October Effect

and finance Allah shmoop What was the market crash of

1929 aren't people while there was cheap and easy credit

and that's what the crash was really about Greed and

a big bad bear market nobody could have imagined happening

at the time right Nonprofessional retail investors were allowed to

borrow some 90% of their investment portfolio to go buy

new stocks beyond the stocks they already owned So quick

Math If someone invested $1000 of their own hard earned

savings and the stock tripled like it did in the

mid twenties for a lot of easy money yeah well

then that $1000 would have become $3000 in a very

short period of time Great but in fact margin rules

were almost non existent in era it was coming to

allow investors to have 334 even five times they're invested

equity as borrowed margin or set another way on an

initial $1000 invested Many investors were stupidly allowed to buy

$5000 worth of stocks So really volatile right If things

go the wrong way it hurts But let's take a

simpler approach If an investor had been allowed to margin

there account up to 90% of its value like 50%

is generally the maximum today that you could borrow Then

that investor on $1000 of their own invested capital could

have purchased $1900 worth of that stock that tripled So

doing the math three times 1900 gets you What is

that $5700 You pay back the $900 of margin that

you borrowed against yourself and you'll have netted something like

$4800 in profits albeit a little bit last because you'll

have paid interest to the brokerage's that allowed you to

borrow money in this manner That's a margin interests So

in the margin case while the $1000 ofyour invested capital

maybe 4.8 times your money rather of any paltry three

times your money had you not been leveraged and that's

way more dough to crow about right And in those

days well that extra $1800 would have bought you like

a house So everything was great 90 50 1926 27

28 when the market mostly generally went up and provided

easy money for the well heeled invest who could play

the game and everyone was incentivized to keep the party

rolling Yes that's a flapper girl Brokerages could charge fat

commissions on transactions and nobody complained Why Well because the

markets rise more than eight for those commissions Brokerages could

also charge big interest rates on borrowed margin because the

markets rise Masked all those costs and everything ended up

sweet and beautiful is the prince married the princess and

they went off to their castle in the clouds Oh

but wait Then reality struck One day a not so

kindly old woman offered Snow White the apple she bit

and the market went down down down Such that panic

selling ensued and more or less Everyone who was on

the hook to pay back borrowed money in the form

of margin had their loans called immediately by the kindly

smiling brokerages as they more or less lost while mohr

than everything meaning that not only did the investors lose

all of their investments but the brokerages who had underwritten

those loans themselves went bankrupt because the stocks went down

so far that even the margin limit covenants were violated

That is on the stock purchased $4000 with the $900

a margin That $1000 worth of stock ended up being

worth well $500 or maybe a lot less so even

if the brokerages sold every share of that original $1000

investment now worth only $500 While the $500 in original

value remaining didn't even come close to covering the $900

in margin the brokerages clients took out in loans in

the first place So yeah it sounds like the crazy

maddening crowds at work and the crowds back then were

mad Everyone was buying on margin and if you weren't

well then sucker you were just yet another sucker hauling

bricks or ice or railroad ties for a living Life

was way easier when you could just phone in a

stop order in you know play golf all day So

this was bad and 1/2 and it's part of the

process of investors panicking They lost trust in the financial

system of America Many investors then wanted to sleep on

a pile of their hard earned saved $20 bills so

they ran to the bank on Mass and asked for

their money back They wanted to withdraw all their money

from the banks And guess what The banks didn't have

the money sitting around because they loaned it out for

mortgages and car loans and horse loans or over the

head back then So the frame then was a failed

stock market Lack of trust in the banking system in

America no credit then offered Teo Well pretty much anyone

You can imagine what America would be like if we

didn't have credit cards alive and well and no adult

supervision to get this country out of the deep financial

hole that I dug well along came FDR With the

New Deal he primed the pump and creating federal guarantees

for banking deposits upto a little certain amount like FBI

see limits of 100 grand and change today He also

enforced vastly stricter regulations on banks brokerages and pretty much

anything financial such that going forward this country ran a

dramatically Mohr conservative balance sheets and investment people had to

disclose well pretty much everything The result Well gradually greed

came to overtake fear again and in mid thirties or

so the market slowly trundled northward again It's what I

look like And then everything gave rise Teo Well this

really beautiful sight Welcome to America