Thursday, February 23, 2012

Why The Stock Market Crashed in 1929 and 2008: Parallels of Two Generations

Someone deleted my post about this topic, so i'll post it again lol.



Why The Stock Market Crashed in 1929 and 2008?: Parallel's of Two Generations

        



              The Industrial Revolution in America brought a change in lifestyle for many people.  The urbanization of American society brought new jobs, inventions, and new wealth to many.  “After World War I, the United States, benefiting from a half a century of industrial progress, achieved the highest standard of living any person had ever known, though one that still left many millions in poverty.  National income soared from $480 per capita in 1900 to $681 in 1929.”(Leuchtenberg, 1781)  As a result in increased wages, American citizens now had more money to spend leading to more cash flow culminating in a productive economy.  First, let’s first take a look at America’s new car industry.  The Federal Road Act of 1916 brought a network of roads for Americans to travel giving people a reason to drive.  Henry Ford’s Model T was first produced in the first decade of the 1900’s, but finally became prevalent in American society in the 1920’s.  His ability to implement the interchangeable part brought great productivity and efficiency to his automobile factories.  “In 1914, Henry Ford had revolutionized production by installing the first moving assembly line with an endless-chain conveyor; three months later, his men assembled an automobile, down to its smallest parts, in 93 minutes.”(Leuchtenberg, 1791)  By 1929, Americans were driving 4.8 million automobiles, which averaged out to one in every five persons which was greater than every other developed country by a wide margin.  For the first time, people were able to purchase vehicles on credit in proportioned installments.   American car production became such an ordinary thing that Americans started asking for a new, more luxurious car with different colors and styles which led to Ford’s Model A.  “When Ford announced the Model A early in 1928, 500,000 people made down payments without having seen the car and without knowing the price. (Leuchtenberg, 1861) Ford went on to say that machinery was the “Messiah.”  Technology during the 1920’s brought new electronic gadgets within the home which caused consumer frenzy during the decade.  New appliances such as washers, dryers, and radios began to appear in stores across the country. Advertisement for the radio, another new invention, led to more consumer knowledge on new products which led to mass consumption and the rise of consumerism.  Mass consumer spending on credit or installments is like a ticking time bomb waiting to happen.  In the end, America flourished in the 1920’s, but as the realist always says,” nothing can last forever.” Tariffs on foreign goods began to rise on imported goods, which caused foreigners to do the same to America exports.  This problem slowed trade, which caused many Americans to lose their jobs, and this helped lead America in the depression.  Many Americans put money into the growing Stock Market of the 1920’s saw their money dwindle away as the Stock Market crashed in 1929.  Americans all through the 1920’s invested large amounts of capital because investment banks allowed individuals to pay ten dollars for every one hundred dollars of stock you wished to purchase.  This investment strategy allowed investors to make quick money, but this method caused an artificial rise in the Stock Market which subsequently crashed in 1929.  Banks all over the country collapsed after many international upheavals such Great Britain leaving the gold standard.  By 1931, over 2,000 American banks closed their doors.  Just before Christmas of 1930, the Bank of the United States in New York City closed its doors, leaving most of its 40,000 depositors with nothing.  As a result, many Americans took all of their cash out of their respective banks, and put them into safe deposit boxes, or hid them away within the privacy of their own homes.  “The endless downward spiral of liquidation reached the point where they threatened the existence of the banks themselves.  Once deflation threatened the financial structure, bankers were curiously unwilling to experience the spiritual benefits of chastening, and they demanded government protection from the consequences of their actions.”(Leuchtenberg, 2551)  The industrial nation especially the automobile industry was badly overbuilt.  This problem led to fall of investment and the fall of production, which no government sponsor was going to help.  No other industrial nation in the world had as unstable or as irresponsible a banking system.  “The banks provided everything for their customers but a roulette wheel.”(Leuchtenberg, 2461)  By 1934, manufacturing output drop over fifty percent of that of 1929.  As production slowed in the United States, so did the flow of money and the amount of jobs available to men ready and able to do so.  “In the three years after the crash, 100,000 people were fired on the average week.”(Leuchtenberg, 2471)  The Great Depression crippled not just the American Economy, but the moral and self-esteem of her citizens.





