at a profitable price, it is likely that the securitization process expanded the market for subprime mortgages. Certainly Wall Street firms acted as if they thought that securitization facilitated the sale of subprime mortgages.

Chapter 14

POST-CRASH INVESTMENT STRATEGIES: BEATING THE BEAR MARKET

Wall Street booms because business is solidly prosperous. Wall StreetÊs buoyancy is the reflection of national prosperity and confidence to which its wondrous financial mechanisms potently contribute. Everyone is willing to invest in or bet on the prosperity of the United States. ·The Magazine of Wall Street, October 19, 1929 It is practical to define a bear market as a stock market that is at a level significantly lower than the marketÊs recent high. One obvious way to beat a bear market is to sell stocks short when they are at maximum prices. But there are two problems with this strategy. First, the stocks might go up rather than down. Second, not all investors are inclined to sell stocks short, given the large losses associated with stock prices going up rather than down after the sale. An alternative to selling short is to sell all currently held stocks in anticipation of a rapid decline in the stock indices. But what if your forecast is wrong? Also, selling all stock has the consequence of realizing for tax purposes all the accumulated capital gains on the portfolio. The tax bill could be large. A third alternative is to stop buying stocks until the bear market decline has ended. The problem here is that it is very difficult (impossible?) to forecast when the stocks are going to stop falling and start going up. In October 1929, Irving Fisher and John Maynard Keynes, possibly the worldÊs two leading economists of the time, were both surprised when

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stocks stopped climbing in the fall of 1929 and stock prices collapsed. They both thought that stocks were reasonably priced in October 1929 and were a good buy in that November and December. Keynes lost a lot of money for himself and his friends. Fisher lost all his wealth including his home. Both eminent economists thought December 1929 was the rock bottom for the market, but in fact (with hindsight) we know that stock prices would continue to fall until well into 1932. In fact, most of the stock price drops of the 1929 crash occurred after December 1929. In October 2008, the author of this book had a large amount of cash resulting from the acquisition for cash of the Anheuser–Busch corporationÊs stock equity by Inbev. As the stock market fell, especially financial services stocks, I bought financial firms I liked and knew well at bargain level prices. Three months later, these bargain prices turned out to be peaks that were not to be realized again in my lifetime. Fortunately, late in 2008, I remembered Fisher and Keynes and their actions in 1929 and stopped buying stocks. Beating the 2008 bear market for me was to stop buying in the fall of 2008. The gains from selling Anheuser–Busch stock were more than balanced by losses from the financial stocks bought in the summer and fall of 2008 (Lehman Brothers, Citigroup, Merrill Lynch, Wachovia, etc.). A GOOD SOLUTION BUT . . . There is a good solution for beating the bear market, but the individual investor cannot implement it. A healthy economic environment with corporations making profits and growing will result in a bull stock market and the disappearance of bear investors. THE LESSONS There are several lessons to be taken away from both the 1929 and 2008 bear stock markets. Lesson 1 is that the initial stock price decreases may not have been justified by the economy or the firmsÊ profit performances. Thus there is a tendency to say, now is a buying opportunity. But soon the firmsÊ unsatisfactory operating results catch up with the lower stock prices and the stock prices, rather than being too low, start looking too high. Lesson 2 is that it may be tempting to buy stocks when the bear market starts, but the basic investment strategy rules still apply. The number 1 investment rule is to diversify. This means that one should not only invest in stocks but also place some resources in assets that are not highly correlated with the level of the stock market.

POST-CRASH INVESTMENT STRATEGIES

181

Lesson 3 is learned from both 1929 and 2008. One might think that the stock market level is justified by the financial performance of the firms and the economy. But history proves that major stock price surprises do occur, and most of us are not bright enough to judge when declines in stock prices are going to be seen. Are your portfolio asset mix and your wealth needs consistent with a 50 percent surprise decline in stock prices? The fact is that the stock price level is volatile and your investment strategy should be consistent with that fact. The reasons for the volatility may not be discovered until well after the prices decline. In 1929, the October stock crash was triggered by the collapse of public utility stock prices, after a decision by the Massachusetts public service commission and attempts by the Hoover administration to stop stock speculation. The decision by the Massachusetts public service commission and its consequences were surprises to the average investor in the stock market. In 2008, real estate prices stopped going up. The average investor in stocks was not aware that for a number of years banks had made loans to house buyers who did not have sufficient resources or incomes to buy the real estate. These transactions gave rise to a large number of subprime mortgages. In addition, bond rating agencies were lax (generous?) in their reviews of the creditworthiness of the mortgage paper (or collateralized debt obligations) that resulted from the issuance of the subprime mortgages. Thus favorable credit ratings were given to debt securities that were not good credit risks. Some firms that bought this risky paper engaged in credit default swaps (CDSs), where they paid a fixed fee each period to some entity (say AIG); they would then be paid by the swap counterparty only if the mortgage was not paid. The buyers of these CDSs failed to notice that the counterparty of many swaps tended to be one counterparty. When real estate prices stopped going up, the borrowers stopped paying on mortgages where the total owed was larger than the value of the property on which the mortgage was taken ou. The counterparty in the CDSs was then unable to pay, given the very large number of defaults, and banks were left with bundles of nearly worthless mortgages. Given that the mortgage investments were frequently financed with more than $30 of debt for each dollar of equity, it did not take many defaults to cause banks to have severe financial difficulties. Banks had a surplus of bad assets and were not eager to add to their collection of risky unliquid assets; thus the credit markets froze. With no credit, business activity shrank rapidly and a recession began. What started as a financial sector stock price decline rapidly spread to other sectors as the lack of credit and growing pessimism caused the entire stock market to fall more rapidly and severely than it had ever fallen.

especially short-term debt. I converted my major asset (my retirement amount with College Retirement Equities Fund) from stocks to a variety of other investments.. the offering of mortgages to unqualified buyers. some profit-seeking financial entities will use too much debt and the financial institutions will fall into difficulties. Lesson five. We cannot accurately estimate and completely avoid risk. The second is that risk can be hedged and thus be completely eliminated. in itself. but we are safe (economically self-contained). All my choices were not optimal (e. sloppy credit analysis by credit rating agencies. One is that future risk can be very accurately estimated. when taxed. In addition. In 2008. if not constrained by law. my decisions overall turned out to be reasonable. the basic financial risk is magnified by the financing of assets with debt. in 1929.182 BEATING THE BEAR Thus. thus the hedge may not be completely effective. CONTINUATION OF LESSONS AND ILLUSIONS Lesson four for investors. but in general. Given the tax laws and a desire not to be exposed to large potential losses from common stock price shocks. Such gains on stocks (dividends and capital gains) were taxed at 15 percent. which then triggered a financial panic. in actual fact the counterparty absorbing the risk is also subject to the risk of not being able to pay. my investment portfolio reached a level that I thought was adequate for the future needs of my family. the financial markets always have risk. given the 2008 crash. The period 2008 – 2009 has shown how intertwined most or all countries are. The average investor in common stock in 2008 did not realize that this set of events was laying the foundation for a 50 percent drop (and more) in stock prices. and the use of excessive short-term leverage by investing banks led to defaults of subprime mortgages. a decision by one stateÊs public service commission regarding a stock split (one share of common stock was to become three shares) · which.g. The third illusion is that another country may be at risk. the tax laws favored stock investments that were not protected by tax-deferral provisions. had zero real financial significance · triggered the great 1929 crash. were taxed at 35 percent. Lesson six. while tax protected investment vehicles. an investment in a Real Estate Investment Trust was less than optimal). . ACHIEVING THE WEALTH TARGET In 2003. While one can think the risk is perfectly hedged. There are also three illusions held by many.

