What Made the Great Depression So Great?

October may not be the cruelest month for investors. Based on the averages, that's September. But when Wall Street stumbles at this point of the year, it does so extra hard. And that's why, in the Oct. 3 episode of Motley Fool Answers, Alison Southwick and Robert Brokamp are joined by former Fool Morgan Housel to kick off a four-part series on the history of market crashes in the United States. In this episode and segment, they discuss the big one -- the Great Depression. And part of what planted the seeds for it can be traced to World War I, starting with what seemed like a perfectly fine idea at the time: Liberty bonds. But, of course, there was a lot more that went into creating the perfect storm of conditions that sank the economy.

A full transcript follows the video.

This video was recorded on Oct. 3, 2017.

Alison Southwick: October is an auspicious month here. Not only did a couple -- a few -- market crashes happen in this month, but it's also October, so we thought, let's dedicate the whole month to looking back at the history of market crashes in the United States. And joining us to talk about that is Morgan Housel. Hi!

Morgan Housel: Hey, guys! How are you?

Southwick: So the first one we're going to talk about is the Great Depression.

Robert Brokamp: The big one. The granddaddy of them all.

Southwick: The big one. And then we'll just move forward in history.

Housel: They didn't mince any words naming it.

Southwick: No, they did not.

Housel: They just wanted to make it accurate and so they called it the Great Depression.

Brokamp: It's not just a depression. It is a "great" depression.

Southwick: It's great! So let me set the stage for you. It's the Roaring Twenties. In the wake of World War I, the nation's wealth more than doubled. This means that a lot of people had enough money to become full-blown consumers. They could buy newfangled things like electric refrigerators, and radios, and, lest we forget, the Model T. In this prosperous America you could have anything -- except alcohol, of course.

But the party did stop, and suddenly. So today Morgan joins us for this month-long series looking at market crashes in the U.S. And why not start with the big one? The Great Crash. Black Tuesday. But before we get into the actual crash, Morgan, thanks for joining us!

Housel: Thanks for having me back.

Southwick: You're going to be doing a lot of talking today ...

Housel: Yeah.

Southwick: ... and hopefully our listeners like you, so ...

Housel: Well, if not, there's a lot of podcasts out there. You can turn this down.

Southwick: That's true. We'll give you your money back. All right. So what was life like leading up to the Great Depression?

Housel: I think whenever people talk about what caused the Great Depression and what caused the Crash of 1929, it's always easy to point to one thing. But then what caused that one thing? Like, you can always keep going back in time and say what really caused all this to happen. And if we're talking about the Great Depression, I like to start in World War I.

Something really important happened in World War I. Frederick Lewis Allen, who was a great historian who wrote of history in the 1920s and the 1930s, he made this point that during World War I, to finance a war, they sold Liberty bonds to average, everyday Americans. Not just wealthy people, but everyday Americans were buying Liberty bonds to finance the war.

And it was the first time that most Americans had any experience with a stockbroker, because stockbrokers up until that point only dealt with wealthy people and aristocrats, and now it was everyday train conductors and farmers going and talking to a stockbroker to buy these Liberty bonds, because there was just a push of patriotism to buy these bonds.

And because of that, not only did people get their first taste of what it was like to work with a stockbroker, but stockbrokers had to learn all kinds of new skills to sell to these average, everyday people. And high-pressure sales tactics had to needle their insecurities and get them to buy something that they really didn't need. But the salesman's job was to kind of convince them that you needed this.

So it's set up in the late nineteen-teens, this early dynamic of Main Street's affiliation with Wall Street that had no relationship before that. So that's where I think the seeds of the Great Depression were ultimately planted, of getting everyday people who didn't have a lot of money, had no sophistication, no training or education, involved with Wall Street.

Southwick: But then they had no place to get educated, either. You were just going to have to trust this stockbroker guy.

Housel: So that's kind of like the first seeds that were planted. And then after World War I, all the troops came home. Devastating period for the war, and the economy instantly falls into a really deep recession. Really bad. High deflation, really high unemployment in the early 1920s.

