Can the Wall Street Crash Happen Again?

By: Jay Northco
Submitted: 2007-01-17 16:17:34
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While the Dow soars above historic highs, oil and housing prices are falling. Are these sectoral adjustments or indications of a radical shift in the economy? Could we see another stock market crash like The Wall Street Crash Of 1929? Why are investors getting jittery?

The Wall Street Crash, and the subsequent Great Depression of the 1930s, are well known phrases but few people know what really happened and understand the dynamics that led to the crash. The Wall Street Crash, also called the ‘Great Crash,’ was a stock-market price collapse that started on October 24 ("Black Thursday") and continued through October 29, 1929 ("Black Tuesday"), when share prices on the New York Stock Exchange (NYSE) collapsed.

The Dow Jones Industrial Average, recovered early in 1930 only to decline until finally bottoming out in the bear market in 1932. The market did not surpass pre-1929 levels until 1955. The Dow had reached a high of 381.17 on September 3, 1929. Three days later, on Black Thursday, the stock market suffered its first crash. A then-record 13 million shares were traded that day. More investors were involved in the stock market than ever before and many had borrowed money to invest and those over-leveraged investors were jittery. The crash began on the Thursday when those investors panicked and rushed to sell their shares.

At 1:00pm on Black Thursday, several leading Wall Street bankers met to find a solution to the panic and chaos that was unfolding on the trading floor. The group included the heads of Morgan, Chase National and National City Banks and they bid on large blocks of "blue-chip" stocks to show confidence in the market. The tactic succeeded in halting the slide that day and the panic abated. The markets were calmer on the Friday.

Over the weekend, however, newspapers published dire and sensational stories about the fragility of the market. By Monday, agitated investors panicked by the press, were champing at the bit to liquidate. When the markets opened on Monday morning, investors decided to get out of the market en mass and the slide resumed with a record 13% loss in the Dow for the day. Many wealthy tycoons joined with members of the Rockefeller family and other financial giants to buy large quantities of stocks in order to demonstrate confidence in the market on the Monday but this time the tactic failed. Tuesday saw more the same another 15 million shares were traded and the market bottomed out.

So why did the crash happen and what can today’s investors learn?

One of the great myths about the great crash was that it precipitated the Great Depression. Financial analysts and historians disagree on how much effect the crash had on the looming Great Depression of the 30s.

The economy was already collapsing prior to the Wall Street disaster and poor people, who would be the most affected by the Depression, were not investing in the stock market. For them, poor farming conditions and the great dust bowl would be far more significant to their plight. The image of the Wall Street tycoon leaping through their skyscraper windows is a myth. Most survived the crash with their mansions intact. They lost large amounts of paper wealth but they had sufficient funds to survive and then prosper in the low market.

For the middle class it was a different story. Throughout the 1920s the market had been doing so well that many ordinary Americans were investing. More people were investing although many could not afford to do so. People were investing on speculation—borrowing from banks, buying stocks with an eye to selling them in the future for a profit that would cover the debt and interest and more. When prices began to drop, people realized they would not only fail to make money but they might not be able to cover the debt either and so panicked. Banks had lent heavily to fund this share-buying spree and when the market collapsed they found themselves saddled with debt, which caused many banks to fail. Millions of people lost their savings and, disastrously for the economy, businesses lost their credit lines and were forced to close, which caused massive unemployment. The middle class now found themselves without savings and, in many cases, work. The over-reaction of the Hoover administration to the Wall Street Crash probably exacerbated the situation and the passage of the Smoot-Hawley Tariff Act caused more harm than the crash itself.

Could it happen again?

Investors are continually told “no” and that there are things are in place to stop the sort of crash that happened in 1929. But evidence seems to imply otherwise.

To prevent panics such as 1929, buying on speculation was made illegal. Stock markets instituted measures to temporarily suspend trading in the event of rapid declines.

The US Glass-Steagall Act of 1933, mandated a separation between commercial banks, which take deposits and extend loans, and investment banks, which underwrite, issue, and distribute stocks, bonds, and other securities.

For decades, these rules seemed to protect the markets and no more collapses occurred. Invested slowly came back to the market. But when the Regan administration relaxed some of the regulations managing brokerages in the early 1980s, the stock market began to pick up.

The crash of Monday, October 19, 1987 was even more severe than the Crash of 1929. On Black Monday of 1987, the Dow Jones Industrial Average fell 22.6%. While it was the largest single day drop in history, it did not precipitate a recession or depression. Other economic indicators were on the upswing and the crash seemed to only affect the larger investors.

The late 1990s also saw a period of “irrational exuberance” as billions were invested in speculative ‘dot-com’ businesses. The ‘dot-com boom’ will be remembered for the founding spectacular failures of new Internet-based companies that eshewed standard business models, and focused on increasing market share at the expense of the bottom line and launched IPOs based on ideas rather than demonstrated businesses. Most major investors such as Warren Buffett had not jumped on the band wagon and when the collapse came in 2000 were not affected. The same can not be said for the majority of passive investors who saw the value of their mutual funds plummet. That crash followed by drastic US deficits implemented by President George W Bush, a collapse in Asian real estate markets and the September 11 attacks marked the beginning rather lengthy recession in Western nations.

So what of today? Even more mutual funds pumping their value on speculative stocks, an overpriced bubble market with millions of people involved, many of whom are seeing their other investment, their houses, sinking in value, and all with access to computers and brokerages that can sell their stocks quickly makes for a very volatile situation. The next crash will probably indicate more than any other whether investors are more sophisticated today and will avoid repeating 1929 style panic collapse or will precipitate a much larger, quicker and significant exit from the market.

Article source: Expert Articles