The Great Boom and Panic

[Ed. Note: Following is part 4 of a 5-part installment series on Robert T. Patterson's classic work, "The Great Boom and Panic," which examines the stock market crash of 1929, and its application to today's trading environment.]

"Those who could view the market's action in perspective must have realized that the slight gain on Friday [Oct. 25, 1929] and the somewhat larger loss on Saturday, which left the market below Thursday's closing level, might well mean that prices already had rallied as far as they possibly could under the dramatic stimulus of the banker's intervention," writes Patterson. "Obscuring such an objective view of the situation, however, was the renewed spirit of confidence which infused the whole population of stockholders generally and speculators in particular. Even many of the very sophisticated probably believed that the predicted, almost promised, support would be evident at the opening on Monday the twenty-eighth, and that the market would at the very least give some appearance of stability."

We have already observed how several heads of major banks across the country along with the Federal Reserve itself hastily formed a consortium and attempted to arrest the panic decline by infusing huge amounts of money into the market. Their efforts, however, would be largely for naught, for when the long-wave cycle turns down and is running against the market (as in the case of the 1929 crash) nothing can stop it. Herein lies a great obstacle to the financial security of millions. The great majority of investors believe; indeed, have always believed, that the "Establishment" (i.e., the Big Government/Big Business alliance) will never allow the securities markets to crash, thereby injuring their own pocketbooks. And indeed the Establishment will not idly stand by without acting during such times of crisis, as they showed in 1929 (and many times in more recent years). So long as the long-term trend is still up, there efforts at supporting the market will always be successful, as in 1987, 1997, 1998, and more recently, on April 4, 2000. However, when the trend has run its final course and finally changes direction, not even a concerted effort of every banker, businessman and bureaucrat on planet earth will succeed in supporting the vast waves of selling and liquidation that are sure to ensue. The reasons for this are as complex as they are arcane. Suffice it to say that there exists a common psychology—really a mass emotion—deeply rooted within every individual that makes up the common marketplace. When the cycles begin to change it will manifest itself in the attitudes and behavior of the masses, and this collective force is unstoppable once it has taken root. This explains why all efforts at halting the stock market collapse of 1929 were utter failures. It also will explain why any effort at stopping the market collapse that is due this fall will equally be a failure.

As an aside, we would note with great interest the similarities between the trading environment of 1929 and our present trading environment. Earlier in 1929, traders were given a scare when a tremendous amount of volatility suddenly came onto the market, resulting in a severe setback and the fear that a crash was coming on. However, this pocket of bearishness quickly dissipated and the Dow proceeded to soar to its ultimate high before commencing the Great Crash. We have already witnessed a nearly identical phenomenon just this week (April 3) as both the NASDAQ and the Dow have seen extraordinarily high volatility and trading activity and an intra-day crash in the NASDAQ. Both indices are now firmly in a bullish position again and should proceed to new highs in tandem for the remainder of this spring. But the unusual activity of this week was clearly an early warning of what is to come later this year.

Back to 1929. Patterson relates the market's opening on Monday, Oct. 28 —three trading days after the initial panic decline—gave a clear indication that all was not well on Wall Street. Trading volume began running extremely high and stocks across the board were declining in share price at a rapid clip. "The mere change of a figure on the ticker tape meant that some people throughout the country were poorer by millions of dollars," writes Patterson. "Those who wondered where this wealth went might well have wondered also where it had come from, and what kind of conjuring had created and destroyed it. What sort of wealth was this?" The obvious answer to Patterson's rhetorical question (obvious, that is, in retrospect) is that this wealth was based on nothing more substantial that credit created at the whim of the country's central banks, as well as the "money" created by the securitization of enormous amounts of common stocks, bonds, and related derivatives. This is the type of "wealth" that tends to evaporate into the thin air from whence it was created. In other words, it was the type of pseudo-prosperity we enjoy today.

Patterson makes reference to "marked shrinkage" in the value of bank stocks during the crash and how that it "was not regarded by the public as indicating doubt as to the banks' solvency." Then, as now, the stocks of the leading banking institutions and money center banks were important indicators not only of the soundness of the stock market as a whole, but of the banking sector in particular and of the overall money situation of the entire country. Keeping a watchful eye on such leading bank stocks as Citigroup, J.P. Morgan, and Chase Manhattan is surely a wise policy in the final stages of this secular bull market. Bank failures were not at all uncommon in the throes of the Great Depression, and they surely will not be uncommon in the coming depression.

"How very bad the market situation had become began to be revealed," writes Patterson. A frightful phenomenon—almost as fearful as the "air pockets" witnessed in several of the actively traded stocks during the panic (refer to our previous essays for more on this). A headline in the Oct. 30, 1929 New York Herald-Tribune read: "Street Puzzled when 37 Active issues Vanish." We quote the article below:

"One of the most peculiar circumstances surrounding yesterday's trading was the absolute disappearance of the market in thirty-seven of the list's active issues. Wall Street was at somewhat of a loss to explain this anomaly, but, in a few cases, it was learned that the specialists in the issues in question received large selling orders and could find no bids.