Protect consumers and investors from financial abuse. that rewards innovation. The above proposals are described as being essential ( p. but „More can and should be done in the future. The objectives of the proposals (p. One cannot invest in common stock and expect with certainty that all will be well for all time. it could be the result of legislation to correct the 2008 – 2009 turmoil in the financial markets. 4). BEATING THE BEAR: LESSONS FROM THE 1929 CRASH APPLIED TO TODAYÊS WORLD We live in a world of uncertainty. 2. the Department of the Treasury published a position paper titled Financial Regulatory Reform. Promote robust supervision and regulation of financial firms. Although the market might ultimately recover the losses and prove the most desirable investment alternative. 2) are as follows: „We must build a new foundation for financial regulation and supervision that is simpler and more effectively enforced. 3–5): 1. Raise international regulatory standards and improve international cooperation. 5. 3. and that is able to adapt and evolve with changes in the financial market.‰ Everyone can agree that something should be done to prevent the recurrence of the fall 2008 financial panic and the resulting harm to the worldÊs economy. Establish comprehensive supervision of financial markets. This means that the average investor should be diversified sufficiently to withstand the shocks in value that history has proven that can and will occur. . that protects consumers and investors.1 We can expect the laws that Congress will pass to follow some of the suggestions supplied by the Treasury. The problem is that there is a tendency to overreact and pass legislation that excessively restricts the freedom of the financial markets.‰ The five key objectives of the reforms are ( pp. This was the result of the financial legislation passed by Congress in the 1930s. 4. the recovery period might be too long for the average investor.POST-CRASH INVESTMENT STRATEGIES 183 PROPOSED REFORM·2009 In 2009. Both 1929 and 2008 teach us the lesson that the stock market can experience severe decreases in value. Provide the government with the tools it needs to manage financial crisis. and unless we are careful (and thoughtful).

7 billion and earned an internal rate of return of 0. It is likely that scholars 10 years or more from now will see things that we are too close to in 2009 to analyze properly. the Fed cut the funds rate to zero.1274 on an annualized basis).S. Of course. 2009). 12) and an equivalent amount of criticism (see Anna Jacobson Schwartz. But it is possible that this book can help to build a foundation for those future scholars. In any event. . p.6 billion of TARP funds they had received (Wall Street Journal. Both authors note that the Fed appropriately followed in 2008 and 2009 a monetary policy of extreme ease. However. government were to be seen. Essentially. The New York Times Sunday Opinion. But SchwartzÊs primary criticism was that Bernanke was silent when the Wall Street firms were buying high-risk securities with large amounts of low-cost debt. She is right. I tried. Schwartz warns that the consequences of such a policy can be excessive investment and the creation of a bubble. p. July 26. 2009. 12).184 BEATING THE BEAR THE RECORD OF BEN BERNANKE (2008–2009) Ben Bernanke was chairman of the Federal Reserve during the period of 2008 – 2009. a total of 22 banks had paid back the $40. But we can be optimistic that the federal government will make a reasonable return on its TARP investments (leaving out the auto industry).101 for a period of less than a year (0. His performance received considerable praise (see Houriel Roubini. It should be remembered that the objective of TARP was not to make profits for the federal government but rather to stabilize the financial and credit offering systems. PERSPECTIVE AND CONCLUSIONS Writing about the panic and crash of 2008 – 2009 as it occurs is somewhat limiting. But should Bernanke have known that the quality of newly issued mortgages had decreased and that credit rating agencies had relaxed their standards? It will be interesting to find out what information Bernanke had and what information he could have gotten had he requested it. TARP: SOME INCOMPLETE RESULTS The Troubled Asset Relief Program (TARP) was implemented in the fall of 2008. As of August 2009. the story on the profitability of half of the TARP funds is not yet written. July 26. given the facts that were brought to light in 2008. it would be nice for the economy if a profit for the U. August 28. 2009. The federal government received $44. The New York Times Sunday Opinion.

Ibid. Herbert Hoover. p. DC: U. 1. DC: U. Ibid. 4. Ibid. 17. Ibid. 3. 111. Ibid. Ibid.NOTES INTRODUCTION 1. Senate Committee on Banking and Currency. 8. 9. Ibid. 1929). 2. 69. 10. 5. 121. p. Ibid. p. Stabilization ( Washington. pp. 2. Ibid.S. p. Ibid. Ibid. p. BrokersÊ Loans (Washington. 79–80. 12. The Memoirs of Herbert Hoover (New York: Macmillan. 5. 7. p. 77. Government Printing Office. House of Representatives. Ibid. 14. . p.. 80.. 118. 16. 6. p. Ibid. 15.... 11.. p. Ibid. Ibid.. 1952). Government Printing Office.S. Committee on Banking and Currency. CHAPTER 2 1.. 1928). p. 96. 13.

M. my former colleague at Cornell University.‰ Business History Review (Summer 1975). Friedman and A. p.. p. 75. 18. May 1987. p. p. p. M. Economic History. 14. 11. pp. p. Bogart and Kemmerer. Friedman and Schwartz. 297–98. 3. 21. Friedman and Schwartz. 298. 91– 93. CA: Stanford University Press. . The National City Bank of New York Newsletter (June 1929). „Market Fundamentals versus Price-Level Bubbles: The First Tests. The Lords of Creation (New York: Harper. Ibid. 1933). J. Schwartz. The National City Bank of New York Newsletter (April 1929). R. 1867–1960 (Princeton. 16. 6. Kindleberger. 39. 175. April 1929. 234. The South Sea Bubble (Stanford.‰ Journal of Political Economy. 13. 20. Central Banker (Washington. Ibid. P. 1958). Ibid. Nilsson. Proceedings of the Nineteenth Annual Convention of the Investment Bankers Association of America (Chicago. J. Garber. 1963). 3. 20. 412. p. M. p. NJ: Princeton University Press. A Monetary History of the United States. The National Cyclopedia of American Biography. 76. A Monetary History of the United States. Investment Bankers Association of America. DC: Brookings Institute. „The Stock Market of 1929 Revisited: A Note. p. 241. March 1929. 745–70. 1960). presented this fable in an unpublished paper entitled „Making Securities Secure. J. L. 1935). pp.‰ American Economic Review. 9. 12. 10.. 1932). Friedman and A. 249. Allen. August 1980. 17. For a set of a priori reasons casting doubt on the importance of sunspot variables and why these are not good reasons for ruling out self-fulfilling expectations. 19. G. 396. P.‰ 19. p. C. pp. 231. The Federal Reserve Bulletin. Manias. 8. 1963). White. Panics. 1978). CHAPTER 4 1. p. 15. L. 353. p. Schwartz. Monetary History. Sirkin. 7. 1930). Arthur E. p. pp. 2.. NJ: Princeton University Press. Ibid. F. The South Sea Bubble (London: Peter Davies. Ibid. Flood and P. The Federal Reserve Bulletin. Viscount Erleigh. p. and Crashes ( New York: Basic Books. 22 (New York: James T.. 816. 75 –76. 49. Different sources will give different rates but the same magnitudes.186 NOTES 18. 4. see M. Benjamin Strong. V. Chandler. Woodford. 5. Carswell. p. 17. vol. p. CHAPTER 3 1. „Three Questions about Sunspot Equilibria as an Explanation of Economic Fluctuations. Monetary History. 1867–1960 (Princeton.

