Welcome to Commodity Traders - Information on Causes of Stock Market Crash in 1929

I was reviewing the history of the securities industry and thought it might be enlightening to share some insight on the Crash of 1929 and how it compares to now.

The '29 Crash was a preamble to history-making legislation for the banking and securities industries.

The Dow Jones Industrial Average peaked at its all-time high on Sept. 4, 1929 and by Oct. 24, it lost 20 percent of its value.

By Oct. 29, 1929, the market had fallen a total of 39.6 percent from its high. $14 billion dollars of wealth was lost. The market gained 30 percent from its lows by the next summer, then fell disastrously to 89 percent below its September 1929 high. It took almost 30 years for the market to return to those 1929 highs.

Crash of 1929

The Crash of 1929 was blamed on 1) Overvalued stocks traded at an average price to earnings ratio (P/E) of 60. 2) Margin buying. It only took 10 percent equity to purchase stocks on margin. Investors had over-borrowed accounting for the pre-crash buying frenzy. 3) Fed policy. The president of the Federal Reserve Board, Adolph Miller, aggressively raised interest rates on margin loans (short term rates). 4) Bad banking structure. Four to five banks opened daily in the 1920s. There was no federal regulation on capital requirements or loan amounts that banks could lend. Banks were cash poor and lacked liquidity. They were also invested in the stock market. Between 1923 and 1929 banks were closing at a rate of two per day. By 1932, 40 percent of the banks had closed.

Crash of

The economy was in a record expansion from 1992 to . The initial public offering new issue market traded at over $1 billion market cap with no earnings. The Nasdaq traded at 4234.33 Sept. 1, and dropped 45.9 percent to 2291.86 by Jan. 2, . October recorded a low of 1,108.49, a 78.4 percent drop from its all- time high of 5,132.52. $8 trillion of wealth was lost.

Causes of the crash: 1) Corporate corruption. Companies inflated their profits using accounting loopholes while padding their own pockets. They received outrageous stock options diluting the interests of stockholders. 2) Stocks were overvalued - trading in the hundred and thousands on a P/E basis. 3) Day-traders and momentum investors surfaced with the Internet. Trades were quick and cheap. Millions of novice investors flooded the market. 4) Conflict of interest by research firms. Analysts and investment bankers often were in lockstep.

Key factors become clear when studying major market crashes. Investors get over-zealous. Stocks become over-valued. The Federal Reserve misjudges liquidity and/or inflation controls. This was true in 1929 when interest rates were raised aggressively and was also true in when Fed Chairman Alan Greenspan increased interest rates rapidly, to slow down an exuberant economy.

In 1929, new legislation was passed to correct the ills of the system:

* The Glass Stegal Act banned any connection between commercial and investment banking.

* The Securities and Exchange Commission was formed to punish securities regulation violators. The Federal Deposit Insurance Corp. was established to insure individual bank accounts to $100,000.

The Crash gave birth to new regulations:

* Day traders must have at least $25,000 in their account in order to trade the markets.

* CEOs and CFOs must be accountable for financial reporting. New penalties for fraud are in place.

* Accounting reforms require more disclosure on financial statements including options or offshore companies.

* New requirements for the separation of investment banking and analyst research have been adopted. Major firms have been hit with fine that have deceptive practices. Reform will continue.

To put it succinctly, the Crash of screamed of greed and speed. What have we learned? P/E ratios and corporate earnings matter. Superior companies do survive crashes and can emerge even stronger.

Judith A. McGee is president and CEO of McGee Financial Strategies Inc. in Portland. She is a nationally recognized author and lecturer on financial planning, and serves as an expert witness in divorce and dissolution cases. For questions or comment, contact McGee, 503-597- 2222; e-mail, judith@mcgeenet.com; on the Web at http:// www.mcgeenet.com.