The Great Boom and Panic

[Ed. Note: Following is Part 3 of a multi-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.]

Finally, the day had arrived, a day that would live forever in the annals of Wall Street infamy—"Black Thursday," October 24, 1929. Writes Patterson, "Few speculators and brokers were in a mood to enjoy the 'fine fall day.' Before ten o'clock that morning brokerage offices everywhere were packed to the doors with anxious or frightened people. Almost every Stock Exchange member was on the trading floor, even the elderly ones who seldom appeared there. Every available employee and extra telephone operators were on hand. A curious public thronged the New York financial district and crowded the galleries of the two major exchanges.

"From the opening gong, the volume of trading was heavy. In the first few minutes some very large transactions were recorded on the ticker at prices that showed no particular pattern or trend…During the night a vast quantity of both buying and selling orders had accumulated with the brokers, and on the books of the Stock Exchange specialists there were standing orders to buy stock at prices below—some far below—those at the preceding day's close. For the first half hour or so these open orders and some new orders to buy absorbed the selling, and some stocks even made moderate gains. But the selling increased, and as prices dropped they touched off stop-loss orders."

Here Patterson touches on an insightful point that contains tremendous relevance to the present. Stop-loss orders, while ordinarily serving the function of protecting investors from severe market slides should their speculations on a stock's price prove wrong, in this case served only to exacerbate the growing wave of selling pressure. Indeed, stop-loss orders greatly magnified the crash of October 1929, making it many times worse than it probably would have been without them. Today, especially with the advent (yea, the ubiquity) of online trading, stop-loss orders have proliferated to a level unheard of in Wall Street history. In light of the market's cyclical position later this year, this represents an avalanche waiting to happen.

Continues Patterson, "By eleven o'clock the rush to sell had become a mad stampede. Large and small stockholders alike, whose margins were disappearing or were about to be wiped out, gave up any last frayed hope they may have had and tried either to salvage something from the debacle or avoid being put in debt to their brokers for more than they could pay. Many probably were already thus in debt, and many more would become so during the day. 'Sell at the market!' was about all the beleaguered customers' men could hear, over the telephones and from those who crowded around them. To 'get out' regardless of price was the desperate resolve of thousands of these trapped speculators." As if to emphasize his point, Patterson adds that "Sell at the market!" was "the only effective order that could be given" on that fateful day.

Throughout the developing panic, ticker tape machines in boardrooms and brokerage houses across the country could barely keep up with the tremendous volume of transactions taking place. Indeed, at several times during the most pronounced parts of the panic, the ticker ran several hours behind. "Late in the morning," relates Patterson, "as the flood of liquidation overwhelmed what little buying resistance [i.e., support] was left, many stocks dropped steeply, with wide gaps between successively lower prices. No buyer was eager to step out into such a storm, and only great price concessions could tempt a bold few to take the stock that was being offered. The situation was worst when, at times, there were no buyers for various important stocks at any price. Confronted with such a vacuum, bewildered brokers, deluged with orders to sell, had to wait helplessly until a bid appeared. These 'air pockets' in certain stocks were more terrifying than any other aspect of the panic. They were frightening enough to those who had to sell but could not; they were probably even more so to the bankers and brokers, who realized their effect on the value of the collateral pledged with the banks to secure on the value of the collateral pledged with the banks to secure a large amount of stock market credit. At this point, some banks and brokerage firms, had they been subjected to audit, would probably have been found insolvent."

Of course, it would be needless to expand on this theme as touching our present bank credit situation.

Patterson, however, sees fit to explain with greater detail the import of this development. He writes, "Beyond the immediately critical problem of the stock market was the fact that an important part of the country's money supply—the currency and checking account deposits that passed from hand to hand—had been derived from stocks pledged for loans at the banks. This helped to support the expansion of industrial and commercial activity that had taken place. By creating deposit credit to finance the purchase of securities the banks had monetized them, making them the basis of a significantly large part of the money-credit structure. That structure would necessarily contract as the shrinkage in stock values forced repayment to the banks." Thus, by helping to create the bubble in stock prices in the late 1920s, the banks were unwittingly creating a massive and self-immolating deflationary structure. A structure frighteningly similar stand in place today.

