What Really Lifted America Out of the Great Depression?

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. It wasn't just a sharp stock market drop -- the decline lasted for three years, broke a lot of banks, and punished millions of people who had made investments (not just in stocks but in new equipment and land) based on the optimistic idea that the good times were here to stay. In the face of those years of bleakness, what got us moving again? There are still sharp disagreements.

A full transcript follows the video.

This video was recorded on Oct. 3, 2017.

Alison Southwick: How did we recover? How did we get out of this?

Morgan Housel: This is where things could get political, and a lot of people still disagree with this 90 years later. Franklin Roosevelt is elected in 1932. He starts the New Deal. There's that element of it, of economic stimulus from the New Deal, and just changing tactics. There's also a thing with all recessions that prices get low enough -- stock prices, housing prices, labor prices -- then it's attractive to get back in business.

Every investment, every business opportunity is attractive at some price, and prices got ridiculously low in the 1930s everywhere. The price of labor. The price of food. By 1932, stock prices were down 89% from their 1929 peak. They were just completely obliterated, but there were still a lot of good companies out there that were still profitable. Still paying dividends.

There's a recreation of what the S&P 500 would have been back then. Robert Shiller put it together. The dividend yield in 1932 was almost 20%, which is crazy, but that's how low prices had fallen. So whenever prices get that low, there's just enough opportunity that even if there's an inkling of optimism or opportunity somewhere, somebody's going to take it, and eventually it just feeds on itself. Suddenly there's a pretty big boom, both in the economy and in the stock market from, 1932 to 1937. And it was pretty big. I think stock prices tripled during that five-year period from 1932 to 1937. It was actually one of the best five-year periods in history to own stocks.

Southwick: You talked about the FDIC. Did that come out of this? What other legislation or regulation came out following the Depression to keep this from happening again? Because it's obviously never going to happen again.

Housel: Knock on wood.

Southwick: No, it's only going to happen for the next three episodes of this podcast. Not this bad, of course.

Housel: So the few big ones besides FDIC insurance -- one is the SEC. A lot of the reason that the market grew so high in the 1920s is because fraud and bad behavior in the stock market was rampant. One of the big actors during the 1920s, who made a fortune from ripping people off in the stock market, was Joseph Kennedy, JFK's father. He made a fortune in the 1920s bringing together groups of investors. They would corner a stock and put out false information. Since they had it cornered, they could drive up the price. Rising prices got other people excited, and then they would dump their shares back on them. There was all this misbehavior in the stock market that was perfectly legal back then, even though they were really taking advantage of vulnerable people.

So with that came the SEC, and the punch line of the story is, "You know who the first chairman of the SEC was?"

Southwick: The same guy?

Housel: Joseph Kennedy.

Robert Brokamp: What was FDR's quote about that?

Housel: I forget.

Brokamp: Something along the lines that if you want to catch a bank robber, you've got to put a put a criminal in charge. Something along those lines.

Housel: That was the other big thing, besides the FDIC, was the SEC. And then there's two other big securities laws that came out of it, one in 1933 and one in 1940, that just set the standards for how mutual funds can be bought and sold. How mutual funds can be operated. For how financial advisors have to act and what they have to disclose. Those rules are still in effect today and really regulate and govern the lives of financial advisors and investors today.

And if you're ever talking to a mutual fund manager behind the scenes when they're talking shop, you'll hear people say "40 Act funds." That's the Securities Act of 1940, and it's still in the lexicon today for investors, and that came from the Crash of 1929.

Brokamp: And obviously out of the New Deal also came Social Security ...

Housel: Right ...

Brokamp: ... which was passed in 1935, and one of the ways that FDR and the New Deal helped people get back to work -- that was necessary back then, because unemployment was 25%, which is almost inconceivable these days -- was the Works Progress [Administration], the WPA, which was responsible for tens of thousands of projects all over the country. You can't go anywhere in this country, pretty much, without coming across a road, a school, a bridge, a dam, something that was built by these unemployed people who were able to work for the government, and they put them to work doing these things.