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October 28, 09

NEWS / On the Anniversary of 1929 Crash, How Is It Different Now?

By Katherine Lewis
Special Correspondent

Washington — Four-score years ago, on Oct. 28 and 29, 1929, the U.S. stock market crashed. Those two days, known as Black Monday and Black Tuesday, burst a bubble of speculative trading and helped trigger the Great Depression.

On this 80th anniversary of the great crash, it is striking to compare the modern stock market to the market of the 1920s. Stock investing has spread to every corner of the globe and into nearly half the households in America. New investments have been invented, from credit-default swaps to mortgage securitizations. Layers of government and self-regulation aim to ensure orderly trading and prevent fraud — and while there are those who argue for more regulation due to the recent financial crisis, the regulation is a change from the free-for-all of the Roaring ‘20s.

At the same time, many of the factors that led to the 1929 crash remain. There are still cycles — some call them cycles of greed and fear — that cause speculative bubbles to build and then pop. And investing remains an inherently risky activity, in which you can lose money as easily as make it.

“The thing that’s most the same is human nature. Those animal spirits are the same today as they were back in the 1920s,” said Mark Zandi, chief economist at Moody’s Economy.com in West Chester, Pennsylvania. “Speculation infected that equity market as it did our housing and credit markets in this crisis.”

In 1929, only about 2 percent of American households owned stocks, compared to almost 50 percent of American households that have direct or indirect investments in the market today. One reason for the difference is that buying and selling cost much more in the ‘20s than in modern times, when electronic trading helps billions of shares change hands around the globe every day, according to Michael Goldstein, professor of finance at Babson College in Wellesley, Massachusetts.

The ease of trading means more people from all around the world are investors in U.S. stocks. “New York might be 10,000 miles away from where you live, but a crash in New York will still affect Belfast, Beirut and Beijing,” Goldstein said. “It reverberates.”

In 1929, there was neither a Securities and Exchange Commission nor independent self-regulatory organizations such as FINRA (the Financial Industry Regulatory Authority). The New York Stock Exchange commanded the majority of trading, yet had no circuit breakers to halt a selling panic, Goldstein said. Today there are rules that halt trading in cases of extreme drops.

The wide adoption of mutual funds has helped investors diversify, in stark contrast to the ‘20s, when an individual might own shares in just one or two companies.

In the 2008 market slump, one in four stocks declined more than 75 percent, but only one in 15,000 equity mutual funds experienced a loss that big, according to Don Phillips, a managing director of Morningstar Inc., a Chicago-based investment research firm specializing in mutual fund analysis.

“It is a very positive step that investors are investing more through funds, whether it’s actively managed or an index fund,” Phillips said. “Diversification doesn’t shield you from everything, but it mitigates the possibility of a catastrophic event. It’s a lot better than being in an individual stock that went to zero.”

Still, the experience of going through a market crisis — the Dow Jones Industrial Average index dropped 33 percent in 2008 — has left many investors feeling burned and reluctant to invest in stocks, even when there are bargains available, said Arne Alsin, a portfolio manager with Alsin Capital Management, based in La Quinta, California.

“Confidence can be lost in a heartbeat, and it takes years to rebuild,” Alsin said. “It’s too bad because there are wonderful opportunities.”

So while some things have changed and some have stayed the same, what lessons can be drawn from the 1929 crash? The most important one clearly registered with Federal Reserve Board Chairman Ben Bernanke, an expert on the Great Depression in his prior career as an academic.

It is widely accepted among economists that in 1929, the Fed blundered disastrously by tightening monetary policy after the stock market crash, rather than cutting interest rates to encourage growth, and by taking insufficient action to stem panic. That worsened the economic crisis and tipped the country into the Great Depression, said Eugene White, an economics professor at Rutgers University in New Jersey.

“One of the lessons which everyone took from that was the Federal Reserve should not take its eyes off the real economy to focus on asset bubbles,” White said. As a result, Bernanke’s Fed acted swiftly to pump liquidity into the banking system last year, creating liquidity facilities and intervening directly in the markets to buy mortgages and other paper when other investors ran scared.

But perhaps the most important lesson to take away from the 1929 crash, in addition to the stock market crashes in 1987 and 2008, is that no generation is immune. “You’d be foolish to kid yourself to ever say, ‘That event can’t happen to the stock market [today],’” Morningstar’s Phillips said. “Markets can be very fickle.”

In modern times, investors have accepted as conventional wisdom that stock markets will average 10 percent annual rates of return over the long term. But if you are about to retire or in the early years of retirement and the market tanks, the healthy long-term average doesn’t prevent your nest egg from shrinking.

“We live in a world that’s a lot messier and a lot more volatile,” Phillips said. “It’s important to study these things and hopefully you can mitigate your susceptibility to ‘fear and greed.’”




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