The Security Exchange Act was a significant part of the New Deal brought forth by Roosevelt and his administration.  Problems of corruption and cheating were embedded in Wall Street and its stock brokers for many years leading up to the Crash of 1929.  Roosevelt scolded the banks for what it did to the American people, so he wished to implement a piece of legislation to stop this corruption.  In his inaugural address in 1933 he spoke about Wall Street crookedness by saying, “The rulers of the exchange of mankind’s goods have failed through their own stubbornness and their own incompetence, have admitted their failure, and have abdicated.  Practices of the unscrupulous money changers stand indicted in the court of public opinion, rejected by the heart and mind of men….there must be strict supervision of all banking and credits: and investments, so that there will be an end to speculation with other people’s money.”(Ganzel3)  This piece of legislation was made possible by the Ferdinand Pecora, who acted as a prosecutor in the outcry of Wall Street Bankers.  “The Securities Law, gave the FTC  power to supervise issues to be accompanied by a statement of relevant financial information, and made company directors civilly and criminally viable for misrepresentation.”(Leuchtenberg, 592)  The Pecora inquiry brought to light that the JPMorgan partners had not paid a dime in income taxes in two years.  The Securities and Exchange Commission was put in charge to oversee Wall Street, and to prevent any illegal or corrupt business from occurring.  “The Securities Act aimed to prevent manipulation of the securities market by insiders by placing trading practices under federal regulation.”(Leuchtenberg, 902)  After the new Securities and Exchange Commission was put in place, and Joseph P. Kennedy was named its first chairman, the SEC aimed its regulatory eyes on the banks for reasons such as: bank could no longer buy stocks with depositor’s money, companies that wanted to sell shares to the public to raise money had to disclose a host of financial information to potential investors, and for the first time, investors could find out if a company was worth the price it was asking.  The SEC also regulated the major stock exchanges, the brokers and dealers, mutual funds, as well as investment advisors. 





During the forty years after Franklin D. Roosevelt implemented the Securities and Exchange Act, the United States saw great economic growth, all in part of the regulation of the Stock Market on Wall Street.  Credit was much harder to get during this time because the government would only allow banks to issue loans to the buyers who they knew would pay back the loan.  In 1972, JPMorgan only had 110 employees, and had a capital of twelve million dollars, and by the 1990’s both numbers increased to 50,000 workers worldwide and disposable capital in the area of several billion dollars.  This increase in capital came as a result of the Reagan Administration.  During the 1980’s, Reagan began a thirty year period of financial regulation of the Stock Market.  Reagan was influenced by his Financial Advisor Allan Greenspan, who remained there for the next thirty years.  Greenspan was an advocate for the deregulation of Wall Street affairs because he said, “Let business do as business does,” because the financial sector will regulate itself.  As a result of this new plan, banks began lending money in large amounts like they had once did during the “roaring” 1920’s.  The housing industry began to boom once again in the United States, and caused an artificial price increase in property and home value which essentially doubled during this time.  Consumer spending increased along with the booming housing and construction industry.  Americans were spending money on credit much more than ever as a result of two new and significant laws that were passed during this period of financial deregulation.  The deregulation period during the 1980-90’s help lead to the creation of new stocks known as derivatives.  Derivatives were created out of American credit from house and car loans, student loans, and other forms of credit.  This new industry allowed investment banks to gamble on anything, and grew into a 50 trillion dollar market.  Derivatives were said to have made the market safer, but all along it made the market quite unstable.  Efforts to regulate the derivatives market was turned down by bullying tactics among large bank CEO’s.  Greenspan said in July of 1998, that “it was unnecessary to regulate derivatives because they were privately negotiated by intelligent professionals.”(Ferguson4)  In 2000, Phil Gramm, a member of the Senate, set a bill in place to regulate this new market, and it was passed with the Commodity Future’s Exchange Act.  This new market changed the whole foundation of money lending in the United States.  Local lenders no longer had to worry about whether home owners were going to pay their mortgages because lenders then sold the mortgages to investment banks who then sold them to investors.  These investors now saw capital gains every time a home owner made their payments.  Because of the housing boom, quick money was to be made by investors all over the world, but it made the market very unstable because it made huge capital gains at the expense of American Consumer Credit.  Banks were also now able to gain substantial amounts of leverage as a result of new financial laws.  Leverage is the amount of money a bank or investment firm can borrow compared to what amount of capital they have.  During this time, banks could now borrow up to thirty to forty times the amount of money that they had.  During this time, the SEC and chairman Christopher Cox conducted no major investigation of the investment banks.  Henry Paulson, the CEO of Goldman Sachs, helped lobby SEC to relax limits on leverage.  During this time 146 people were cut from the SEC, which left one person employed in in the Risk Management Department.  Greenspan, now the head of the Federal Reserve Board, had the right to regulate mortgages given out with the Home Ownership and Equity Protection, but refused to use it.  Every facet of the financial sector seemed to be involved in the corrupt acts that were going on.  Security Rating Agencies, which rated how safe a stock was to buy, were paid off by investment firms because they were giving out high ratings to what seemed to be subprime or risky loans because of the high-interest rates put on them.  The Rating Agencies saw profits four times the amount that they previously made.  During the late 90’s leading into the new millennium, subprime loans went from $30 billion to nearly $600 billion in just a ten year span.  As a result of this increased flow of capital, it seemed as though the more money these banks lent out, the more profit they made from these complex derivatives known as Collateralized Debt Obligation or CDO’s.  CEO’s and corporate executives were receiving bonuses exceeding hundreds of millions of dollars as a result of this booming industry in which money was created out of debt.  As one saw during the 1920’s, this booming economy could not last forever.  This time period known as “The Bubble” had flaws so deeply embedded in its system that it was bound to burst eventually. 





