The Great Crash of 1929


by J.K. Galbraith

Massive land speculation,  dramatic growth in margin lending, promotion of exotic investment structures by “trusted” investment bankers, promotion of tech stocks that reaches rampant levels.  Sound familiar?

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 !

Well what a ripping yarn this is.  Galbraith gets us started with the Florida land speculation that  really took off in the summer of 1925. The boys were up to the usual tricks “what was usually called seashore became 5, 10 or 15 miles from the nearest coast”.
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.]
The congestion of traffic into the State of Florida became so severe that in the Autumn of 1925 the railroads were forced to proclaim and embargo on non essential freight, which interestingly included all the building materials required for developing the subdivisions.  Values rose wonderfully. By the Spring of 1926 things had started to slow down but as Galbraith notes the momentum build up by good bubbles is not dissipitated in a moment.  Interestingly enough the collapse of the boom was helped by a couple of black swan events. In the Autumn of 1926, 2 hurricanes arrived.  The worst on 18 September 1926 killed 400 people, tore the roofs from thousands of houses, and poured tons of water and a number of elegant yachts into the streets of Miami.
That gives you a bit of a flavor but you really need to read this book.
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 every boom there is an exotic structure – derivatives anyone ?
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.

Of course no bubble would be complete without a nice underlay of technology froth.  in 1928 it was too early for the internet, the computer, or television.
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.

And Galbraith wraps the whole thing up nicely in the aftermath of the crash including of course a number of high profile frauds that emerged after the event.

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.

I highly recommend this book to you.  it just reinforces that history does repeat and that was there are a few tweaks a speculative bubble is a speculative bubble with many, many of the same characteristics.  With the added bonus that Galbraith is a brilliant writer and this is a ripping yarn.  If anyone wants to buy my copy of the book, it is available for $15 cash or $8 down and 6 monthly installments of $2.
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