by J.K. Galbraith
Yep well it all happened in the period 1925 to 1929 and is brilliantly recorded and explained by the legendary economist J.K. Galbraith in this classic book of 1954.
I picked this book up in September 2008 for $2 at my local second hand book mart. I was pleasantly surprised when I check that within weeks it had reentered the Amazon best seller list at about $15 for the paperback. I was pleasantly surprised at my non-speculative gain on this book about speculation !
Suburbs became an astonishing distance from town as the speculations spread northward. An enterprising Bostonian, Mr. Charles Ponzy, developed the subdivision “near Jacksonville”. It was approximately 65 miles West of the City. [In other aspects Ponzy believed in good, compact neighborhoods; he sold 23 lots to the acre.]
One of the key things that I learned was how rapid and dramatic was the growth of margin lending. (It had not previously occurred to me that margin lending was even available in the 1920’s)
To simple numbers in 1929 about one and a half million people of the American population of about 120 million had an active association with the stock market. Of that 1.5 million trading accounts only about 600,000 of the accounts were used for margin trading.
The amount of money on margin loans from brokers was increasing very fast in 1928
Here’s a few snapshots of the growth :
||Total Margin loans outstanding
|early in the twenties||$1 Billion to $1.5 B|
|early 1926||$2.5 B|
|June 1927||$3.5 B|
|June 1928||$4 B|
|1 Nov 1928||$5 B|
|31 bDec 1928||$6 Billion|
People were swarming to buy stocks on margin loans.
At the beginning of 1928 the interest rate on margins loan was about 5%. the interest rate rose steadily through 1928 and during the last week of year it reached 12%.
This got the attention of the International Money Markets. In Montreal, London, Shanghai and Hong Kong it was talk of these rates. Everywher men of means told themselves that 12% was 12% and a great river of gold began to converge on the Wall Street – all of it to help Americans help buy common stock on margin. Corporations also found these rates attractive. At 12% Wall Streetmight even provide them a more profitable use for their working capital of the company than additional production. Few firms made this decision; instead of trying to produce goods with these manifold headaches and inconveniences they confined themselves to financing speculation. Many more companies started lending their surplus funds on Wall Street. There were still better ways of making money. In principle, New York banks can borrow money from the Federal Reserve Bank at 5% and re-lend it for margin loans at 12%. In practice they did. This was, possibly the most profitable arbitrage operation of all time.
In the twenties it was investment trusts.
“The investment trust did not promote new enterprises or enlarge old ones. It merely arranged that people could own stock in old companies through the medium of new ones. Even in the United States, in the twenties, there were limits to the amount of real capital to which established enterprises could use or new ones could be created to employ. The virtue of the investment trust was it brought about the almost complete divorce of the volume of Corporate Securities out-standing from their volume of Corporate assets in existence. The former could be twice, thrice, or any multiple of the latter.”
So trusts did nothing more but invest in real companies or even better invest in other trusts. And a late but hard player in this game was Goldman Sachs.
Now let me think what could fit the category. We need something that is new technology, disruptive, and with an unlimited growth opportunity.
Aha – Radio.
Yep the tech stock of choice in 1928 was Radio Corporation of America.
As Warren Buffett has said, “It is only when the tide goes out that you learn who has been swimming naked.”
And Galbraith also explains some of the observations about how things could be changed to reduce the chances of this happening again. If only everyone had learned these lessons.