The Mihir Chronicles

The Great Crash 1929 by John Galbraith

September 20, 2020

I. Brief Summary

The Great Crash, 1929 was first published in 1955 and has been in print ever since. The durability of this literature tell us something about the durability of speculation.

I wanted to dig deeper into the Great Depression of 1929 primarily to understand the human psychology around greed. John Galbraith examines the events around this economic meltdown. There are many lessons to be learned but I took two things away from it. 1) Don't underestimate the likelihood of stock market crash again. 2) The next economic meltdown may not be the same as the previous one in terms of magnitude.

The second point is important to me. Each meltdown has different characteristics and the recovery is dependent on monetary and fiscal policies. As having to go through the 2008 financial crisis, I have been expecting the same magnitude of recession for quite some time. Time and time again, I have been proven wrong and I have given up on making such sort of prediction. 2008 recession really put a scar on my investing behavior, but Galbraith said it better—“A new adventure in stock market speculation sometime in the future followed by another collapse would not have the same effect on the economy as in 1929. Whether it would show the economy to be fundamentally sound or unsound is something, unfortunately, that will not be wholly evident until after the event.”

That does not mean, invest blindly, but a vigorous analysis is still required. Just don't bother predicting the timeline of any financial meltdown or the magnitude of it. Someone predicting an economic downturn or a stock market crash after 7 years might be just right. Galbraith remind us that an economic machine is complex and there are lot of variables playing all at once. Therefore, it is not an easy task what can cause another meltdown.

II. Big Ideas

  • Millions of Americans thought they could easily become rich. Why? Simply because prices for everything was rising—stocks, real estate, art, etc. This increase in price in asset classes attracts attention and buyers, which produces even higher prices. Optimism continues eventually coming to an end. “When prices stopped rising — when the supply of people who were buying for an increase was exhausted—then ownership on margin would become meaningless and everyone would want to sell. The market wouldn’t level out; it would fall precipitately.
  • When markets are in trouble, people with authority, credibility, and power sound the same — “The economic situation if fundamentally sound. There is no cause for worry. The high tide of prosperity will continue.” One ought to put a critical lens on where there is superficial optimism. This sort of optimism even blinds the experts from seeing a storm brewing. Great titans such as Rockefeller, government officials, chairmen of the banks, economic professors and business schools failed to understand the severity of what was coming.
    • From Cambridge slightly less spacious reassurance came from the Harvard Economic Society, an extracurricular enterprise conducted by a number of economics professors of unexceptionable conservatism. The purpose of the Society was to help businessmen and speculators foretell the future. Forecasts were made several times a month and undoubtedly gained in stature from their association with the august name of the university. By wisdom or good luck, the Society in early 1929 was mildly bearish. Its forecasters had happened to decide that a recession (though assuredly not a depression) was overdue. Week by week they foretold a slight setback in business. When, by the summer of 1929, the setback had not appeared, at least in any very visible form, the Society gave up and confessed error. Business, it decided, might be good after all. This, as such things are judged, was still a creditable record, but then came the crash. The Society remained persuaded that no serious depression was in prospect. In November it said firmly that “a severe depression like that of 1920–21 is outside the range of probability. We are not facing protracted liquidation.” This view the Society reiterated until it was liquidated.
  • Credit was plentiful and cheaper. Interest on the loans that carried stocks on margin was often 8%, 10%, or more. Banks would borrow money from the Federal Reserve Bank for 5% and relend it for 12%. Banks supply funds to brokers, brokers to customers, and the collateral goes back to banks in a smooth flow. That was the essence of which Wall Street operated by. The purpose of Wall Street was to accommodate the speculator and facilitate speculation.
    • “The rich man’s chauffeur drove with his ears laid back to catch the news of an impending move in Bethlehem Steel; he held fifty shares himself on a twenty-point margin. The window-cleaner at the broker’s office paused to watch the ticker, for he was thinking of converting his laboriously accumulated savings into a few shares of Simmons. Edwin Lefèvre (an articulate reporter on the market at this time who could claim considerable personal experience ) told of a broker’s valet who made nearly a quarter of a million in the market, of a trained nurse who cleaned up thirty thousand following the tips given her by grateful patients; and of a Wyoming cattleman, thirty miles from the nearest railroad, who bought or sold a thousand shares a day.
    • “Yet there is probably more danger of overestimating rather than underestimating the popular interest in the market. The cliché that by 1929 everyone “was in the market” is far from the literal truth.
      • “The member firms of twenty-nine exchanges in that year reported themselves as having accounts with a total of 1,548,–707 customers. (Of these, 1,371,920 were customers of member firms of the New York Stock Exchange.) Thus only one and a half million people, out of a population of approximately 120 million and of between 29 and 30 million families, had an active association of any sort with the stock market. And not all of these were speculators. Brokerage firms estimated for the Senate committee that only about 600,000 of the accounts just mentioned were for margin trading, as compared with roughly 950,000 in which trading was for cash...However, it is safe to say that at the peak in 1929 the number of active speculators was less—and probably was much less—than a million.
  • The most notable piece of speculative architecture was the investment trust. A typical trust held securities in hundreds and thousands of operating companies. As a result, the investor was able to spread his risk far more widely than were he himself to invest.
    • The investment trust became, in fact, an investment corporation.4 It sold its securities to the public—sometimes just common stock, more often common and preferred stock, debenture and mortgage bonds—and the proceeds were then invested as the management saw fit. Any possible tendency of the common stockholder to interfere with the management was prevented by selling him non-voting stock or having him assign his voting rights to a management-controlled voting trust.
    • During 1928 an estimated 186 investment trusts were organized; by the early months of 1929 they were being promoted at the rate of approximately one each business day, and a total of 265 made their appearance during the course of the year. In 1927 the trusts sold to the public about $400,000,000 worth of securities; in 1929 they marketed an estimated three billions worth. This was at least a third of all the new capital issues in that year; by the autumn of 1929 the total assets of the investment trusts were estimated to exceed eight billions of dollars. They had increased approximately elevenfold since the beginning of 1927.
    • “Investment banking houses, commercial banks, brokerage firms, securities dealers, and, most important, other investment trusts were busy giving birth to new trusts.”
    • Were the sponsor a stock exchange firm, it also received commissions on the purchase and sale of securities for its trust. Many of the sponsors were investment banking firms, which meant, in effect, that the firm was manufacturing securities it could then bring to market. This was an excellent way of insuring an adequate supply of business.
    • “Knowledge, manipulative skill, or financial genius were not the only magic of the investment trust. There was also leverage. By the summer of 1929, one no longer spoke of investment trusts as such. One referred to high-leverage trusts, low-leverage trusts, or trusts without any leverage at all.
  • Instead of trying to produce goods, a few corporations got into financing speculation. Corporations and banks became too complex by forming an investment trusts and holding companies issuing securities. Everywhere a new company was being formed to capitalize on public interest for investing.
  • A gambler wins only because someone else loses. Where it is investment all gain.
  • “Should the American economy ever achieve permanent full employment and prosperity, firms should look well to their auditors. One of the uses of depression is the exposure of what auditors fail to find. Bagehot once observed: 'Every great crisis reveals the excessive speculations of many houses which no one before suspected.'
  • “Mr. Hoover’s first step was out of the later works of John Maynard Keynes. Precisely as Keynes and Keynesians would have advised, he announced a cut in taxes. The rate on both individuals and corporations was cut by one full percentage point. This reduced the income tax of a head of a family with no dependents and an income of $4000 by two-thirds. The man with $5000 got a similar reduction. The tax of a married man with no dependents and an income of $10,000 was cut in half. These were dramatic reductions, but their effect was sadly mitigated by the fact that for most people the taxes being cut were already insignificant. The man with $4000 had his annual tax burden reduced from $5.63 to $1.88. The man with $5000 got a cut from $16.88 to $5.63. For the man with $10,000 the reduction in annual tax was from $120 to $65. The step, nonetheless, was well received as a contribution to increased purchasing power, expanded business investment, and a general revival of confidence.

