2. Excessive use of debt which led to a false prosperity
According to author Jeffrey Kaplan, consumerism took hold of America during the 1920's.
"By the late 1920s, America's business and political elite had found a way to defuse the dual threat of stagnating economic growth and a radicalized working class in what one industrial consultant called "the gospel of consumption"-the notion that people could be convinced that however much they have, it isn't enough. President Herbert Hoover's 1929 Committee on Recent Economic Changes observed in glowing terms the results: "By advertising and other promotional devices . . . a measurable pull on production has been created which releases capital otherwise tied up." They celebrated the conceptual breakthrough: "Economically we have a boundless field before us; that there are new wants which will make way endlessly for newer wants, as fast as they are satisfied."
By 1929, the richest 1% owned 40% of the nation's wealth. The top 5% earned 33% of the income in the country. The bottom 93% experienced a 4% drop in real disposable income between 1923 and 1929. The middle class comprised only 20% of all Americans. Society was skewed heavily towards the haves. By 1929, more than half of all Americans were living below a minimum subsistence level. Those with means were taking advantage of low interest rates by using margin to invest in stocks. The margin requirement was only 10%, so you could buy $10,000 worth of stock for $1,000 and borrow the rest. With artificially low interest rates and a booming economy, companies extrapolated the good times and invested in huge expansions. During the 1920s there were 1,200 mergers that swallowed up more than 6,000 companies. By 1929, only 200 mega-corporations controlled over half of all American industry.
There are some disturbing parallels between what was happening during the 1920s and what has been happening in America in the last 10 years. Today, the richest 1% own 21% of the nation's wealth. The bottom 50% has experienced a 4% drop in real disposable income in the last eight years. During the dot.com boom of 1998 – 2000, small investors used massive amounts of margin debt to speculate in companies with no earnings. When this bubble collapsed, a lesson should have been learned that would last a lifetime. Instead, Alan Greenspan lowered interest rates to 1% and encouraged everyone to take out an Adjustable Rate Mortgage. The speculation in real estate reached phenomenal heights by 2005. The downside of that speculation is now only half finished. Stabilization of house prices is at least another year away and another 20% to the downside. That would still leave prices high on a historical basis. Home prices did not fall on a national level during the Great Depression. In the last ten years, there have been hundreds of mergers, particularly in the financial industry. The repeal of the Glass-Steagall Act in 1999, spearheaded by Senator Phil Gramm, allowed the massive consolidation in the industry. This is why our financial institutions have become too big to fail and are on the brink of collapsing the world economy.
3. Excess speculation by a small group of wealthy investors
The administrations of Warren Harding and Calvin Coolidge are considered the most corrupt in American history. Coolidge's administration was committed to laissez-faire non-regulation government. He announced to all Americans, "The business of America is business." The top tax rate was lowered to 25% in 1925, the lowest top tax rate in any decade since. Exports boomed due to the low value of the Dollar versus the British Pound. The ruling elite of society were the Wall Street speculators. Only 1.5 million people out of an entire population of 120 million invested in the stock market. Ben Strong, attempting to help Britain, reduced rates in 1927. This ignited a speculative frenzy in 1928 and 1929. Margin loans increased from $3.5 billion in 1927 to $8.5 billion in 1929. Stock prices rose 40% between May 1928 and September 1929, while daily trading rose from 2 million shares to 5 million shares per day. The market reached a peak of 381, with a PE ratio of 23 based on normalized earnings, on September 3, 1929.
Ben Strong died in October 1928. Therefore, he did not witness the terrible pain inflicted upon Americans by his reckless policies. Alan Greenspan has not been so fortunate. He is able to witness how his reckless interest rate reductions have resulted in a worldwide financial collapse. He continues to defend his actions, but his legacy will forever be linked to this disaster. These low rates caused a speculative frenzy in stocks and then housing. The Bush administration's belief in allowing free markets to regulate themselves led financial institutions to take ridiculous risks using massive amounts of debt. Despite two ongoing wars and growing budget deficits, the Bush administration decreased taxes on the wealthy. The dollar declined dramatically in the last eight years, resulting in increased exports. The PE ratio of the market reached an astronomical 38 in 2000, before crashing below 20 by 2003. Currently, the PE ratio of 25 exceeds the level at the peak prior to the Crash in 1929.
The stock market declined to 41 by 1932, an 89% decline in three years. The PE ratio of the market declined to below 5 by the mid 1930's. The market did not return to its 1929 level until 25 years later, in 1954. As the market began to fall, prominent Wall Street CEOs did their best to prop up the market. Charles Mitchell of National City Bank on October 21, 1929, a few short days before the crash, said, "I know nothing fundamentally wrong with the stock market." George Harrison, the new Federal Reserve Chairman, provided tremendous amounts of credit to the banking system in 1929 and early 1930, attempting to keep the party going. In the last few months, how many times have we heard Hank Paulson, John Thain, and other Wall Street cheerleaders tell us the banking system is safe and sound? Ben Bernanke has reduced interest rates dramatically, pumped money into the banking system, and taken bad assets onto the Fed balance sheet. So far, this does not appear to be working. The market has declined 30% from the peak, but is overvalued on a historical basis with profits about to plunge during the coming downturn.
4. Government responding with tighter credit, higher taxes and higher tariffs
Ben Bernanke, a self proclaimed expert on the Great Depression, concluded that missteps by the Federal Reserve in 1930 and 1931 resulted in the financial crisis becoming a depression. After the stock market crashed, speculators began selling dollars for gold in 1931. This caused the value of the dollar to plummet. The Federal Reserve raised rates and reduced the money supply by 30% to try and prop up the dollar. Investors began to withdraw their dollars from banks, and banks began to fail. By the end of 1932, 9,000 banks failed. People hid their cash under their mattresses. Bank deposits were uninsured, so when banks failed, people lost their life savings and businesses failed. Panic and fear gripped the nation. The remaining banks hoarded their cash, refusing to make loans to businesses. Treasury Secretary Andrew Mellon declared, "Liquidate labor, liquidate stocks, liquidate real estate, values will be adjusted, and enterprising people will pick up the wreck from less competent people."
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