The New York Stock Market Crash of 1929 Preludes the Great Depression

The “roaring twenties” end with the stock market crash of October 1929. 

The “roaring twenties” began with a short-lived recession in the United States, social unrest and hyperinflations in Germany, Austria, and Russia. Disagreements on German reparations and inter-Allied war debts undermined international cooperation among Great Britain, France and the United States. Structural economic imbalances resulting from World War I and the restoration of the gold standard greatly increased the fragility of the international monetary and financial system.

After World War I ended, New York became the preeminent global financial center and lent heavily to Europe and Latin America. Between 1922 and 1929, US gross national product grew at an annual rate of 4.7 percent; industrial production grew at an annual rate of 3.1 percent, and unemployment averaged 3.7 percent. The US economy boomed around automobiles, electrical appliances, and chemicals.

US lending abroad dropped sharply after June 1928, as investors avidly purchased the stocks of utilities and high-tech firms, driving up the price of securities. Commercial banks, restricted from trading or purchasing equities, set up securities affiliates to enter investment banking and brokerage businesses.

Robust equity and debt markets further stimulated the belief that stock prices would only increase, setting the stage for a bubble. Financial intermediaries lent funds on the call money market and individual investors took loans to buy stocks on margin. The Dow Jones index went from 191 in early 1928 to a record high of 381.2 in September 1929. 

Similar to contemporary closed-end mutual funds, highly-leveraged investment trusts like the Goldman Sachs Trading Corporation bought securities at ever-increasing prices (particularly utilities stock) using large amounts of debt and preferred stock. Their business model was prone to fail the moment stock markets reversed their course.

News about public utility regulation and rising interest rates in the United States and abroad led to panic selling on Black Thursday (October 24) and Black Tuesday (October 29) of 1929. Nervous investors liquidated their holdings and the markets plummeted. The Dow Jones index fell to 248.5 units by the end of 1929.

The fall in equity prices tightened credit, but the Federal Reserve Bank of New York intervened and New York banks increased their loans. The Board of Governors of the Federal Reserve censured the New York Fed and kept tightening monetary policy.

Commodity prices fell. Industrial production decayed. Committed to the preservation of the gold standard and balanced budgets, policymakers did not use monetary or fiscal policies to stabilize the economy, greatly worsening the situation. As lenders retreated, nervous amidst bankruptcies and the Great Depression, fewer firms issued long-term capital in the 1930s. By 1932, stocks had lost nearly 90 percent of their value.

 

This article was originally published as part of a series commemorating the 150th anniversary of Goldman Sachs’ founding in 1869.