III. Quotes

  • One’s foresight is forgotten, only one’s errors are well remembered.
  • Speculation does not depend entirely on the capacity for self-delusion.
  • It is another feature of the speculative mood that, as time passes, the tendency to look beyond the simple fact of increasing values to the reasons on which it depends greatly diminishes.
  • As in all periods of speculation, when men sought not to be persuaded of the reality of things but to find excuses for escaping into the new world of fantasy.
  • All people are most credulous when they are most happy.
  • No one, wise or unwise, knew or now knows when depressions are due or overdue.
  • One of the oldest puzzles of politics is who is to regulate the regulators. But an equally baffling problem, which has never received the attention it deserves, is who is to make wise those who are required to have wisdom.
  • A bubble can easily be punctured. But to incise it with a needle so that it subsides gradually is a task of no small delicacy.
  • The regulation of economic activity is without doubt the most inelegant and unrewarding of public endeavors. Almost everyone is opposed to it in principle; its justification always relies on the unprepossessing case for the lesser evil.
  • If buying and selling stocks is wrong the government should close the Stock Exchange. If not, the Federal Reserve should mind its own business.
  • In the early months of 1929. There was worry that the country might be running out of common stocks.
  • Every day prices rose; they almost never fell.
  • Between human beings there is a type of intercourse which proceeds not from knowledge, or even from lack of knowledge, but from failure to know what isn’t known.
  • At luncheon in downtown Scranton, the knowledgeable physician spoke of the impending split-up in the stock of Western Utility Investors and the effect on prices. Neither the doctor nor his listeners knew why there should be a split-up, why it should increase values, or even why Western Utility Investors should have any value. But neither the doctor nor his audience knew that he did not know.
  • Wisdom, itself, is often an abstraction associated not with fact or reality but with the man who asserts it and the manner of its assertion.
  • The striking thing about the stock market speculation of 1929 was not the massiveness of the participation. Rather it was the way it became central to the culture.
  • Don’t part with your illusions; when they are gone you may still exist, but you have ceased to live.
  • The singular feature of the great crash of 1929 was that the worst continued to worsen.
  • The man with the smart money, who was safely out of the market when the first crash came, naturally went back in to pick up bargains.
  • The man who is gifted in the arts of abuse is bound to be a notable.
  • A banker need not be popular; indeed, a good banker in a healthy capitalist society should probably be much disliked. People do not wish to trust their money to a hail-fellow-well-met but to a misanthrope who can say no.
  • In the United States the suicide wave that followed the stock market crash is also a part of the legend of 1929.
  • Like alcoholics and gamblers, broken speculators are supposed to have a propensity for self-destruction.
  • The weak destroyed not only the other weak, but weakened the strong.
  • Speculation, accordingly, is most likely to break out after a substantial period of prosperity, rather than in the early phases of recovery from a depression.
  • If savings are growing rapidly, people will place a lower marginal value on their accumulation; they will be willing to risk some of it against the prospect of a greatly enhanced return.
  • Far more important than rate of interest and the supply of credit is the mood. Speculation on a large scale requires a pervasive sense of confidence and optimism an’ conviction that ordinary people were meant to be rich.
  • To uncover an evil man among the friends of one’s foes had long been a recognized method of advancing one’s political fortunes.