19. 4. Senate Committee on Banking and Currency. NJ: Princeton University Press. 1933). Miller. 456. p. Benjamin Strong. 289. The Memoirs of Herbert Hoover (New York: Macmillan. 260. William Allen White. p.. p. „Business. Warburg. Chandler. 49. 512–514. Appendix 2 is made up of excerpts from the 1933 stock exchange practices hearings before a subcommittee of the U. 11. S. pp. 447– 48. 18 –19. 12.‰ p. Central Banker (Washington. In fairness to Mellon. Ibid.‰ The Magazine of Wall Street (June 15. „Federal Reserve Policies. Miller. Monetary History. OÊConnor. Government Printing Office. WorldÊs Work (June 1929). 454. CHAPTER 6 1. IL: Dow Jones–Irwin. p.‰ p. 15.‰ pp. Ex-Senator Owen. Quoted in „Behind the Scenes with the Federal Reserve Board. Benjamin Strong. as quoted in Chandler. p. p.‰ American Economic Review (September 1935). P. Chandler.S. 1939. Memoirs. The Dow Jones Averages. 14. p.S. 5. his statement was made at the request of Hoover. pp. as quoted in L. Friedman and Schwartz. 1885 –1985 (Homewood. See H. Herbert Hoover. The thinking of Miller and Hamlin is illustrated by the following Hamlin entry (February 11): „Miller reminded me that Governor Norman at our lunch said his purpose in coming over was to pay his respect to Governor Harrison of Federal Reserve Bank of New York·never mentioning Governor Young of the Federal Reserve Board!‰ Norman went to Washington only because Harrison had strongly recommended it. H. DC: Brookings Institute. M. p. „Federal Reserve Policies: 1927–1929. 1986). . 3. DC: U. MellonÊs Millions (New York: John Day. Cited in Hoover. Leinbach. 2. 18. Monetary History (Princeton. „Federal Reserve Policies. pp. A. The Memoirs of Herbert Hoover (New York: Macmillan. 456. 443. p. B. was one of the proponents of this position. 1963). 7. The Federal Reserve System: Its Origin and Growth (New York: Macmillan. 9. Pierce. 18. 48. 370. 465. 1952). Benjamin Strong. Stock Exchange Practices (Washington. pp. Friedman and Schwartz. 6. 17. M. 310. 10 –14. Burger and A. C. one of the framers of the act establishing the federal reserve system. Strong. „Federal Reserve Policies. 1934). 10. All market measures in this chapter are from P. A Puritan in Babylon. Committee on Banking and Currency. William Hard. 20. E.‰ WorldÊs Work (June 1929). V. Miller. 1952). 8. p. 1929). p. 16. p. K. Hoover. 1958). 290. 17. Miller. 1930). 13.NOTES 187 2. 453 – 54.

188

NOTES

3. The New York Times, March 4, 1929, p. 3. 4. The Financial Chronicle, August 3, 1929, p. 683. 5. Forbes, August 1, 1929, p. 25. 6. The Magazine of Wall Street, August 24, 1929, p. 736. 7. The Financial Chronicle, August 10, 1929, p. 847. 8. The Financial Chronicle, September 7, 1929, p. 1505. The term „forced accounting‰ was used because the accounting was necessary to conform to the relatively new tax laws. 9. The New York Herald Tribune (September 6, 1929). 10. Preston Field, The Magazine of Wall Street (October 19, 1929), p. 1077. 11. Forbes, October 1, 1929, pp. 19 – 21. 12. The Commercial and Financial Chronicle (November 23, 1929). 13. C. P. Kindleberger, Manias, Panics, and Crashes (New York: Basic Books, 1978). 14. The Magazine of Wall Street (November 16, 1929), p. 91. 15. J. K. Galbraith, The Great Crash, 1929 (Boston: Houghton Mifflin, 1961), pp. 51 –70. 16. Hearings before a Subcommittee of the Committee on Banking and Currency United States Senate, Part 3 (Washington, DC: U.S. Government Printing Office, 1931), p. 480. 17. Forbes (November 15, 1929), p. 24. 18. Irving Norton Fisher, My Father, Irving Fisher (New York: Comet, 1956), p. 264. 19. J. Wanniski, „The Smoot–Hawley Tariff and the Stock Market Crash of 1929,‰ Midland Corporate Finance Journal (Summer 1987): p. 11. 20. Ibid., p. 13. 21. Committee on Banking and Currency, Stock Exchange Practices (Washington, DC: U.S. Government Printing Office, 1934), p. 7. 22. Ibid., p. 5.

CHAPTER 7
1. Daniel Gross, Dumb Money (New York: Free Press, 2009). 2. K. Kelly, Street Fighters: The Last 72 Hours of Bear Stearns the Toughest Firm on Wall Street (New York: Portfolio, 2009). 3. W. D. Cohan, House of Cards: A Tale of Hubris and Wretched Excess on Wall Street (New York: Doubleday, 2009). 4. Office of Inspector General, Office of Audits, SECÊs Oversight of Bear Stearns and Related Entities: The Consolidated Supervised Entity Program (Washington, DC: U.S. Securities and Exchange Commission, 2008). 5. L. G. McDonald and P. Robinson, A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers (New York: Crown Business, 2009). 6. R. Lowenstein, When Genius Failed (New York: Random House, 2000), p. 234.

NOTES

189

7. D. Wessel, In Fed We Trust, Ben BernankeÊs War on the Great Panic (New York: Crown Business, 2009). 8. Paul Krugman, „School for Scoundrels,‰ The New York Times, Book Review, August 6, 2009, p. 11. 9. J. Fox, The Myths of the Rational Market (New York: HarperCollins), 2009.

CHAPTER 8
1. Committee on Banking and Currency, Stock Exchange Practices (Washington, DC: U.S. Government Printing Office, 1934), p. 9. 2. I. Fisher, The Stock Market Crash and After (New York: Macmillan, 1930), p. 41. 3. The Federal Reserve Bulletin, December 1929, p. 783. 4. E.H.H. Simmons, The Principal Cause of the Stock Market Crisis of Nineteen Twenty-Nine (New York: New York Stock Exchange, 1930), p. 10. 5. Fisher, The Stock Market Crash, p. 229. 6. Ibid. 7. The First National City Bank of New York Newsletter, November 1929, p. 164. 8. Ibid., p. 159. 9. Ibid., p. 164. 10. Stock Exchange Practices, pp. 31–32. Whitney was Richard Whitney, vice president of the NYSE in 1929. 11. Ibid., p. 42. 12. As shown in J. Edward Meeker, Short Selling ( New York and London: Harper, 1932), p. 251. 13. Ibid., p. 252. 14. M. Mayer, Wall Street: Men and Money (New York: Harper, 1955), p. 75. 15. F. R. Macaulay and D. Durand, Short Selling on the New York Stock Exchange (New York: Twentieth Century Fund, 1951 [mimeographed]). 16. Ibid., p. ix. 17. Ibid., p. xiv. 18. Fisher, The Stock Market Crash, p. 44. 19. The Commercial and Financial Chronicle, September 21, 1929, p. 1008. 20. The Commercial and Financial Chronicle, September 28, 1929, p. 1957. 21. The Commercial and Financial Chronicle, October 5, 1929, p. 2121. 22. The Federal Reserve Bulletin, December 1929, p. 757. 23. Fisher, p. 48. 24. For an interesting discussion of the effects of the availability of credit in financial markets on the real sector, see B. S. Bernanke, „Nonmonetary Effects of a Financial Crisis in the Propagation of the Great Depression,‰ American Economic Review (June 1983), pp. 257– 76.

190

NOTES

CHAPTER 10
1. R. G. Ibbotson and R. A. Sinquefield, Stocks, Bonds, Bills and Inflation: The Past and the Future (Charlottesville, VA: Financial Analysts Research Foundation). Appendix 2 to this chapter gives roughly the same relative magnitudes, but there are differences depending on the exact method of calculation. 2. Using the change from 1928 to 1932, we have: (1.908 – .540) ÷ 1.908 = .72. 3. J. K. Galbraith, The Great Crash, 1929 (Boston: Houghton Mifflin, 1961), p. 16, 29. 4. P. A. Samuelson, „Myths and Realities about the Crash and Depression,‰ Journal of Portfolio Management (Fall 1979): 9. 5. Ibid. 6. M. Friedman and A. J. Schwartz, A Monetary History of the United States, 1867–1960 (Princeton, NJ: Princeton University Press, 1960), p. 247. 7. Ibid., pp. 241– 43. 8. I. Fisher, The Stock Market Crash and After (New York: Macmillan, 1930), p. 89. 9. Ibid, p. 90. Fisher points out · with a characteristic touch of humor · that an interest rate of 3.4 percent converts to a price earnings ratio of 33 to 1. 10. J. S. Lawrence, Wall Street and Washington (Princeton, NJ: Princeton University Press, 1929), p. 88. 11. The Federal Reserve Bulletin, August 1930, p. 494. 12. J. W. Kendrick, Productivity Trends in the United States (Princeton, NJ: Princeton University Press, 1961). 13. KendrickÊs last period of study was 1948 –1953. 14. Lawrence, Wall Street and Washington, pp. 177, 187. 15. Fisher, Stock Market Crash, p. 91. 16. Forbes (October 15, 1929): 95. 17. The Magazine of Wall Street, June 1, 1929, p. 197. 18. The National City Bank of New York Newsletter, October 1929, p. 197. 19. Barrie A. Wigmore, The Crash and Its Aftermath (Westport, CT: Greenwood, 1985), p. 572. 20. Ibid., p. 641. 21. Ibid., p. 648. 22. Forbes (October 1, 1929): p. 77. 23. E. K. Burger and A. M. Leinbach, „Business,‰ The Magazine of Wall Street, June 15, 1929, p. 289. 24. The Federal Reserve Bulletin, October 1929, p. 665. 25. H. Kaufman, The Road to Financial Reformation: Warnings, Consequences, Reforms (New York: John Wiley & Sons, 2009). 26. Ibbotson Associates, Stocks, Bonds, Bills and Inflation: 1988 Yearbook (Chicago: Ibbotson Associates, 1988), pp. 177, 162. The index is based on the record of 90 of the largest stocks (p. 27). 27. Burton G. Malkiel, A Random Walk Down Wall Street (New York: Norton, 1975), pp. 37, 38.

