FOOL ON THE HILL
An Investment Opinion
The Day the Sky Fell Bill Mann (TMF Otter)
October 29, 1999
Davenport, Iowa (Oct. 29, 1999) -- Seventy years ago today the stock market crashed, serving as the catalyst for nearly a decade of economic woe unsurpassed in the modern history of the United States. The damage this event caused on the collective psyche of two generations of Americans is something that perhaps only the current long-term rise in stock prices has assuaged. This single bad day, this really, really bad day, served to bring about several sea changes without which the United States would be a very different place today. Among the institutions brought about from the Great Depression:
Unemployment Benefits, Welfare, Social Security
Never before had the government actively stepped in to play the role of benefactor to the nation's downtrodden or its elderly. Franklin Delano Roosevelt's administration changed this, taking its place as the prime caregiver away from the private charities that had served this role for more than two centuries.
Government Debt Spending
A fixture today, the current federal debt approaches $5 trillion dollars. Prior to the Great Depression, the prevailing doctrine was one of maintaining a balanced public budget. Before FDR, the thought of running up a huge federal deficit for the good of the economy, or certain sectors thereof, would have been looked upon as the highest level of irresponsibility. The New Deal and other programs initiated in the 1930s changed this perception. The United States has not since had a president, Democrat or Republican, who was not willing to incur additional federal debt in order to maintain and preserve prosperity, even if some of them had the fortune to not have to make that choice.
It may be forgotten now, but the Income Tax was not made legal in the United States until after 1910. For the first two decades after its enactment, it still did not have much effect on the U.S. economy, with the vast majority of Federal revenues being derived from customs and excise taxes. Only in the 1930s, when the U.S. government had the sword of Damocles of economic collapse hanging over its head, did it begin to look to the income of the haves to help fund programs for the have nots. Prior to 1929, the highest Federal income tax bracket was at a paltry 3% of total income. Following the Depression, the percentage of income taken by taxes has risen ever since, to a current rate exceeding 40%.
Separation of Banking Institutions
Although to this day economists debate the root cause of the Great Depression, at the time it was certainly convenient for the politicians to blame the excessive power wrought by the private banks. The banks were singled out for the percentage of total assets in the U.S. they had under their control in the form of cash, debt, and hard assets. The panic in 1929 and 1930 was certainly exacerbated by thousands of banks being undercapitalized, however it is fairly clear that Hoover ordering the banks to close to keep them from being run on did not do much for public confidence, necessary as it may have seemed at the time.
Still, in 1932 the U.S. Congress passed what is known as the Glass-Steagall Act, which forced the brokerage commercial banking segments, as well as the insurance companies, to run as separate entities. Additionally, such institutions as the Federal Depository Insurance Corporation (FDIC) and the later doomed Federal Savings & Loan Insurance Corporation (FSLIC) were formed to prevent later panics by guaranteeing depositors' funds. Ironically, in the case of the FSLIC, some argue that this safety net was brought down during the Savings and Loan Crisis of the 1980s in no small part due to the lack of diversity in the S&L's portfolios, due in no small part to restrictions placed upon them by Glass-Steagall.
Certainly inflation has always existed -- it is a basic function of economics. But only after the Crash of 1929 did inflation become part of Federal policy. The unprecedented Federal spending during FDR's New Deal, followed immediately by military spending during World War II, was done on the issuance of billions of dollars of Government and War Bonds. This added liquidity produced economic gains that eventually killed off the Great Depression. But in so doing, the government shifted its focus from controlling costs to stimulating economic activity, and thus in times of recession it has become willing to allow accelerated rates of inflation.
But what of this day in October, the day that witnessed the carnage of the Roaring '20s? This day had long reaching psychological effects as well on America and its view of public markets. Simply, for most of 50 years following the Crash of '29, the vast majority of the American public viewed equities as being extremely high risk, the providence of the super-rich and the professionals. Not until the end of the 1973-74 recession did the common American, the John Q. Public from Davenport, Iowa, really consider stocks to be a plausible alternative to savings, government and corporate bonds. It should be remembered that the true investing greats of the middle of this century -- the Phillip Fishers, the Benjamin Grahams, and even the early Warren Buffets -- were an anomaly for the fact that they were investing in common stocks at all, much less for their relative success at it. If people invested in common stocks, they tended to be in the bluest of the blue chips -- General Electric, Commonwealth Edison, Ford, Coca-Cola.
I am not casting aspersions here. I, like most of my contemporaries, have never known a time with such a contraction of the general well-being of the populace. Even the more recent, and in the case of the Crash of '87, dramatically sharper, one day declines have been followed by consistent, long-term gains in stock prices. These short-term events were certainly shocking for most people, and catastrophic to others, such as Long Term Capital Management, but they did not bring about the economic collapse some people predicted at the time. Still, even the most long-term of us can be a bit superstitious, and darn it if we all don't get just a bit wary each time October rolls around.
So what's the moral of this story? Maybe it's just to stop and remember what has happened in the past, and what, at some point in the future, will happen again. Those who believe that "it is different this time" and believe that a rising share price is a catalyst of a healthy company, and not the other way around, will likely be shocked when it does happen. Proper investing requires that we have the knowledge of what risks we take. In 1929, they believed that the good times would never end. I sometimes hear the same song today, and I wish that it would be true. But it isn't, and the concept of expecting 50% returns year in and year out is pure folly, and if this goal is approached without an understanding of economic risks it can lead to an October surprise of the worst kind.
I am with David Gardner, Tom Gardner, and several other Fools in Davenport, Iowa for a financial conference sponsored by the Quad City Times. If you're in the area, we hope you'll stop by to see us.