The Wall Street Crash of 1929 and its Impact on Financial Markets and Financial Institutions

Introduction

The 1920s were filled with economic prosperity. However, all that came to an end in October 1929. On a day that has since been christened Black Tuesday more than 16 million shares were sold on the stock market in Wall Street, and that led to the immediate collapse of the economy, and by 1930 the US was experiencing the Great Depression (BBC 2019). There were a number of reasons that led to the immediate and precipitous crash of the stock market in that year. One of those reasons was the overproduction and underconsumption in agriculture (BBC 2019). Farming techniques and mechanism improved and farmers began producing more food, but at the same time, the demand for grain had reduced due to the prohibition. Thus, overproduction led to falling prices. The other reason was the overproduction and underconsumption of consumer goods (BBC 2019). The other reasons that contributed to the issue and they are, they decline in traditional industries, protectionism, a laissez-faire attitude from the President in dealing with the issue and an increase in debt. The event is worthy of study because the consequences of the market crash were many and far-reaching and the policies enacted to combat the crash serve as a reminder on what to do and what not to do when facing an event of such magnitude.

Impact on Financial Markets

The Wall Street Crash of 1929 had adverse effects on the financial markets. The Dow fell from 381.2 to 41.22 which was a 90% loss (Amadeo 2019). The demand for stocks reduced substantially (White 1990). Before the crash, the market was on a bullish run. People bought stocks with the anticipation that they would be able to sell them at a profit in the future. Due to this a lot of money was injected into the market. However, after the crash of 1929, the demand for stocks plummeted significantly. As said above, one of the key factors that precipitated the crash was the sale of 16 million shares (BBC 2019). People simply did not want to invest in the stock market anymore, and that led to a decrease in the demand for shares. The other effect on the financial market is that the stock bubble burst (O’Connell 2018). Before the crash, there was a market bubble in which investors had unrealistic expectations of how much stock prices would increase. That is why the market experienced a bullish run before the crash. The crash burst the market bubble, and it served as a reminder to investors that one should not overpay for stocks that are already pricey. Therefore, the above are the major impacts that the Wall Street Crash of 1929 had on the financial markets.

Impact on Financial Institutions

The crash had an adverse effect on banks. One of the major impacts is that some commercial banks had to shut down after the crash (Green 1970). Many banks had to shut down because some of them had invested heavily in stock. However, the factor that caused most banks to shut down is due to their investment in real estate and on government and corporate bonds. Their investments did not pay off. Thus banks had to shut down since they experienced great and insurmountable losses during that time. The other impact that the crash had on financial institutions is that there was a high rate of loan defaults (Richardson et al. 2013). Investors had sought loans so that they could purchase stocks on the open market because they believed that the stocks would appreciate in due time. The crash robbed them of that hope and even when they sold their stocks, they did not have enough finances to cover the loans that they had taken from commercial banks. Thus, may investors defaulted on their loans and this affected financial institutions adversely. The Economist (2019) notes that many individuals lost their life’s savings in the crash and very few individuals had savings during that time. Since very few people were saving during that time banks had no money to spend and that led to the closure of some commercial banks. Therefore, the Wall Street Crash of 1929 had adverse effects on financial institutions.

Monetary and Fiscal Policies During and After the Crash

Federal Reserve Policy contributed to the crash. Walk (2018) notes the Federal policy during that time was to raise interest rates as a means through which securities speculation could be limited. The higher interest rates caused economic activity to slow down in the US. The policy not only had ramifications for the US but for the world too. Due to the international gold standard, central banks in other countries were also forced to raise their interest rates and this triggered recessions in many countries since global commerce was forced to contract (Elliot 2017). However, after the crash happened, there was a balance of payment crisis which was precipitated by a demand to covert a large quantity of reserves into gold (Cogley 1929). This caused a fall in the interest rates which helped slow down the decline in domestic activity and facilitated an outflow of gold to Britain and France. Clement (2009) notes that in the US the Federal policy of raising interest rates was misguided since during that time the best thing would have been to loosen credit markets. Loosening credit markets would help in providing liquidity in the market but due to the increase in rates the liquidity rates in the market were very low.

During that time there are a number of fiscal policies that were applied by governments. According to the Roosevelt Institute (2018), one of the fiscal policies that was applied is that the government decided to increase its spending. The government decided to engage the unemployed public to perfume public works. Roosevelt Institute (2018) notes that around 60% of unemployed individuals were hired by the government to plant a billion trees, to modernize rural areas, to build churches and various diverse real estate and to carry out various public work projects. By hiring many unemployed people to carry out public works projects the government was increasing its spending and injecting more money into the economy. Additionally, it was placing more disposable income into the hands of their citizens. The government also increased its capital taxation. During this time, it is not only profits which were taxed but dividends too. Clement (2009) notes that the key policy change that had an effect was the taxation of dividends not the taxation of profits. Dividend tax rates ranged from 9.2% to 30.1% while profit tax rates ranged from 11.9% to 21.2% (Clement 2009). The increase in taxes put more money in the government coffers which allowed them to increase government expenditure as a form of market stimulus.

Conclusion

The Wall Street Crash of 1929 was one of the worst ones ever experienced due to the adverse effects that it had not only on the US but for the world at large. The collapse was caused by overproduction and underconsumption of agricultural goods and various consumer goods. The crash had adverse impacts on the financial markets and financial institutions. In relation to financial markets 16 million shares were sold and that led to the precipitous crash of the market. There was a great decrease in the demand for stock while at the same time the market bubble burst. Before the crash, the market was experiencing a bullish run where investors bought stock under the assumption that they would be able to sell it later. Financial institutions were also adversely affected, and some of them had to close down. Financial institutions had invested heavily in real estate, government bonds, and commercial bonds. The crash meant that they would not get a return on their investment. Many people also defaulted on their loans. People had borrowed money from banks to invest in the stock market. The crash of the market meant that they did not have enough money to repay their loans. Also, very few people saved during that time and that had adverse effects on financial institutions. The government applied various monetary and fiscal policies. In terms of monetary policy interest rates were increased to reduce the amount of money spent in the stock market and then they were reduced during and after the crash. In relation to fiscal policies, governments increased their spending which injected money into the economy. Additionally, capital taxation on profits and dividends increased which gave the government more money to spend on public projects. In the end, the Wall Street Crash of 1929 serves as a reminder of the positive and negative effects of fiscal and monetary policies.

References

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• Cogley, T., 1999. Monetary Policy and the Great Crash of 1929: A bursting bubble or collapsing fundamentals? Accessed 26th March 2019.
• Elliot, L., 2017. Crash course: what the Great Depression reveals about our future. The Guardian. Accessed 26th March 2019.
• Green D, G., 1970., The economic impact of the Stock Market Boom and Crash of 1929. Newsweek. Accessed 26th March 2019.
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• Richardson, G., Komia, A., Gou, M. & Park, D., 2013. Stock Market Crash of 1929. Federal Reserve History. Accessed 26th March 2019.
• Roosevelt Institute., 2018. The real less from the great depression: Fiscal Policy works. Accessed 26th March 2019.
• The Economist., 2019. Reactions of the Wall Street Slump. Accessed 26th March 2019.
• Walk, V., 2018. A brief history of the 1929 stock market crash. Business Insider. Accessed 26th March 2019.
• White N, E., 1990. The Stock Market Boom and Crash of 1929 revisited. The Journal of Economic Perspectives, vol.4(2), pp.67-83.