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Markets & Stocks

Lessons from 1929
75 years later, debate over whether the crash had to happen, and post-1987, if it can happen again.
October 29, 2004: 11:45 AM EDT
Yuval Rosenberg, CNN/Money contributing writer

NEW YORK (CNN/Money) - The numbers are still stunning.

On "Black Monday" in October 1929, the Dow Jones industrial average tumbled 12.8 percent, and the next day, "Black Tuesday," it sank another 11.7 percent. The crash of 1929 took the market down 23 percent in just two days and nearly 30 percent over six days that fall.

Things would get even worse. By July 1932 the market had plummeted almost 90 percent, and it would take 25 years before the Dow would surpass its 1929 peak.

Now, as we look back seventy-five years later, several questions come to mind: Can it happen again given the reforms instituted after the 1987 crash. And this probably unanswerable puzzler: Did the crash of 1929 really have to happen in the first place?

Economists are still exploring the dynamics that came together to create a perfect storm of panic selling that fall.

Historian John Kenneth Galbraith described market conditions back then as a "speculative orgy" in his book "The Great Crash 1929."

"On the first of January of 1929, as a simple matter of probability, it was most likely that the boom would end before the year was out," Galbraith wrote. "The market wouldn't level out; it would fall precipitately."

That certainty, of course, comes with hindsight. Other economists note that prominent economic thinkers of the time, including John Maynard Keynes and Yale's Irving Fisher, felt comfortable enough investing -- and suffered heavy losses.

"Stock prices have reached what looks like a permanently high plateau," Fisher said, just weeks before the crash.

Climbing valuations
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Seventy-five years ago, the stock market crashed -- a plunge that helped usher in the Great Depression and permanently marked the American psyche. CNNfn's Allan Chernoff looks back at the dark days of October 1929.

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Even in retrospect, stock valuations in pre-crash 1929 don't seem hyper-inflated, certainly not by today's standards. The price-to-earnings ratio of the market climbed from about 12 to 14 in 1928, then reached 15 in 1929, according to Harold Bierman Jr., an economist at Cornell University.

The S&P 500 today trades at 15.5 times forward earnings, according to Thomson First Call.

But if P/Es weren't quite stratospheric, the market had certainly run up considerably and fears about valuations were widespread. From March to September 1929, stocks rose almost 30 percent, capping a climb that had been going on for much of the roaring '20s.

"Eventually the market would have had to decline," says V.V. Chari, an economist at the University of Minnesota and an adviser to the Federal Reserve Bank of Minneapolis. "It didn't have to come to a screeching halt, but the market had risen so rapidly from '25 to '29 that I see no way that it could have stayed at those nosebleed levels."

The market was attracting plenty of attention.

Public figures from President Herbert Hoover to Fed Chairman Roy Young, among others, warned against speculation.

"Playing the stock market has become a major American pastime," The New York Times reported in March of that fateful year, adding, "It may be said that the number of individual brokerage accounts handled by members of the New York Stock Exchange have about doubled in the last two years."

Historians put the total number of active speculators at well under a million. These buyers used a great deal of leverage, a factor that has been blamed for much of the pain of the crash. Margin rules in 1929 allowed investors to pay only a tenth of the purchase price.

Robert McElvaine, historian at Millsaps College in Jackson, Miss., and author of "The Great Depression: America 1929-1941," notes that stock in the Radio Corporation of America, the Internet stock of its day, soared 394% in 1928, from $85 to $420. But an investor buying on thin margin could have put down just $10 a share and seen returns of 3,400 percent.

With those kinds of potential returns, a crackdown by the Federal Reserve may not have done much, McElvaine says.

Others disagree. Even if stocks were due for a downturn, a more aggressive tightening of monetary supply by the Fed could have deflated the market and perhaps helped avoid the crash, most economists argue. Most also agree that the Fed then blundered by tightening after the crash, exacerbating and extending the Great Depression.

A crash today?

So could we again be confronted with a great crash someday?

It's possible. But many of the problems that caused the escalating intraday losses of the past have been addressed. After the crash of 1987, the New York Stock Exchange instituted new "collars" and "circuit breakers" meant to cool the market if it's overheating.

Now a 10 percent drop in the Dow before 2 p.m. leads to a one-hour halt in trading, for example. A 20 percent drop before 2 p.m. causes a two-hour stoppage. And a 30 percent plunge at any time shuts down trading for the day.

Those fixes should help -- though as we've seen all too recently, a pronounced market slide can be pretty painful even when it takes place over the course of a number of months rather than a day.  Top of page

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