Election of 1928 and the Stock Market Crash

Election of 1928 and the Stock Market Crash

In 1928, Republican presidential candidate Herbert Hoover declared that the United States was “nearer to the final triumph over poverty” than any nation in the history of the world. This kind of rhetoric was expected from presidents and would later be used to make it appear as though Hoover had not anticipated the challenges of the next four years. The criticism is only partially valid. Hoover, more than most political leaders of his day, understood that some of the era’s affluence was based on speculation. As secretary of commerce under Harding and Coolidge, Hoover understood these challenges as well as most Americans and had long cautioned about the dangers of stock market speculation.

As a candidate in the 1928 presidential election, however, Hoover’s strategy was to connect his leadership of the Commerce Department with the decade’s prosperity. The strategy paid dividends as Hoover easily defeated Democrat Al Smith with the support of 21 million voters to Smith’s 15 million supporters. The only consolation for the Democrats was that they were successful in mobilizing immigrant voters, although a large part of this growth was simply a reaction to the nativist rhetoric of many within the Republican Party. Smith was the first Catholic to secure the nomination of any major political party. Although the Klan and others who subscribed to anti-Catholic sentiment had declined, Smith’s campaign was still tormented by nativist detractors. These efforts backfired, at least in the long term because they brought Catholic voters into the Democratic fold. These two groups—Catholics and immigrants—would prove essential components of the future Democratic coalition that would provide large majorities for their party in future elections.

Part of Hoover’s appeal in the 1928 election was the connection in voters’ minds between the prosperity of recent years and the Republican Party. His cabinet was composed of business leaders and reflected the confidence of years of financial success. The stock market had been encouraged by nearly a decade of increasingly positive earnings results. There were certainly signs of decline within major industries and real estate, but this was true even during the most robust periods of economic growth. Some of the positive signs were unique to the US. For example, American finance and industry had gained globally in the wake of World War I. US banks and the federal government were receiving millions each year in interest payments from loans made to their Western allies during and after World War I. The United States also enjoyed a favorable balance of trade and a domestic market that was the envy of the rest of the world.

Figure 6.26

The stock market crash of October 1929 led to bank failures that caused many Americans to lose their life savings as well as their jobs. State and private charities had cared for individuals in the past, but these entities were quickly overwhelmed by the magnitude of the Great Depression.

In retrospect, at least, the global signs of economic decline were obvious. Germany was saved from delinquency in its reparation payments only by a series of temporary reprieves that delayed repayment. US banks had invested heavily in Germany both before and after the war. Had it not been for US money that was still flowing to Germany, German banks would have defaulted on their obligations to Western Europe long ago. Even worse, Western Europe’s interest payments to US banks and the federal government were dependent upon the receipt of German payments. In other words, America’s leading position in world affairs obscured the fact that it stood atop a delicate house of cards that depended on US capital to shuffle the deck. If US banks were unable to provide continued loans to their international creditors, these foreign governments and banks might default. This could start a cycle of defaults that would leave US banks to face their own precarious liquidity issues at home.

These US banks had invested their own depositor’s money, loaning money to corporations that were also low on cash reserves. Domestic consumer purchases of homes, automobiles, and appliances were declining for two important reasons. First, consumers who could afford these items had already purchased them, while others had purchased them on credit. Neither group could be expected to make the same level of discretionary purchases indefinitely. Second, the distribution of wealth in the nation was dangerously uneven. Corporations had borrowed billions to produce factories that could churn out consumer goods, but there simply were not enough middle-class consumers who could afford their products. The wealthiest 1 percent of Americans controlled over a third of the nation’s wealth, and the bottom 50 percent had almost no personal savings whatsoever. The middle class had grown slightly wealthier, but few people could truly be considered middle class. This group of consumers was simply not large enough to sustain the new economy, which was based largely upon consumer spending.

The most obvious sign of financial crisis came in October 1929 when the average valuation of every publicly traded US company dropped by nearly 40 percent. Although this decline merely returned most stocks to the prices of the mid-1920s, the Stock Market Crash of 1929Refers to a series of days in October 1929 when the aggregate value of publicly traded companies listed on the New York Stock Exchange declined by as much as 10 percent. Although similar panics had led to declines like this over the course of a few days, the stock market crash saw multiple trading sessions in a row, where prices declined rapidly despite the efforts of leading bankers to bolster the market. Because many investors had bought stock with borrowed money, these declines led many individuals, banks, and corporations to go bankrupt. By 1933, the stock market was down by over 80 percent. was not merely a setback. Hundreds of millions of shares had been purchased with borrowed money with only the stock itself as collateral. When these stock prices fell, the loans could not be repaid. As a result, thousands of banks failed, and millions of depositors lost their life savings.

Even banks that had not made risky loans or speculated in the stock market were punished because depositors did not want to take chances that their bank would be the next to fail. At this time, it is important to remember, the US government did not provide insurance for bank deposits. The result was that banks no longer had money to lend to individuals or businesses to keep the economy going. To make matters worse, banks also began to call in their loans early, which forced businesses to sell their own stock, lay off workers, or simply declare bankruptcy.

This incredibly risky strategy of buying stock with borrowed money was known as “buying on margin.” The practice remains legal in the modern era, although it is more heavily regulated. Buying on margin allowed individuals to “leverage” their money to buy more stock than they normally could by using existing stock as collateral. For example, someone with 500 shares of General Electric valued at $100 per share would have an investment valued at $50,000. The use of leverage and margin could permit the investor to use those shares as collateral for a loan of another $200,000, which he would use to purchase another 2,000 shares of GE stock. If GE stock increases in value, the individual stands to make a substantial profit. However, if the stock declines by 40 percent, as most stocks did, the individual’s 2,500 shares at $60 each would be worth only $150,000. Because he still owes the bank $200,000 and has only $150,000 in stock to pay it back, he and the bank might be in serious trouble. During the 1920s, many private citizens, corporations, investment firms, and even banks found themselves in precisely this situation. Had the investor simply bought the 500 shares with money he owned, he would still have $30,000 worth of stock even after the 40 percent decline.

It may be easy in hindsight to see the folly of such an investment strategy, but the stock market’s unprecedented rise during the 1920s enticed many investors to become gamblers. The era’s prosperity had led to dramatic increases in stock prices, partially due to genuine corporate profits but also because many other speculators were also buying stock with money they did not actually have. Eventually, there were not enough new investors to keep buying stocks, and the prices began to decline.

However, these stock price declines were not the only cause of the Great Depression. Stock prices had doubled in the final two years of the 1920s and were overdue for a correction. The greatest significance of the stock market was its effect upon the banking system. The economy’s decline had actually begun sector by sector in the mid- to late 1920s in response to declining consumer demand. It was only after the crash of Wall Street that investors started paying attention to the years of declining consumer demand. Prior to the crash of October 1929, investors were happy to purchase stock at inflated prices. Afterwards, the realization that corporate profits lagged behind stock prices led to three consecutive years of stock market declines.

These declines erased the wealth of many potential entrepreneurs and led to the near-collapse of the banking system. It also shook the confidence of credit markets in ways that would prevent economic recovery. Recovery was also prevented by the unequal distribution of wealth in an economy based on consumer spending. When consumers could no longer afford to act as consumers are expected to act, sales declined, and the downward pressure on all financial markets continued. Between bank failures, the stock market crash, massive unemployment, and the complete erosion of consumer demand, it became increasingly clear that the economy would not recover on its own as quickly as it had in the past.