What caused the Stock Market Crash of 1929?

The stock market crash in 1929 marked the beginning of the Great Depression, which lasted nearly 10 years through the 1930’s. Equity values plunged in the Dow Jones Industrial Average (DJIA) nearly 90% from 1929-1932, evaporating significant wealth. Many reasons can be attributed to the market crash, however the speculative bubble formed during the 1920’s and panic selling were the main factors that led to the meltdown.

During the 1920’s, the Dow increased roughly five fold in value over a nine year span due to irrational exuberance in the equity market and easy credit which led to investors buying on margin. After World War I, the stock market offered a way for individuals to create wealth for themselves. This led to equity in-flows that were never seen before. Due to the sudden rise in equity values, more retail investors invested money into the market, thus creating an even sharper stock market increase. In this time period, investors only had to put down roughly 20% of the value in equity shares and could borrow the rest on margin (lenders included banks and other investors).  The combination of irrational exuberance by investors that believed the stock market would rise infinitely and easy credit led to a speculative bubble that required a correction.

On March 25, 1929, a mini crash occurred in the stock market due to a slow down of the U.S. economy, foreshadowing what was to come in October. After the mini crash in March, National City Bank provided $25MM in credit to halt the slide and keep investors in the market in order to prevent a major selloff. Over the next few months, the American economy began showing more signs of slowing. Steel production, construction and auto sales all began to show a slowdown. Poor economic news and the debate of the controversial Smoot-Hawley Tariff Act in Congress led to the bubble bursting on Thursday, October 24th, 1929. Black Thursday, as it is now known, saw a selloff of 11% at the opening bell on heavy volume. Once the vast majority of investors heard of the market downturn over the weekend, the DJIA dropped 13% on Monday, October 28th and another 12% on Tuesday, October 29th due to panic selling from investors who wanted to get out of the market before they lost more of their wealth. Investors who purchased a high percentage of securities on margin also fled the market in order to cover potentially high margin calls. To quantify the dramatic loss in value, the DJIA went from a high of 381 on September 3, 1929 to a low of 41.22 on July 8, 1932.

Due to the speculative bubble of the 1920’s and subsequent burst that led to the Great Depression, several regulations were put into place, such as the creation of the Glass-Steagall Act (which was repealed in 1998) and the halt of trading in the event of an unusual selloff due to high trade volume. The severity of the market crash in 1929 was felt for years, as the DJIA high on September 3, 1929 was not reached again until November 23, 1954. Due to the regulations enforced after the stock market crash in 1929, it is highly unlikely that an event of that magnitude will repeat itself.

Disclaimer: This article represents the opinion of Mitlin Financial Inc. It should not be construed as providing investment, legal and/or tax advice.