AIG, an American insurance firm, was the ticking time bomb that sold these CDO’s which called Credit Default Swaps.  These CDS’s for short, worked like insurance policies, so if AIG’s CDO’s went bad, the company paid its investors for its losses.  Speculators such as the investment banks themselves could buy CDS’s by AIG in order to bet against CDO’s they did not own.  Complex Derivatives made it possible to insure homes by several different individual, and instead of insuring the CDO’s, AIG paid out huge bonuses to their executives.  Unfortunately, AIG defaulted on its own debt even though up until it declared bankruptcy it was said to be have an AA rating. It was forced to close its doors, and starting the domino effect in the financial sector.  Investment bank such as Goldman Sachs, started betting against the same CDO’s they sold to investors, and ended up profiting off the losses of their investors, and even went as far as paying hundreds of millions of dollars to insure themselves against AIG’s collapse.  Timberwolf Securities sold $600 million worth of bad securities.  Later while being interrogated by Congress, reports came out that their traders called the sale “a shitty deal.”  By 2007, over one-third of the mortgages in the United States defaulted. Members of the Treasury as the Federal Reserve did nothing to warn the public of the impending crisis even though they had their fair share of warnings of its eventual implosion.  By 2008, an election year, foreclosures had reached over a million, and the new chain of investing had imploded as lenders failed, and investment banks were stuck with CDO’s they could not sell.  Even though in the same year, two huge U.S. investment banks, Bear Stearns and Lehman Bros went bankrupt, Henry Paulson now Bush’s Secretary of the Treasury, said “things are under control….it’s going to keep growing, and if it does we are not in a recession.”(Ferguson4)  This came two years after he sold his $485 million share of Goldman Sachs with no taxes removed to take the position with lesser pay in the government, which essentially was a savvy business move that saved him nearly $50 million. 





            This financial crisis, which was started by the same people who wished to deregulate the financial sector, has now engulfed the world into a utter madness.  Paulson asked for a $700 billion bailout, which was granted by Bush Jr.  Most of the bailout money came from the American tax dollars, so essentially the citizens of the U.S. paid to help maintain an entity that failed the people in which it represented. Executives now walked away with hundreds of millions of dollars while the unemployment rate now staggers around ten percent.  By 2010, foreclosures reached nearly six million people, and is still growing.   The financial sector has a major influence on politics because lobbyist who represent the investment banking industry spend $5 billion on politicians.  During a time when regulatory services such as the SEC, the FTC, as well as the federal government itself were needed, they played a blind eye to system that they knew was corrupt, and used negligence as a reason for letting such a problem happen.  The rising power of the financial sector has made itself too big to fail because if the banks were to collapse, as would the entire economy of the U.S.  As a result of a falling economy, U.S. companies go global for cheaper labor, further damaging the working industry for American families.  Even though we lead the world in information technology, one needs a higher education to get a job in the new industry, but college tuition is on the rise which makes it almost impossible for most middle class families to send their children to college.  The inequality of wealth in America is highest in the world.  Obama’s campaign in 2008 promised to put tighter regulation of financial sector by having a risk regulator and increased captital requirements, but it is said to have made weak changes to the financial world.