Back in New York, top bankers and business were conferring in an effort to find ways of mitigating the effects of the crash, and, if it were possible, to stop it altogether. Writes Patterson, "A critical question was whether it should permit the Federal Reserve Bank of New York to reduce the rediscount rate, which had been raised to 6 percent two months before." The Fed, it seems, had successively boosted interest rates in 1929 in an effort to contain the equities bubble, but to no avail. The parallels between the Federal Reserve interest rate policy of 1929 and that of 2000 are nothing less than astounding.

Throughout the duration of the awful panic of October 1929, waves of fear gripped the nation's investors. But alas, even in times of widespread panic, hope springs eternal in human hearts, thus there began to spread talk that the crash had overreached itself and that a recovery was near. "There was a hopeful, well-intentioned conspiracy of many people to believe—and to make others believe—that dauntless faith and a certain capacity for what must be called rationalization were all that was needed to end the crisis," writes Patterson.

According to a Wall Street Journal column appearing at that time, nearly "90% of the Street believed that the worst was over and that stocks would not return to their low levels of yesterday." It was this false confidence, however, that would prove to be most damaging to the financial futures of untold multitudes.

The enormous toll that the panic had on portfolios and pocketbooks was second only to the frayed nerves and exhaustion which attended the worst part of the panic. According to one brokerage house employee, "The telegraph operators handling out-of-town business went without sleep for 30 and 35 hours, time and again. Trays with sandwiches and coffee were passed around every two hours. None of our clerks went home at all during the worst. My brother didn't sleep a wink in 27 hours. He had been working 18 hours a day for weeks, and he was only one of hundreds of clerks. Girls at the adding machines and typewriters fainted at their work. In one odd-lot house 37 keeled over in one afternoon from sheer exhaustion. In another, 19 had to be sent home…Our worst trouble was answering customers who asked for reports on their orders…Nobody knew where he stood. I know we didn't at times. Neither did the banks!"

Bear in mind, all of this occurred in a time when every order was recorded on paper, thus there at least existed a paper trail that would eventually (even if it took weeks to uncover) lead directly to a given customer's order. Today, no such paper trail exists as everything is done electronically at most brokerage houses. Imagine the chaos that will ensue this time around as phone lines and Internet accounts are jammed for days on end, lines crashing, records being lost in the black hole of cyberspace, etc., etc. It boggles the mind to even consider it for a moment.

In an effort at stirring up confidence in the U.S. business outlook during this time of crisis, President Hoover declared that "the fundamental business of the country, that is production and distribution of commodities, is on a sound and prosperous basis." Would that that were the case today! Instead of the production and distribution of commodities by way of an industrial base, we are left with nothing more substantial than an electronically-based, debt-driven service sector which, we would point out, is utterly dependent on a strong industrial outlook. With the loss of our country's industrial base, the next Great Panic will hit even harder as the U.S. stands on even weaker ground than we stood in 1929.

A member of the Senate at that time, Senator King, aptly summed up the country's predicament at that time, even if it was belated:

"Gambling in stock has become a national disease. This malady reaches all classes of people, from preachers to stable boys…It was inevitable that a day of reckoning would come and that billions would be lost as the water and hot air were eliminated from hundreds of stock issues. In my opinion there will be further declines as the people begin to learn the facts and to use common sense. There has been not only an inflation in the value of stocks, but in various forms of property. This has resulted in a somewhat fictitious prosperity." Senator King was undoubtedly a relic of a bygone era—honesty among politicians. Aside from its quaint historical value, King's remarks serve today as warning of an uncanny similarity between the national culture of 1929 and 2000.

Yet another honest and insightful Senator—Senator Edge of New Jersey—had this to say:

"I do not see what the Senate can possibly do to help the situation. The main difficulty is over-speculation and the piling up of immense brokers' loans. It seems almost impossible to place the responsibility for this condition in any one quarter. Congress cannot pass laws to prevent people spending their money." It is all but certain that this time around, our elected leaders will not be quite so resigned in their opinion of the next stock market crash. One can almost hear even now the cacophonous cries of the unenlightened masses, imploring their Congressmen to "do something!" And "do something" they will—only the results will be less than desirable.