NOTES

191

28. J. B. Williams, The Theory of Investment Value (Cambridge, MA: Harvard University Press, 1938), p. 520. Williams states the stock reached an all-time high of $310 in 1929 (p. 523). We did not reconcile the difference between MalkielÊs and WilliamsÊs estimates, but it probably involves the valuation of rights attached to the stock. 29. Ibid., pp. 516 –17. 30. B. Graham and D. L. Dodd, Security Analysis (New York: McGraw-Hill, 1934), p. 6. 31. Williams, Theory of Investment Value, pp. 572 – 73. 32. Ibid., p. 512. 33. G. Sirkin, „The Stock Market of 1929 Revisited: A Note,‰ Business History Review (Summer 1975): 223–31. 34. Ibid., p. 226. 35. Ibid., p. 230. 36. Ibid., p. 231. 37. R. Sobel, Panic on Wall Street (New York: Macmillan, 1968), p. 368.

CHAPTER 11
1. Galbraith, J. K., The Great Crash, 1929 (Boston: Houghton Mifflin, 1961). 2. U.S. Senate Subcommittee on Banking and Currency, Stock Exchange Practice Hearings, (Washington, DC: U.S. Government Printing Office, 1933). 3. Pecora, F., Wall Street Under Oath (New York: Simon and Schuster; 1939). 4. Hoover, H., The Memoirs of Herbert Hoover (New York: Macmillan, 1952). 5. U.S. Senate Subcommittee, Stock Exchange Practice Hearing. 6. The term „selling against the box‰ refers to a process in which an investor owning stock, wanting to „protect‰ a gain, sells the stock short. If the stock goes down, the investor wins. It is a legitimate process (though not necessarily advisable).

CHAPTER 13
1. Forbes (October 1, 1929), p. 11. 2. Ibid. 3. J. S. Lawrence, Wall Street and Washington (Princeton, NJ: Princeton University Press, 1929), pp. 187, 245. 4. Investment Bankers Association of America, Proceedings of the Nineteenth Annual Convention of the Investment Bankers Association of America (Chicago: ABAA, 1930). 5. E.H.H. Simmons, The Principal Causes of the Stock Market Crisis of Nineteen Twenty-Nine (New York: New York Stock Exchange, 1930), pp. 3 – 7. 6. Forbes (December 15, 1929), p. 26. 7. Forbes (December 1, 1929), p. 68.

The First National City Bank of New York Newsletter (December 1929). Government Printing Office.. 17. Kaufman.. 2009). Ibid.. 681–91. The Memoirs of Herbert Hoover (New York: Macmillan. p. 1952). pp. 169. Schumpeter. 18. . p.S. and 873 –77. Volume IX. 1939). Department of the Treasury. Ibid. DC: U. p. (New York: John Wiley & Sons. Stock Market Study.. p. Herbert Hoover. 10. 11. 1961). Depression Decade. 15. Twenty Years of Federal Reserve Policy (Cambridge. 1003. hearings before the Committee on Banking and Currency. pp. Consequences. Senate (Washington. see S. 1002. Rinehart and Winston. 12. CHAPTER 14 1. The Economic History of the United States (New York: Holt. 1933). pp. 13. and J. 1955).S. 16. p. 2009. 5. 10.192 NOTES 8. 9. E. 1929). 17. 596 – 611. A. U. Business Cycles (New York: McGraw-Hill. 16. H. Brooklyn Daily Eagle (October 24. Ibid. For two academic discussions of this issue. 13. Financial Regulatory Reform. 14.. Broadus Mitchell. MA: Harvard University Press. Ibid. p. Reforms. The Road to Financial Reformation: Warnings. p. Harris. 18.

(1960). The Lords of Creation. E. Bluefield Water Works v.). Economic History of the American People.. „Stock Market Crash of October 1929. Bogart. New York: Longmans. Newman. Chicago: University of Chicago Press.. (1992). „Business. DC: Brookings Institute. and J. The Great Myths of 1929 and the Lessons to be Learned. (1986). Gordon (ed. New York: Harper. Washington. Government Printing Office. The South Sea Bubble. L. Barsky. L.‰ American Economic Review (June).S.‰ Journal of Economic History (June). H.‰ in The American Business Cycle. (1935).‰ in The New Palgrave. Washington. Stanford. F. 262. L. (1929). Balke. and D. „Bull and Bear Markets in the Twentieth Century. Carswell.C.BIBLIOGRAPHY Allen.. Burger. E. (1958). Benjamin Strong. Committee on Banking and Currency. 265 – 68. L. J. B. Westport. B. K. M. Leinbach. (1983). (1990). R. Gordon. S.. J. G. Bierman. 257–76. Brooklyn Daily Eagle. . and A. London: Macmillan. P. U.. P. Eatwell (eds. and J. 1929. J. (1991).). M. (1931). R. and R. Milgate. DeLong. Hearings on Performance of the National and Federal Reserve Banking Systems. (1944). Central Banker. „Historical Data. „Nonmonetary Effects of a Financial Crisis in the Propagation of the Great Depression. October 24. CT: Greenwood Press. S. Chandler. 679 (1923).S. CA: Stanford University Press. Kemmerer. Jr. N.S. B. Green. V. Bernanke. DC: U. Cecchetti. S.‰ The Magazine of Wall Street (June 15).

(1934). and A. . 591 (1944). The Hatry Case. C.S. C.. DC: U. The American Business Cycle. (1937). My Father. (1979). (1980). (1929). S. (1929). Hatry. (1928). The Stock Market Crash and After. DC: U. (1961). London: Peter Davies. (1939). Hearing Before a Subcommittee of the Committee on Banking and Currency. Graham. Washington. New York: Comet. Hearings of Senate Committee on Banking and Currency on BrokersÊ Loans. Princeton.) DeLong. Government Printing Office. 1960. S. 675 – 700. M.S. J. J. Boston: Houghton Mifflin. Dodd. 1867. Washington. (1933).p. U. Security Analysis. and P. The South Sea Bubble. L. C. Gordon. Crisp.S. London: Rich and Cowan. Erleigh. Papers. and D. MA: Harvard University Press. (1933). Galbraith. Government Printing Office. E. B. The Great Crash. (1931). Library of Congress. K. Washington. WorldÊs Work (June).194 BIBLIOGRAPHY Committee on Banking and Currency. Washington. William. Fisher. and Andrei Schleifer. A Monetary History of the United States. Cambridge. J. Hope Natural Gas Company 320.‰ Journal of Political Economy (August). G. (1928 –1929). J. The Federal Reserve Bulletin. Friedman. DC: U. Garber. (1986). I. Hearings of House Committee on Banking and Currency on Stabilization. (1956). Federal Power Commission v. 1929. New York: Macmillan. United States Senate. R. „The Great Crash. R. Viscount. M. K.S. Stock Exchange Practices. Eight Current Misconceptions. Twenty Years of Federal Reserve Policy. NJ: Princeton University Press. Government Printing Office. Schwartz. Committee on Banking and Currency. (Prepared by seventeen friends of Clarence C. (1991). Part 3. Hard.‰ Journal of Economic History (September).... Stock Exchange Practices. et al. Irving Norton. Fisher. „Market Fundamentals versus PriceLevel Bubbles: The First Tests. Chicago: University of Chicago Press. Hatry. I. Galbraith. Light Out of Darkness. London: n. 60 – 62. (1963).‰ Journal of Portfolio Management (Fall). Hamlin Diary. P. J. DC (unpublished).. New York: Archives of the Federal Reserve Bank of New York (unpublished). Harrison. New York: McGraw-Hill. (1934). The Commercial and Financial Chronicle. 745 – 70. The First National City Bank of New York Newsletter. (1928). B. Most of the seventeen had impressive credentials. Hamlin. (1930). Irving Fisher. (1933). 48. „The Stock Market Bubble of 1929: Evidence from Closed-End Mutual Funds. Harris. April–May. Flood. February–March.

