I understand the general issues around the crash. But what was the defining factor that cause it all to happen as it seems to happen pretty much instantaneously on ‘Black Thursday’s.
I understand the general issues around the crash. But what was the defining factor that cause it all to happen as it seems to happen pretty much instantaneously on ‘Black Thursday’s.
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There are several dynamics that affect the markets but on a basic level it all comes down to simple “market sentiment”. That means how the people participating in the market feel about its future. People invest money in the market because they expect it to grow, thus increasing valuation and giving them returns on their investments. The more money that flows into the market, the more liquidity there is, the more activity there is, and it shows a positive sentiment because the market at large seems to believe things are good.
When this sentiment reverses however, people start withdrawing their money from the market, which has the opposite effect to all the things stated prior. As valuations drop, people lose money, which leads to people to panic and pull their money out or assume short positions (positions that benefit from market downturns) which gives an overall negative sentiment about the future of the market.
Negative market sentiment is not always necessarily a bad thing. It may cause a slow year or a short lived recession that’s only really a recession on paper, but there are also market panics, which is a chain reaction of people panicking and pulling out massive amounts of money out of the market in a very short amount of time. This amplifies stock volatility greatly, meaning prices drop significantly and sharply. These are called market crashes, which is the financial equivalent of a stampede occurring just because someone saw someone else running so they started running too even though they don’t know why they’re running.
That’s all it is. In the case of the 1929 crash the main culprit was the fact that the market was overvalued. People were investing their money into the stock market because interest rates offered by banks were low. The US was rapidly industrialising and business magnates were becoming richer but this didn’t really trickle down to the common people, so the output of many sectors was far outpacing what was actually being consumed by people who had small purchasing power, all the while stock market valuations were increasing due to high investment activity which meant that the valuations were diverging further and further from reality. Overproduction of goods without the necessary consumption of them led to the price of goods dropping, businesses scaled down production and downsized their workforce by firing people, increasing unemployment. Banks and institutional investors realised that under these conditions there was simply no way the market could keep going up so they all started selling off their holdings, which triggered a panic sell which tanked the valuation of the stock market, leading to the Great Depression. However it’s worth noting that the stock market crash alone is not what caused the depression, rather the high unemployment and low wages of working people coupled with many sectors downsizing were what would inevitably lead to a recession, the crash was just the herald that it had begun.
Putting in a plug here for John Kenneth Galbraith’s “The Great Crash, 1929”. It’s a short book and very readable, and goes into beautiful detail.
It was a credit crunch, the stock market crashing was due to the credit crunch.
On good times people feel optimistic, they borrow money because times are good and everyone is making money.
Say you are a farmer, after a couple good years you think you should buy more land. You go to the bank ask for a loan, the bank sees land values rising and think it’s a safe loan. Even if the farmer cant pay , well the bank can repo the land and sell it , get their money back.
And after a few good years the land values rise more, he goes out and gets loans to buy more land. Hell he takes out secondary loans on the land he bought a few years ago to buy equipment or build barns ect.
As long as times are good, land values keep rising and you can take out more loans .
Then you hit a drought, or a few years of poor harvest or low crop prices. Now the farmer can’t pay his loans. No problem, the bank just takes the land and sells it to recoup the loan right?
Well guess what , all his neighbors did too, and all the neighbors are in the same situation. So everyone is trying to sell, and with the drought and low crop prices, no one wants to buy land prices crash.
Now the bank is in trouble, they loaned out 10 million, but even when they repo the land and sell it, they only get 6 million back.
Now even the farmer that never took out loans and is diligent about saving money goes to the bank but it’s bankrupt, it lost her money now she has no money either.
Worse people who do have.money still , see all these defaults and stop loaning out there money , so now the young farmer who wants to buy some of the land all their neighbors are selling can’t , no one will loan them money.
This is an example using farming but the same thing happened everywhere across industries. Manufacturing, rail roads , mining, and Wall Street as well .
You want the real ELI5? The very same people that are in power today, especially in the Presidency (tariffs one of the major policies of the Republican presidents before 1929).
I’m going to be very general and just point out that just about all economic crashes are caused by one concept – investment in something that is suddenly considered to have far less value than originally thought.
If an investment class loses 10% value, that’s bad but it’s not catastrophic
But, if a whole lot of people borrowed money they don’t have to invest in that asset, and it goes down enough that the person lending them money gets a little spooked they might not be able to collect on that debt, they’ll ask for more interest/premiums on that debt. Or margin call them.
This might cause the investors to need to sell their asset, driving the price down further. Caring more people to default on the debt, causing more people to sell. Causing a crash.
If people are hurt so bad they need to sell other assets to pay debts or remain solvent, that impacts the whole economy. Big crash.
If the people lending the money (banks) can’t collect enough from the debtors to pay their own debts, the banks go under and now people have just lost their savings accounts.
The Wall Street crash happened ‘cause ppl were going crazy buying stocks like everyone thought they’d get rich fast. They were even borrowing money just to buy more stocks and when prices started dropping it was like a domino effect, people panicked, couldn’t pay back loans, and the whole market just crashed. But it wasn’t just that…Bfr all this there was already a big gap between rich and poor ppl, factories were making way more stuff than ppl could actually buy and the government didn’t really have good rules to keep things in check. So when things went bad and the crash messed up economies all around the world
(According to what I studied in history classes)
It’s insane that people keep saying it was a failure of liquidity, as if someone being able to borrow more money to cover their stock bets was the way things should have been.
As a result of the crash, banks were separated between the ones that handle checking and savings, car and house loans (Wells Fargo, Chase, Citibank) and the investment banks (Merrill Lynch, Morgan Stanley, Goldman Sachs, etc).
Before this, there were hundreds of banks across the US, and they were gambling with the depositors money on stocks. Also, if you gamble on margin, it increases your wins, but also increased your losses.
If your stock bets are down, you are still ok if you have enough money to cover the margin (you borrowed by using your stock as collateral so you can buy extra stock). If the stock value dips too much, there is a margin call, and your stock has a forced sale to make sure the loan gets paid off.
When everyone has a forced sale at the same time, nobody has any money to buy up the good stock at a bargain price.
There was widespread corruption and stock manipulation, with the survivors laying waste to the vast majority of investors (bank managers). The SEC was soon formed in the hopes of avoiding this happening again.
Hundreds of small banks went under, and the depositors money was gone.
As a result, the community banks were separated from the large investment banks (later reverted by Clinton), and individual bank depositors were given federal insurance to cover their bank accounts if the bank goes under (FDIC)
A lot of the same issues we have today. A tech bubble busted. Tech stocks like Edison were way over valued.
Ben Bernanke (yes, that Bernanke) et al were awarded the Nobel price recently for their analysis of the crash they published in the 1980s. TL;DR: (my brief summary, not theirs) if the banks run out of money to lend then a crashed economy can’t be restarted.