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IT'S NOT 1929
By Karen Blumenthal A long streak of excess lending got out of hand as banks and even some established industrial companies made a stream of risky loans. Consumer spending on cars and clothes was slipping, but no one was paying attention. The stock market grew shaky in September, and then in October, the bottom fell out.
Suddenly, everyone seemed to want to sell. But there were few buyers, and over six bleak trading days, the Dow Jones Industrial Average lost a third of its value. It was a panic, said a senior New York Stock Exchange official, “where all at once, the inconceivable terrors of the unknown and the unfamiliar are thrust upon the public mind; confidence is paralyzed, and until it is restored, chaos reigns.” The year, of course, was 1929, although it sounds just enough like today to make us wonder if we should stock up the pantry, take the cash out of the bank and hunker down for a 21st-century Great Depression. No doubt, the parallels are stark and frightening. But the differences between now and then are even greater. COLLATERAL DAMAGE Let’s start with lending. In the late 1920s, as the stock market took off, banks expanded their lending for purchases of the most unpredictable of assets: stocks. At the time, investors could borrow up to 75% of the value of a stock purchase, and use the stock’s price gains to repay the loan. By 1929, almost $4 of every $10 in bank loans went to buy shares. In addition, companies like Chrysler, General Motors and Standard Oil of New Jersey made tens of millions of dollars available for stock loans. In one egregious example, an energy company called Cities Service sold stock to investors and then used the cash it generated to make loans for people to buy When the market started to fall, however, brokers had to call clients to demand more cash to secure their loans—a so-called margin call. And when the downturns persisted, brokers had to sell their clients’ shares, at depressed prices, to recover their loans. The comedian Groucho Marx borrowed from the bank, against his life-insurance policy and against his house to come up with cash as collateral to meet his margin calls. But it wasn’t enough. During that dark week in October, his broker sold all his stocks, wiping out his life savings of $240,000 and leaving him deeply in debt. “I would have lost more,” he said later, “but that was all the money I had.” When those stock assets evaporated, an already weak banking system was crushed. In the first half of 1929, well before the crash, more than 300 banks closed. More than 1,000 banks closed in 1930. Without a Federal Deposit Insurance Corp., depositors lost everything. Initially, the Federal Reserve did nothing. To try to discourage more borrowing on stocks, it kept interest rates high, choking off credit. Unemployment climbed toward 25%, at a time when there was no unemployment compensation. THE FUNDAMENTALS ARE SOUND Most striking was the government’s long reluctance to acknowledge a serious problem. During the crash, President Herbert Hoover insisted that “the fundamental business of the country ... is on a sound and prosperous basis.” But by the middle of 1932, the Dow had dropped 90% from its peak in September 1929. By the end of 1933, an estimated 44% of all first mortgages were in default. Only in the depths of that crisis did the government truly step up to address the many underlying problems. Today, our mortgage mess looks like a disaster, too, but at least banks made loans against houses, assets that should continue to hold at least some value. In the second quarter of this year, according to the Mortgage Bankers Association, 2.75% of mortgages were in foreclosure—high by modern standards, but far from Depression-era levels. The long-term impact remains to be seen, but the acknowledgment and quick action by the Federal Reserve and Congress truly set this crisis apart from 1929. STAY THE COURSE Admittedly, that doesn’t erase the ache of watching our life savings shrink or ease the fear of what might be ahead. Clearly there are repercussions yet to come. But remember that we’ve been through tough times before. The Internet bust was almost as extraordinary as the 1929 crash: Between early 2000 and late 2002, the tech-heavy Nasdaq Stock Market index fell almost 80%. The speculative real-estate lending that resulted in almost 2,000 bank failures between 1987 and 1991, and the Dow plunging 22.6% in one day in 1987. What can you do? Stay the course. You know this, but it’s a time for families to return to the basics. Live within your means. Reduce your debt. Keep saving—and investing. When the cycle turns, and it will, you’ll be glad you did. And it helps to keep your losses in perspective. For more than a decade, I have gone to my local elementary school to tutor. There I spend time reading with children who own no books of their own, whose families can’t afford school supplies and who have never been to a dentist. For the price of 45 minutes a week, I return to my desk feeling as wealthy as any one person needs to be.
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