11 December 2007

Booknotes - The Great Crash 1929

"It has long been my feeling that the lessons of economics that reside in economic history are important and that history provides an interesting and even fascinating window on economic knowledge." p.28

Galbraith wrote this book 25 years after the Great Crash, as an elder statesman, one generation removed from the event.

"The wonder, indeed, is that since 1929 we have been spared so long. One reason, without doubt, is that the experience of 1929 burned itself so deeply into the national consciousness. It is worth hoping that a history such as this will keep bright that immunizing memory for a little longer." p.29

I had to buy my copy recently from an Amazon reseller based in the UK. When my book arrived, it was postmarked from Malmo, Sweden. Looking again at Amazon, I see that a new printing of this work has appeared in the U.S. Whenever there is turmoil in the markets, I guess interest in the history of previous market disasters rises like fear and volatility.

Considering this week's over-zealous run-up in the markets, followed with today's petulant overreaction to Helicopter Ben only dropping the federal funds rate by 25 basis points, it's as good a time as any to look back nearly 80 years.

Here are some of my notes on The Great Crash 1929.

The precursor to the crash: the desire to get rich quickly with little effort via speculation and leverage. Galbraith delved into the mid-twenties Florida land boom (and bust). Apparently, the Ponzi scheme originated in this period: "As the speculation spread northward, an enterprising Bostonian, Mr Charles Ponzi, developed a subdivision 'near Jacksonville'. It was approximately sixty-five miles west of the city. (In other respects Ponzi believed in good, compact neighbourhoods; he sold twenty-three lots to the acre.)" p.33

"The Florida boom was the first indication of the mood of the twenties and the conviction that God intended the American middle class to be rich. But that this mood survived the Florida collapse is still more remarkable...Even as the Florida boom collapsed, the faith of Americans in quick, effortless enrichment in the stock market was becoming every day more evident." p.35

Galbraith is unclear as to the origins of the speculative frenzy in the stock markets. He lamely suggested that growing corporate earnings encouraged upward movement in securities pricing. More interestingly, Britain's return to the gold standard pressured investors to take leave of costly investing in Britain and the Continent, and shifted that money to the U.S. Also the Federal Reserve Bank of New York cut rates and made it cheaper for more people to obtain credit and invest in shares. And then there was the issue of rampant trading on margin and the values of the underlying stocks used as collateral for those loans.


Reassurances from Wall Street professionals, much like the quotes detailed and mocked in "Oh Yeah" that permitted many en masse to abandon fundamental analysis and join the speculative frenzy, untethered to reality.

The Federal Reserve was impotent to quash the speculative market. Raising the "rediscount rate" would not have affected the speculators who were borrowing on margin at twice the rediscount rate (or more) and until the crash, were watching their shares accelerate at an even steeper rate. Galbraith asserted that the Fed could have increased margin requirements, but it decided to keep mousily quiet. Galbraith mocked the Fed's feeble attempts at "moral suasion" via mildly-worded press releases.


The Crash decimated leveraged investment trusts, instruments created to take advantage of the demand for speculative offerings. The values of these trusts were inflated not with tangible assets, but with the perceived value of "the precious ingredient of financial genius." p.79 They seem analogous in some ways to today's hedge funds, many of which don't actually seem to engage in the act of hedging. The Crash also crushed the values of American blue chip industrials like General Electric and AT&T. Solid companies and defensive stocks couldn't avoid the destructions of wealth.


Perhaps the most important lesson in Galbraith's work is covered in Chapter 4 - In Goldman, Sachs We Trust.

What is that lesson? GS seems to find a way to survive financial debacles with their money and reputation largely intact.

According to a lovely chart in the January 2008 issue of Bloomberg Markets detailing the subprime market collapse, GS is the only bank/security firm on the chart to have no subprime-related write-downs, no layoffs, and a recent positive return on its share price.

In 1929, GS launched the Goldman Sachs Trading Corporation, an investment trust organized by GS and largely sold to the public at $104 per share. As of a 1932 Senate hearing which closes Chapter 4, the reader discovers that just three years later, the Goldman Sachs Trading Corporation was trading at 1 3/4, that after a two-for-one split.