PBS Video has a really interesting episode of American Experience available online (until Nov 10, 2013) entitled “The Crash of 1929.” It’s a history of the year leading up to the great stock market crash of 1929, and its immediate consequences.
I’d like to call your attention to a few topics that come up in the video. First, margin. In the video they describe the margin requirements of the time, which were 10%.* What this means is that, if someone wanted to buy a share of stock that cost $100, they could put $10 of their own money in, and borrow $90 from their broker. So, if the stock price were to fall to $90, the stock investor/speculator would be wiped out, and the broker would have to sell their stock at market or the investor/speculator would have to put up more money. If the shares were sold, it would cause the stock price to fall further. A catastrophic series of margin calls is credited with being one of the reasons the panic was as bad as it was.
One of the other areas I’d like to point out, which I think was glossed over in the video, was the temporary increase in interest rates to over 20%. Remember that a lot of lending at that time was done on an interest only basis, with balloon payments. Also banks could call loans at any time (meaning that the loan would have to be paid in full when the bank asked for it, which could be at any time.) This interest rate uncertainty, coupled with bank runs and failures (remember, there was no FDIC at the time, so if the bank failed, you lost your money) was crippling to the economy.
Watching from hindsight, I’m just appalled at the complete lack of regulation and tremendous risk-taking in all the facets of the economy. Banks didn’t have FDIC insurance, so depositors weren’t insured. There were no limits to the amount of margin a customer could take on, only the limits imposed by the brokerage house. Loans were taken out at variable interest rates and had balloon payments, which were also callable. A variety of market manipulations were common and legal, including bear raids and pump and dumps. It’s a wonder the economy didn’t collapse sooner, really.
* Now-a-days the margin requirement is 50%, under Regulation T, which was enacted after the great crash.