After analyzing the similarities between the 1920-30’s and 1990-2000’s, one can draw parallels between the two financial collapses.  The lack of regulation allowed corporate America and the financial sector to make huge private gains at public loss.  As one understands the underlying problems of both economic era’s, one can make one’s own opinion on how deep the government should set its regulatory restraints upon the economic world, but in order to improve the economy the government must make strict new laws against executive bonuses, regulate and monitor rating agencies, as well as the investment firms themselves. Money can make people do some very selfish acts which should be frowned upon by the federal government, and the people that commit such horrible crimes should be held accountable for their actions.  In both era’s in the 20th century, corporate tax laws were made to benefit corporations as one can see with JPMorgan in the 1920’s, and General Electric in 2010.  The distribution of wealth during each era was the biggest in American history during each respective era.  Technology and the media played a role in consumerism and the rise of credit shopping to keep up with the status quo of society during the beginning of the radio age in the 20’s as well as cable television of the 90’s.  In conclusion, the most significant parallel between the two era’s in American history is this: each time America has seen economic collapse, the middle class is affected the most , and has to pay for the cleanup of the economic burden made by the 1% of the plutocracy by manipulation and greed. 

The government had alot to do with this as well.  The government forced banks to give out loans to people that could not afford them.  They wanted lower-middle class people to own homes even though they could not afford it.  With a lower credit rating, they knew that they could make a killing because if your credit score suck, you have to pay higher interest because thats just how it works, the higher the liability you are, the more money you must pay in interest.  The government told the banks if they wanted to expand to a region they had to do what they said, and that was give people mortgages that they knew that could not afford to articially inflate the housing and property industry.  At the time it was a good idea and America flourished, but it brought the whole world to an economic collapse because people really could not afford their homes, and no one thought about the downside of the operation: What would happen when people did not pay their mortgage which was supposed to be the safest way of business for a bank, but they did not care because they could insure their loan or CDO with a CDS that was guarenteed by companies like AIG, who's CEO was absolutely retarded for thinknig it would never fail. 

1.       William E. Leuchtenberg,” Perils of Prosperity.” 1958. The University of Chicago Press, Chicago.

2.       William E. Leuchtenberg, “The New Deal”. 1963. Harper & Row Inc. New York, New York.  Ed. By Henry Steele Commager and Richard B. Morris.

3.       Bill Ganzel, “New Financial Laws.” 2003. Ganzel Group. York, Nebraska.

4.       Audrey Marrs & Charles Ferguson, Charles Ferguson. 2010.”Inside Job.” United States. Sony Pictures Classics.

2 comments:

  1. Fairly liberal mindset here. I see you favor much government regulation and intervention as the solution to current and future problems. Have you thought of the contribution of the federal reserve bank in setting interest rates, thereby influencing loaning and borrowing? Have you considered the influence of the HUD/FHA, etc and other housing authorities in their push to give all Americans the chance to own a home and thus experience the American dream no matter what? Your last two poorly written paragraphs about anti-capitalism/wealth barely draw a comparison between the 1920's and your article seems to loose steam.

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  2. I would not say i am totally anti-capitalist simply because it truly the only economic system that gives talented and hard-working people the incentive to make something of themselves. My thesis i was trying to get across was the failure of banks to regulate themselves especially when the countries economy is lying on their backs. In addition, i also like to hammer home the inabibility of the average person to make rational and intelligent decisions for themselves and their money rather than live up to the status quo and mass media, but at the same time their was increased pressure from many different angles from both generations. Economic cycles work much like waves, having both peaks and troughs that are not to big nor too small, but rogue waves like the bubble period of thr 1920's and the late 1990's into the mid 2000's was just a ticking time bomb waiting to collapse because of maximum risk. I'd have to agree with you that my last few paragraphs fail to bring home proper conclusions particularly involving the Great Depression. But back to the housing crisis, their was pressure put on banks by government agencies to give out home loans especially by the Bush administration because they felt each American family deserves to live in a home. This is absolutely horrible. I certainly agree growing up in a house is much better for a child, but you should encourage individuals to live within their means rather than make irrational decisions in the present rather seeing the bigger picture. Whether these same people encouraged home buying simply to gain even more success for their wallets is something i do not know, but not k seeing both sides of the situation where foreclosure might reach higher than 6% which was the tipping point for Credit Default Swaps to be profitable was something that bankers, insurance companies, and mortgage lenders should have looked closer into. And the only reason interests rates are so low now is because of the FED's "quantitative easing" or the printing of more money which drives our currency down and in essence interest rates. Thanks for the feedback, you definitely helped me see the situation from a different perspective!

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