And Frederick Lewis Allen makes this really interesting point that between the war and then the recession, when people came home, the people just got tired of being tired. After, like, seven years of everything going wrong, there was a period in the early and mid-1920s where people said, "I'm ready to have fun again. We've been dealing with a decade of everything going wrong between war and recession. I'm ready to let loose and have fun again." And it was almost like this spark that he wrote about, that in the early 1920s people were just ready to have fun, and they just let loose.

And a few other things happened at the same time that were really important to the lead-up of the Great Depression. To continue with stories of really awful things happening, in 1921 there was a really awful famine in Russia, and the United States wanted to do something about it. So the U.S. government set an artificially high price for wheat and told farmers, "As much wheat as you can grow, we will buy it from you at this inflated price." The price of wheat at the time was, I think, $0,40 a bushel, and the government said, "We will buy as much as you can grow at a dollar a bushel." They could then send it to Russia to help break the famine.

So you had all these farmers that overnight were minting money and planting as much wheat and corn as they could, and making a fortune doing it, selling it to the government. And it was so lucrative to be a farmer during this time because of these inflated prices that they had what were called suitcase farmers, which were people from, like, Chicago and Minneapolis who were lawyers or insurance salesmen. They would take the train into Iowa, buy a small farm, and grow wheat. They'd come in with their suitcases, and they'd be farmers on the weekend and go home, because you could make so much money doing this.

And farming was such a big part of the economy back then that in the early 1920s, when it started, it was just a huge stimulus to the overall economy -- this big farming surplus that was going on -- at the same time that you had people that were just ready to get back into having fun and helping grow the economy again. It was almost overnight in the early 1920s that the U.S. economy just took off like a rocket ship. Part of that was coming out of this recession in the early 1920s, and then you combine that with this big farming stimulus, and it was just boom, off to the races.

Because of the psychology at the time -- Frederick Lewis Allen writes a lot about this -- people were so ready to have fun again that you mix that excitement with that much extra money that was flowing around, and it was just a boom time in the 1920s. And you mix optimism with a lot of money, and people start making really bad decisions.

Brokamp: And then you also add in debt, because a lot of people didn't have, necessarily, all the money to buy these new consumer goods or these investments, but there were people who were willing to lend them money to do that. Back then, the margin requirement to borrow money to buy investments was only 10%, so if you wanted to buy $1,000 worth of stock you only needed to put down 100 bucks. All that thing had to do was drop 10%, and you lost all the equity in that investment.

Housel: And not only that, but buying stocks on margin in the 1920s, when there was a huge bull market, was the normal thing to do. It was like the equivalent of when people buy homes today. Do they take out a mortgage? Of course. Everybody takes out a mortgage. And back then it was, if you were buying stocks, of course you used margin.

Today if you're using margin, it's like, "Well, you're either reckless or you're brilliant and you have some crazy idea." But back then everybody used margin, and they used a ton of margin. So everyone's stock position was really leveraged up, which did two things. It made the run-up that much more potent, because you had people who didn't have a lot of money to their name that could go out and buy a ton of stock. And also it was just a bunch of dry kindling sitting around for when the crash eventually came.

And also during this period in the 1920s, two of, I think, the most important inventions of the 20th century, the car and the radio, were coming online for average, everyday people. And that just added to the sense of optimism of what we could do as a country, what our potential was. It completely changed American life in the span of a few years, the car and the radio.

So then you add all that together. You have people who for the first time ever have connections to stockbrokers. You have this big economic boom from farming. And you have all this optimism coming from the car and the airplane. And the 1920s, I think a lot of people know, the booming '20s, the Roaring '20s, it was was a great time for a lot of people that just led to a lot of excitement and overoptimism.

And so it led to in the late 1920s, probably the biggest stock bubble that we've ever seen, and that really took place in just, like, a year or two. It was really, like, 1928 and early 1929 that the market just went straight up, just went parabolic. And day after day after day, stock prices for all companies were just going straight up, and increased by several multiples just in the late 1920s. It created a bubble that's hard to measure, because earnings and whatnot weren't measured back then, but probably much bigger than the 1999 stock bubble. Just completely detached from reality by 1929.