Investment Bankers Association of America. C. New York: Simon and Schuster. M. A Report by the Division of Market Regulation. Stocks. (1931).S. E. New York: Twentieth Century Fund. Mayer. New York: Macmillan. Santoni.BIBLIOGRAPHY 195 Hoover. (1975 and 1996). NJ: Princeton University Press. (1961).W.K. (1929). Lowe. Short Selling on the New York Stock Exchange. OÊConnor. Wall Street Under Oath. Meeker. Short Selling. NJ: Princeton University Press. White. (1988). Chicago: Ibbotson Associates. B. Vol.‰ Journal of Economic History (September).). R. Wall Street and Washington. A. U. „In Search of Stock Market Bubbles: A Comment on Rappoport and White. The October 1987 Market Break. Ibbotson. . and C. (1988). Charlottesville. (1961). An EconomistÊs Biography. New York: Basic Books. I. Proceedings of the Nineteenth Annual Convention of the Investment Bankers Association of America. Rinehart and Winston. The Collected Writings of John Maynard Keynes. New York: Norton. and A. and D. Gleerup. New York: James T. New York and London: Harper. Princeton. Macaulay. New York: Holt. W. (1932). (1978). C. Hegeland (ed. D. XX. (1981).‰ in The Security Markets. E. Moggridge. Chicago. Princeton. J. H. Chicago: University of Chicago Press. (1932). G. London: Routledge. (1952). Kindleberger. Jones. (1933). „Some Notes on the Economic Policy of the United States During the Period 1919 – 1932. B. C. (1935). Stocks. Bills and Inflation: The Past and the Future. McDonald. (1930). D. H. H. Productivity Trends in the United States. (1955). Kendrick. Panics. F. Securities and Exchange Commission (February). (1982). 75–76. (1935). Insull: The Rise and Fall of a Billionaire Utility Tycoon.‰ American Economic Review (September).. J. Malkiel. Sinquefield. Stone. 447–56. The National Cyclopedia of American Biography. Maynard Keynes. F. Vol. „Federal Reserve Policies: 1927–1929. F. G. Sweden: C. Wall Street: Men and Money. Manias. New York: Twentieth Century Fund (mimeographed). Ibbotson Associates. 647 – 54. F. P. (1995). Durand. (1992). „Manipulation.. Lawrence. W. G.. A Random Walk Down Wall Street. Miller. The Memoirs of Herbert Hoover. New York: John Day. (1961). Bills and Inflation: 1988 Yearbook.. Growth and Methodology. R. London: Macmillan. and Crashes. J. D. A. MellonÊs Millions. S. Bonds. Bonds. 22. in Money. Pecora. (1962). T. The Economic History of the United States. Moggridge. New York: Harper. (1939). Mitchell. VA: Financial Analysts Research Foundation. J. Pedersen. and R. Liu. Depression Decade: Volume IX.

. (1975). L. N. Philadelphia. G.S. (1994). „The Stock Market of 1929 Revisited: A Note. Simmons. The Economic History of the United States.. New York: Morrow. 1885–1985. Garden City. (1955).‰ Journal of Economic History (September). „Was There a Bubble in the 1929 Stock Market?‰ Journal of Economic History (September). Senate. White.S. (1930). White. PA: Transportation Club. (1985). and M. The Plungers and the Peacocks. Rappoport. A. Sloan. and E. Rinehart and Winston. G. The Great Bull Market. New York: Macmillan.S. and E. P. DC: U. E.. 549 – 74. (1979). Senate. DC: U. P. „The Great Bull Markets 1924 – 29 and 1982 – 87: Speculative Bubbles or Economic Fundamentals?‰ Federal Reserve Bank of St. Santoni. White. M. Sobel. (1968). NY: Doubleday. Soule. (1963). J. Thomas. The Federal Reserve System: Its Origin and Growth. New York: Putnam. B. CT: Greenwood. „Stock Market Bubbles? A Reply. Thomas. P. 6 – 23. (1979). Cambridge. (1987). The Dow Jones Averages. U. Washington. Government Printing Office. 655 – 65. Washington. Volume VIII. The Day the Bubble Burst. (1962). WorldÊs Work. Samuelson. NY: Doubleday and Company. T.‰ Journal of Portfolio Management (Fall). Stock Market Study. Hearings before the Committee on Banking and Currency. Prosperity Decade. (1987). N. J. Warburg. New York: Holt.S. Garden City. (1930). Louis Review (November). Government Printing Office. S. (1933). The Principal Causes of the Stock Market Crisis of Nineteen Twenty-nine. Jr. R. (1995). (1938). MA: Harvard University Press.. (1968). 271 – 81. Williams.‰ Midland Corporate Finance Journal (Summer). U. (1979). 16 – 29. E. „The Smoot-Hawley Tariff and the Stock Market Crash of 1929. Jr. Shachtman. (1940). D. (1967). . The Crash and Its Aftermath: A History of Securities Markets in the United States. New York: Norton. „Where Are the CustomersÊ Yachts?‰ New York: Simon and Schuster. Wall Street in the 1920s.H. The Theory of Investment Value. New York: Macmillan. Sirkin. „Myths and Realities About the Crash and Depression. G. P. (June 1929). Wanniski. Panic on Wall Street. „Was the Crash of 1929 Expected?‰ American Economic Review (March).‰ Business History Review (Summer). (1993). My Years with General Motors. J. Morgan-Witts. F. P. Rappoport. R. 223 – 31.196 BIBLIOGRAPHY Pierce. A. N. Sobel. Subcommittee of the Committee on Banking and Currency. Westport. B. Homewood: Dow Jones–Irwin. (1986). A. The Day America Crashed. Stock Exchange Practices Hearings. 1929 – 33. G. P. Wigmore.H. Schwed.

1929. 1929. 1929 – 1930. 1929. September 6. The New York Herald Tribune. The Commercial and Financial Chronicle. October 1929. The Economist. The Washington Post. 1930. The Financial Times. The First National City Bank of New York Newsletter. October 15. 1925. October 1929. October 1929. .BIBLIOGRAPHY 197 NEWSPAPERS AND OTHER PERIODICALS The Boston Daily Globe. The New York Times. September 1929 – January 1930. The Magazine of Wall Street. The Listener. October 1929. 1929 and 1930. Forbes. The Federal Reserve Bulletin. 1929. London. The Wall Street Journal.

