The primary reason for the crash was unrestrained buying
of stocks on margin, a process by which a buyer pays only a portion of the purchase
price of the stock and the broker pays the difference and holds the stock as collateral.
The buyer anticipates that the stock will rise in value, and he can then resell it,
repay the broker loan, and make a profit. This is still done and is quite legal; however
now the maximum margin that can be borrowed is fifty per cent. At the time just before
the crash, the maximum margin was just five per cent. The result was the Great Bull
Market of 1927 when prices of stock were climbing wildly. This type growth was a bubble,
very similar to the recent real estate bubble which triggered the most recent economic
recession, or the dot.com bubble of several years past. The market was out of control
with cab drivers, janitors, etc. who knew nothing of the market buying huge amounts of
stock on margin, selling and reinvesting their entire proceeds in even larger purchases,
again with the minimum margin.
The situation was so out of
control that the Federal Reserve was urged to step in, but did not do so. Finally,
investors began to worry that the rally was not sustainable, and began to unload stocks.
This resulted in a sudden flurry of selling which forced prices down precipitously.
Although the major crash was on October 29, 1929, (Black Tuesday) prices continued to
spiral downward. By March, 1933 market value had lost 80% of its pre-crash value. Most
of the investments in the market had been on large margins, thus investors not only lost
their investments, they were in tremendous debt. The brokers who made the loans also
sustained traumatic losses.
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