"Rather than offer the shares 'for a bid,' which would have meant sacrificing them at outrageously low prices, the specialists refused to open the market. While the thirty-seven stocks have been among the active issues for some months, they were not traded in at all yesterday.

"In the case of these stocks the offers as well as the bids were withdrawn at the close, so that there was no market in them that could be quoted."

Writes Patterson, "Before the opening on October 29, the New York Stock Exchange had announced the lowering of the call money rate from 6 to 5 percent. This announcement was an unprecedented action that seemed to indicate an overpowering desire to devise some piece of good news. And early in the day two members of the banking consortium, speaking for themselves, offered their opinion that stocks were 'cheap and near a turn.' Efforts such as these hardly rang true, and probably had little effect." During this time, the chairmen of several of the leading NYSE stocks announced significant dividends to their investors in a further (though futile) attempt at calming the market.

Patterson continues, "Of much greater significance than the dividend actions was the action of the New York City banks, led by those whose heads were members of the consortium, in reducing their margin requirements for loans to brokers from 40 percent to 25 percent. A similar reduction was made by banks in other cities. Brokers who required more than a 25 percent margin also reduced their requirement to this lower percentage for their customers. This bank action may have saved some brokerage houses from insolvency, and it probably reduced the number of margin calls that the brokers themselves had to make because of the day's extensive decline." Of course, these concerted efforts were entirely useless.

"Again," he continues, "statements poured forth from many different sources, averring true faith in the New Era [i.e., "New Economy"] and urging the public to buy stocks at prevailing bargain prices. Those who still held a position in the market began to take hope. Many thousands of others on the evening of October 29, however, found themselves suddenly impoverished or destitute. And some were also deeply in debt to their brokers." Thus we see how the Wall Street Establishment are almost never bearish and will do anything in their power to prevent the trading public from cashing in and leaving the marketplace. As long as there is a Wall Street, the old maxim about a "fool and his money" will always hold true.

Finally, the moment everyone had been anxiously awaiting—the first meaningful reversal—set in on October 30-31. Writes Patterson, "The long-awaited reversal thus seemed to be announcing itself, and thousands of speculators and investors hastened to take advantage of it. Many selling orders above the market were cancelled, and 'buy at the market' was the common directive of those fearful of missing the opportunity to 'get aboard' early in the movement. Sizable blocks of stock were taken by the more affluent traders, some of whom had recently 'cashed' large profits on the bear side of the market. U.S. Steel led the rise, which continued throughout the session.

"About an hour before the close on the thirtieth, a report came over the news ticker that John D. Rockefeller, Sr., had announced that for several days he and his sons had been buying 'sound common stocks.' This news gave further strength to the market. Already a cheerful atmosphere had replaced the gloom of the preceding two days. Twice, loud cheering broke out on the floor of the Stock Exchange: at the opening, as prices moved dramatically upward, and later in the day when Richard Whitney, acting president of the Exchange, announced that the governors had decided to limit trading on Thursday to three hours in the afternoon and to close the market for Friday and Saturday. This holiday was urgently needed by brokers and the members of their staffs, many of whom were close to the point of complete exhaustion." A further cause for celebration among investors came when the Federal Reserve Bank of New York announced a reduction in its discount rate from 6 to 5 percent. "Thus," writes Patterson, "after the market had closed for the three-day weekend, all those who were bullish had very good reasons for expecting the advance in prices to continue and perhaps even accelerate on the following Monday."

He continues, "A large segment of the general public was convinced that bargain day was at hand." Patterson relates how that enormous sums of money were wagered on stocks in the days leading up to the opening on Monday, even though the markets were closed. Much of this was done in what was known as the "gray" or "gutter" market. Everyone, it seems, was determined to put every last dollar they had in the market in the hopes (nay, the assurance) that the market would reverse course and the bull market would resume once again. "Where people had no savings to draw upon, they borrowed on life insurance policies, furniture, jewelry, and even on shares in unsettled estates, often at exorbitant rates of interest. Some pawnbrokers ran out of cash and had to stop lending, and finance companies did a record-breaking business." The Monday morning edition of the New York Herald-Tribune ran a front-page headline that blared, "Wall St. Expects Record Revival of Bull Market Today."

"But," writes Patterson, "on Monday morning, November 4, prices opened 'sharply off,' and they continued to decline throughout most of the session. The surprise and disillusionment was tremendous, among the brokers at the exchanges and on down to the one-share buyers…Every day, hopeful, prominent people allowed themselves to be quoted to the effect that the worst was over. Most of the news during this time was unfavorable [and] it was characteristic of the panic, and later of the long depression decline, that very often the most encouraging kind of news item, to which the market formerly would have responded with vigor, seemed to have no effect. The market's reaction to good news became, in a way, a measure of how bad the underlying situation was."