.

industrial. 68. stock buying during. 19. 9 – 10. 168. 129 Babson. George. 179 – 80. 68. James C. 145 – 46. financing. trading. 79. securing loans with. 177 – 78 American Can Company. 174. financing. 41. 159. George W.INDEX AAA ratings. 159 Bluefield Water Works v. Bernard. 89. 58. public utility. 62. 71. 86 – 87. 184 Black Thursday (October 24.. 80.. 107 Bernanke. 125. as excessive. 60 – 61. 27. 118. 70. 13. (AIG). 128. 73. 100 Burger. 107. 179. 120 American International Group. 86. 138 Brandeis. 70. Ben. government. mortgage. 1929). 79 Business credit. (administration). 91. prices of.. from Peru. 106 Baker. 115. 34. 99. John. Warren. common stock vs. 71. 150 Broker loans. P.. 160 Bonds: buying.C. lessons from.S. 66. 154 Blunt. 115. 91. 60 – 62. Roger W. 46 Bank loans. yields from. 80. 57. 165 Baruch. 74. K. 66. 107 Bank of America. to stock. 22 – 24. decreasing. 181. 87 American Telephone & Telegraph (AT&T). 169. 108. 118. 173 Basel banking standards. 81 – 83. See Call rates/loans Buffett. Louis. 106. 127 – 28. 161 Black Tuesday (October 29. 52. 90. 125. E. ratio. 23 – 24. 91 – 92. 122. 180 – 82. 80 – 82. 21 Bonbright. 80. Jr. 107 Bank of England. 107. 1929). 118. 123 Bush. 84... 93. 80 Bear market: defined. 44. increases . 41. 171. 58. 96. as diversifying strategy. See also Stock-market Bear Stearns. 111. 71. 151 Bankruptcy filings. 168 Banking Act (1933). 78. 49. 79. 174 Call rates/loans (broker loans): cost of. ratings. 106. 1 – 5. Inc. 56 – 57.

80 CSE. yields. 165. in public utilities. excessive. 46. 4. 93 – 94 The Commercial and Financial Chronicle. 107. 69 – 70. 43. 98 – 99. 170. 85. restricting. 98. subprime mortgages and. 67. 174. 36. 179. 103. 14 – 15 in. 119 – 20. 133 Common stock: in bear market. ratings. 183. 35. 12. 30 – 31. 73. 85 – 86. 165. 24. J. 15. 97. 182. H. 31 Chase National Bank. policy. 122. 101. 164. 165. 22 – 24. 25. 98. 21. 176. 50 – 51. regulating. 162. 91. for mortgages. 86. 184. 172 Callaway. price decreases in. leverage from. 15. 10. fixed fees for. as financing. 18. 63. 184. 22 – 24. discount rate of. 182 Carnegie. mortgage. 34 Cuomo. Federal Reserve Bank and. for steel industry. 169 – 70 Calvin. 181. failure of. 89 – 90 Dice. 129. 85 – 86. C. 42. 107. 3. 141. 24. value of. 111. 118. 67 – 69. common stock and. 78. equity ratios. 22. 12 – 14. 107. 83. 78. H. myths about. 97. 150. 126. investment percentage of. performance data. 66. short-term. earnings data for. 122 Congress. 164. 9 – 10. 74. 181.200 INDEX profit by. 18. 168. See House Committee on Banking and Currency. paying off. 87. 67. 130. discount rate and. price-earnings ratio and. 177 – 78. . 63. risks from. Trowbridge. 58. 181 Credit default swaps (CDSs): counterparty risks with. 46. 6.. 106. expansion of. 58. 59.. 78. 86. 145 – 46 Capital gains tax. margins for. 92 – 93.. long-term. 42 Clews. Henry. 163 Chandler. paying off. 98. for business. bonds vs. 39. Andrew. 78. 183 Derivatives. 151 – 52 Citigroup. 143. investigation of. 110. 107. 101 – 2 College Retirement Equities Fund (CREF). government purchase of. 92. spending by. A. 81 Debt: borrowing and.. Senate Committee on Banking and Currency Consolidated Supervised Entity (CSE) program. 111. for securities. 181. 26. 168. 89. 10 – 11. defaulting on. See Consolidated Supervised Entity Cunningham. 13. 120 Coolidge. 96. 111 Cash dividends. speculation and. 82–83 Continental Can Company. 98. 50 – 60. 81. defined. securities from.. Lester V. 40. 100. 75. 107 Clearing House Committee. borrowing cost of. unfreezing. 96. 45 – 47. 70. 120. 174. 182. 106. 45 – 46. 168. 86. 17. 21. 106. See also specific corporations Credit: for banks. Andrew. 154 Commodity prices. low-cost. 85. 101. 57. rates for. Federal Reserve Board and. 49. 41. 63. 174. 181. 105 Closed-end mutual funds. 51. 120. price of. 78. renewal of. reducing. 20. 17. 163. 80. 97. 125. 108. 84. 181. of trusts. 181. 94. 66. 31 Corporations: broker loans and. 174. 134 – 37. 81. 9 – 10. 37 – 38. for speculation. 80. 32. on margin. 46 – 47. 173. 161. 66 – 67. 105.. 110. 118. 164. 164. shortselling and. E. 81. portfolio mix of. FDIC guarantee for. 174. 182 Department of the Treasury. 174. 80 – 82. Claud W. 172. 66 Case. 176. 87 – 88. Calvin.

99 – 100 Fisher. railroad index. 51. 165 Drew. 23. 67. 38 – 39. 23. 5 – 7. 45. 57. 40 – 41. 168. 154 201 Federal Reserve Act.. 23 – 25. 168. discount rate and. 63. 45 – 46. 36. reducing. 1929 letter to. 20 . Citigroup rescue by. 154 – 55. 156. increasing. 19. 57. payment rates. price-earnings ratio and. 101. 15. 60. Daniel. 55 – 56. 59 – 60. 168. 126. credit and. 118. 168. stock as. 168 Efficient market hypothesis (EMH). 176 Dodd. 29. 5. 184. 17. 106. from trusts. increasing. 52. 43. 72 – 73. 4. 49. 58. 31. 106. 105 Durand. priceearnings ratios and. 80. 110. 43. 63. market boom and. 109 – 11 Federal Reserve Board: broker loans and. fixing. 48. stock prices vs. reducing. 129 Dow Jones Industrial Stock Index: in 2008. 55 – 56.INDEX Discount rate: credit and. 44. 47. securities loans and. 48. Federal Reserve Bank and. 40. 122 – 23. 163. 42. 156 – 60. speculative loans by. 108. 103. 152. extra.. 100. 57. 44. 5. Federal Reserve Bank vs. 64 – 65. market prediction by. R. 39. 179 Flood. 23. 34 – 49. speculation and. 15. 26. broker loans and. 55 – 56. utility index. 75. 110 – 11. 117. 64 – 65. 92 Federal Power Commission v. 57. 36. Federal Reserve Board and. 48 Federal Deposit Insurance Corporation (FDIC). 163. 38. 45. 116. rediscount rate and. easy money policies of. in 1922–1929. 42. 5 – 6. 52 – 54. 103. 89 – 91. 3. 154 – 56. members before 1929. 53. 155 Edison Electric Illuminating Company. 23. 22. 125. 52 – 54. 111 – 13. valuation model for. 12. 158 First National Bank. D. 98. 110 – 11. 120. real economy and. interest rates and. 46 – 47. 32. priceearnings ratio and. 132 Economist. role in 2008 crash. 71. real estate market and. defined. 168 Dividends: cash. 168. 129. Long-Term Capital Management rescue by. 131. 80. 119 – 20. 21 – 22. dispersing. 40 – 41. 156. 29 – 30. 16. 68. L. Hope Natural Gas Company. 29. 98. 117 – 18. 49. 118 Federal Advisory Council. 50 – 51. 175. 133 Fannie Mae/Freddie Mac. 97 – 99. from utility stocks. 50 Federal Reserve Bank: during 2000– 2009. 77. 87. 71. 91 – 92. yields. 128. 174. 71. 55 – 56. 45 – 47. 154. 34 – 49. David. recovery of. 43. 103 Financial Times. 125 – 27.. credit and. 85. 52. 6. Federal Reserve Board vs. Senate hearings and. 13. 68 Factory production. 37 – 38. 38 Federal Trade Commission (FTC). 49. R. denouncement of. Irving: manufacturing sector and. 61. 176 First National City Bank. government bonds and. 103. 66. 9. 95 Farming productivity. credit and. 74 – 75 Federal Reserve Bulletin: broker loans and. 40.. 160 Financial & Industrial Securities Corporation. 130. 10 – 11. 105 Earnings data. stock decreases and. 120. 130. 111. production and. 22. 169. 71. 71. 134 – 37 Economic fundamentals. 118. 174 The Evening World. 29 – 30. 127. 1 – 5.. speculative loans and.

116 – 17 Garber. 94. speculation and. John Kenneth. B. 9. Morgan Chase. in securities prices. 175. 163. 147 – 48. 122 Industrial production. 175 Greenspan. 116. 118 – 19 Keynes. 44. P. outlook concerns for. 91 Gross. 181. 145 Interest rates: increasing. 174. 21 Harrison. 65. 84 – 85. 10. 65 – 71. 5. 35 – 37. John Maynard.. C.. 36 Jarvis. 129 Great Depression. G. 179 – 80 Kindleberger. Harry. 107. 65 – 71. Henry. 77 – 78. George.. G. 109 – 11 Hatry investment firm scandal.. R. lessons for. 32 – 42. E. 183. W. trusts. 52. 12. 63. A. 118. 116 Forbes. 45. 145 James. 62 Goldenweiser. 44 – 48. 46. 184 Holmes. 52 – 54 Internal Revenue Service (IRS). 101. 63 – 64. 169 Investment-grade securities. P. 26. 146 Galbraith. mutual funds.. 138 INDEX Ibbotson. 41 – 42. pools. 89. 98 – 99. M. 71 – 72. Paul. 12 . 154 Insull. psychology of. 70. Alan. 6. 149 Investment Bankers Association of America. 63 Krugman. 33. 103 – 4.. 20. 92. 17. R. 148.. 71. 175. 108. 119 Inflation: mortgage loans and. wealth target for. 11. 10 – 12. R. 68. 52.. 31 – 32 Kaufman. 150 J. environment for. 80 – 82. C. Robert. Herbert: discount rate and. 141. 59 – 60. 142. 160 – 61. 59 – 60. 69. Warren G. 123 Forbes. W. 24. 25. 72. 182 J. 78 Gross national product (GNP). 174. 107. 118. Charles S. 101 – 2.... 92. 43 – 44. 39 – 40. 48. 100. 64 Latin American loans. 72. 57. real estate prices and. 100 – 104. 32 Hoover. 31 Harding. 177 – 78 Investors/investments: in 1929 stockmarket. 102 – 3 Government bonds. 77 – 78. 19. 2. Ian. 66 – 67. lowering. call loans and. 176 Hawley-Smoot Act. 129 – 32 Industrial Revolution. George R. 15 – 16. 100 – 102. 24 Funston. 17 – 18. 70 Forbes. 147. 125 Government policies (2000 – 2009). B. speculation and. Sam. 31. 20 General Electric (GE). reducing. 6 – 7. 144. 18. 82. 170 – 71 House Committee on Banking and Currency. 87 Graham. 177 Kendrick. 113. 3. William. 110 Hamlin. 26 High-risk securities. 164. 77 – 78. 34. 94 LaFollette. 112 – 13 Hard. 95. 54.202 Florence. 90.. 106. 21. 17 – 18. 65. J. Daniel. M. election of. 49. 149 Fortune. 78. Carter. long-term. 18 Kansas City Reserve Bank. 38 Goldman Sachs Trading Corporation. 168. 116 Industrial bonds. 170 Glass. 145. 169 Friedman. Seligman & Co. Oliver Wendell. 125. 89. 124 Guaranty Trust Company. Keith. 74. 21 – 22. 20. speculation and. 32. 13. Sergeant. 86. 92 – 93.

89. 123 Levy. 1 – 2. 119. 45. historical data vs. 99 – 100. 169 Lehman Brothers. 61. 174 Long-term interest rates. Joseph Stagg. 19 – 21. 42 – 43 Morgan Stanley. G. 96 – 100. 44. R. 24. Robert. 81 – 84. 111 – 12. 21 – 22. 60 – 61. 80. 59 – 62. 168. Sirkin study and. 147 – 50. 145 – 46. 81. economic fundamentals and. lending practices of. investment pools and. 169 Merrill Lynch. 24. 123. 49. A. 52 – 53. 82. stock market crash and. NYSE and. 58. 49 Lowenstein. I. 9. 70. 55 – 60. 125 Malkiel. 55 – 57. M. 126... Charles E. 45.. 79 – 80. 100. 125 – 27. 46 Mellon. 83. Frederick C. See also Mitchell.: March 1929 panic and. 44. 127 – 30. 6 – 7. stock prices and. 63. 33. Charles E. money rate decrease. 91 – 92. securitiesÊ value on. Adolph: credit and. 107 Leinbach. Andrew. 59 – 62. discount rates and. 56 London Stock Exchange. 83 – 85. 106 Long-Term Capital Management (LTCM). 4. 43. 101 – 2 National Bank of Commerce.INDEX Lawrence. 171 – 73. 21 – 22. 144. 42. 115 – 17.. conclusions from. 22 – 25 Massachusetts Public Utility Commission. Hawley-Smoot Act and. 122 – 23. 89 Miller.. speculative loans and. 89 – 91 Long-term debt. overview. 75 Mills. market levels and. 25 – 26. 86 – 87 203 Merton. 142 – 51. 105.. 62. 175. debt on. 35 – 40. 94 – 95. David. See also National City Bank Mitchell. for common stock. 152 March 1929 panic: Banking Act and. See also Stock-market (1929) Margins: buyers of. margins and. 17. stock market crash and. E. 98. Martin. Senate hearings over. 26. production/ productivity and. 99. stock market crash and. loan requirements for. See also Subprime mortgages/ markets Mullins. 3. 96 – 98. price of credit and. 3. 173. Robert. 96 – 97. F. W. 99 New York Evening Post. 71. securities and. 100. 174. 118. 96 – 98 Market myths: before 1929. stock prices/ value and.. 64. 176. 142 – 43. 66. 131 – 32. 34. 181 Mayer. 89 Mutual funds. stock prices and. marketing by. 35. 164. 18. 52 – 54. 98. 145. See Earnings data New York Bank. 80. tax problems of. testimony by. 126 National City Bank: call rates and. 39. 177. 118 – 33. 92 Mortgage-backed securities. 105 The Magazine of Wall Street. 117 – 18. Peruvian bonds and. 20 Mitchell. overview. 91 Macaulay. 52 – 53. 30 – 31. . 47. during 2009. speculation and. Burton G. 12 – 14. 41 – 47. 105 McGarrah. 177 – 78. 103 – 4. 35 New York City Reserve Bank. 12 Mississippi Bubble. 174 Mortgages/mortgage payments: defaults. 27. 23. broker loans and. 83. stock speculation and. 34. 15. 89. 127. 67. 97. 78. 120. Net profits data. during 1929. D. 15 – 16 New York Stock Exchange (NYSE): Black Thursday. 40. M. 156 – 60.. 143. growth rate of.

depreciation of.. 177 – 78. 23. 21. 181 – 82. Franklin Delano. 184 Securities: credit for. Anna. 33. 184. 162 – 63. 131. 38. 104. investment pools and. 181. 30. 165. 79 Production/productivity (1920 – 1929). stock prices and. growth in.. as overpriced. investment-grade. 46. 94. 3. 31.. Paul A. 85. 34 Pecora. testimony. 45 – 46 Price-earnings ratio (P/E): in 2008. 64. 64. investing in. 79. 163 – 64. 108.204 INDEX Radio Corporation of America (RCA). Edison Electric Illuminating Company. dividends and. mortgage. Adolph testimony. selling. 61. 9 – 10. 131. 60 Real economy. 21 Norbeck. 57 – 58. 79. 6. debt and. Ferdinand. 98. 112 – 13. 141 Potter. 181. discounting. 58. 63. 141. ratings for. leverage and. Massachusetts Public Utility Commission. multipliers. 78. for utility stocks. 156 – 58. 138 – 39. 143 – 44. 35 Open Market Investment Committee. 116 – 17 Scholes. 4. 175 Public utility stocks/bonds: common stock and. 109 – 13. 87 – 88 Robertson. prices of. Montagu. 117 – 18. testimony. 42 Ripley. debt. 153. price declines. 67. multipliers.). 3 – 5. debt for. 161 Private equity lending. Wiggin. W. 70 Samuelson. Edmund. 97. Stock Market Study. speculation and. 97. 64. 74 New York Times. Peter. 106. 157. Charles E. 63. 97 Security and Exchange Commission (SEC). Mitchell. discount rate and. 164 – 65. value of. 24. See Discount rate Reynolds. 151 – 52 short-selling and. 4. 126. 45. distribution of. 17 – 18. 22. 104. 53 – 54. 55. 111 – 12. Issac. 116 Roosevelt. 64 Senate Committee on Banking and Currency. William C. 101.S. 156 – 60. Jackson. 5 – 7. 122 – 23. Miller. 13. utility. 95. 164 – 65. 109 – 11. George L. high-risk. 77. 177 – 78. 36. 77 – 78. Harrison. dividends from. 96. 2. 118. 142. 174. See also Senate Committee on Banking and Currency Pennsylvania Railroad. 98. 145 – 46 Platt. 65. price of. 173. 125 . 82 – 83 Senate (U. Charles S. 11 – 12. 89 Schwartz. 108. Hamlin. 105. testimony. 160 – 61 New York Times Magazine. loans for. 142 – 51. 11. 78. 91. financing. yields. 52 – 53. 170. 161. electric rates and. 130 Peruvian bonds. 74. 165 Securities Exchange Act. rate equity base of. 39. interest rates and. Dennis. 61. 58. 5. speculation and. 17. 83 – 85. 89. 72 Risk vs. See also Mortgages/mortgage payments Rediscount rate. Babe. 125. 20 – 21. 10. J. Myron. Albert H.. 145 – 47 Ruth. 118 – 33 Psychology of investment. 146. stock market crash and. testimony. 175 Real estate: inflation of. 126. Z. 144 Norman. 106. Black Thursday and. discount rate and. 154 – 55. 66 Newton. 20.

147 Stock-market (1929): avoidance of. 116. General Electric and. 78. riskiness of. Troubled Asset Relief Program and.). Lehman Brothers and. lessons from. Benjamin. 78. Citigroup and. 102 – 3. 80. 54. 30 – 31. 94. 5 – 7. 74 Snowden. 116 Sirkin. investment trusts during. 104 – 5. Philip. 111. causes of.INDEX Short-selling. 182. 107 Standard and PoorÊs (S&P) index. 57. 177. 119. 81. 180 – 83. 74. interest rates and. 67. 131 – 32 Sirkin study. 77 – 78. financial markets during. 22 – 24. crash of 1929 and. Merryl Lynch and. 165. 147. 77 – 78. 182 Simmons. 101. reality of. 86 – 87. credit default swaps and. 68. market myths and. 16 – 17. short-selling and. market boom. 127 – 30 Strong. 131 – 32 Smoot-Hawley Tariff Act. 64 – 65. 74. 174. 107 South Sea Bubble. George. 84 Supreme Court (U. 165. 81 – 83. 94. 26. real economy and. 12 – 14. 167 – 68. increases in. 85 – 86.S. overview. 89 – 91. 109 – 11. credit use and. 59. 25. 42 – 43. 113. E. 70. expansion of.. 92 – 93. 122 – 23. 103. recovery from. 144. 173 – 74. 181 – 82. Soros recommendation and. 171 – 73. 97 – 100.. dividends and. 180 – 82. causes of. 133. 92 – 93. 176 Sinquefield. 95 Social Security. for commodities. 30. financial requirements for. 3 – 4. government policies and. 69. 25. 115. 172. myths of. A. 128 – 33. stock prices during. 17. 71 – 72. investment pools and. 17. loans and. Bear Stearns and. 27 Soros. 177 – 78. 68. 107 – 8. comparisons of. 103 – 4. 1 – 5. 67. 161. value of. 62. Long-Term Capital Management and. CSE program audit. 67. 7. short-selling and. 7. 118. 80 – 84. focus on. 88. lessons from. predictions and. 179 Short-term debt. Federal Reserve board role. decreases in. 6.. 17. 86. 104 – 5. with splits. 181. 85 – 86. 17 – 18. 117 – 18. 63 – 65. 91 – 92. Max D. 183. 138 – 39 Stock prices: bonds and. margin buying and. 18. 17 – 18. 81 – 82. 127 – 30. 71. 100 – 102. avoidance of. 85. panic from. 157 – 58. 20 – 21. 87 – 88. 172. speculation and. 23. 175 – 76. market crash.H. debt and risk with. 55 – 57. 3. See also March 1929 panic. 80. 129 Speculation /speculators: broker loans and. overview. defined. shortselling. 63.H. 173. 107. 82 – 83. 22 – 25. Goldman Sachs and. real estate prices and. 93 – 94. 104 – 5. 84 – 85. 32. investment trusts and. 64 – 65. R. 78 – 79. forced accounting and. Market myths. 30 – 34 Subprime mortgages/markets: Citigroup and. 52 – 54. 127. myths about. 156. 105 – 7. 105 – 7. default of. Gerald. for public utilities. 174 – 77. 22. SmootHawley Tariff Act. investment environment of. 171 – 73. warnings ignored. Speculation /speculators 205 Stock-market (2008 – 2009): American International Group and. 65 – 71. 56 – 57. 150 . FDIC guarantee. 107 – 8. 78 – 81. 110. 117 – 18. 92. 154 – 55. priceearnings ratio and. 50 – 60. 101 Steuer. 3. College Retirement Equities Fund and. 49. debt and. 172. 74. 87. 182. See also Market myths Stock Market Study. 49. 115 – 17. 13. 80. 107 – 8. 173 – 74. values and.

Barrie. 10 – 11. 170 Temporary National Economic Committee of Congress.S. 152. Owen G. 65. Albert Henry. 10 Wingo. 64. 141 – 42. 81. 91 Western Electric Company. 48 Wessel. speculation and. 74 Warburg. 32 – 36. Steel. See Public utility stocks/bonds Variety (magazine). 159 – 60.. 14. stock market crash and. David. 170 Utility stocks. 128 – 29 Willis. 71 – 72. 71. Roy. 151 Wiggin. testimony of. 57. 21 – 22. 144. 13 – 14 . 66. Parker. 184 Trusts. 156 – 57. See Government bonds Troubled Asset Relief Program (TARP). 38 – 44.S.. 165 U. J. 160 Wall Street Journal.206 Taylor. 151 The Times. 5. Jimmy. J. 64. 14 Wingo. 102. 60. Paul M. 170 Young. 97. 171. H. 163 – 64 Tulip Bubble. 10 – 11. 22.. 151 – 52 Wigmore. 164 Wanniski. 6. 123 Williams. 100 – 102. 65. Effiegene Loeke. 128 – 29.. Otis. 12 – 14 Young. 144 – 48. 4. Myron C. Electric Light & Power. Government accusations. 96. 20 U.S. 68–69. 129–30. broker loans and. 60. B. 100. 164 Treasury bonds. credit and. 15 INDEX Walker. 13 – 14. 48. 103.. 160. 141 – 42 U. 17.

he received his MBA and his Ph. Managerial Accounting. . A Cornell faculty member since 1956. from the University of Michigan. Exxon Oil Corporation. is the Nicholas H. Sun Oil Company. He was a recipient of the Dow Jones Award from the American Assembly of Collegiate Schools of Business for his outstanding contributions to collegiate business education. He has written thirty-two books. He has also taught at INSEAD in Fountainebleau. and more than a hundred-eighty journal articles. the University of Michigan. Cornell University. Financial Accounting. JR. Professor Bierman formerly taught at Louisiana State University. He was a visiting scholar at Cambridge University. He served as a financial consultant at Prudential Bache Securities in New York in 1986. A graduate of the U. including The Capital Budgeting Decision (with Seymour Smidt). IBM. and Xerox Corporation. Emerson Electric.S. Quantitative Analysis for Business Decisions. France and KUL in Belgium. Naval Academy. His industrial experience includes consulting for Corning Glass Corporation.ABOUT THE AUTHOR HAROLD BIERMAN.D. Annapolis. and the University of Chicago. Noyes Professor of Business Administration at the Johnson Graduate School of Management. Eastman Kodak.