What did the poeple of the twenties do to crash the market?

Question

What did the poeple of the twenties do to crash the market?

Answer 1

A lot of people bought stocks on margin, which means effectively that they borrowed money to buy stocks, with a requirement only to put down a certain small percentage of the value.

The difference between buying stocks outright and buying on margin is that if you buy outright, the worst thing that can happen is that your stock goes down to 0 and you loose all your money.

If you buy on margin, say by putting down $5 and borrowing $95 to but $100 of stock, if your investment goes down by only 5%, you lose all of your investment.  If it goes down to 0 you're in debt $95.  What this means usually is that if your investment goes down 5% you either have to post more money as collateral, or you have to sell your stock.

(on the other hand, if your stock goes up by 5%, it's great because you've paid $5 and gotten the same profits the person who paid outright for $100 worth of stock got for $100.  If you're sure the stock is going to go up, which was the general opinion in the 1920s, buying on margin is the thing to do.)

In the 1929 crash, a lot of the stock market was owned by people who bought on margin, so just a little drop forced a lot of them to sell.  A lot of people selling caused a further drop the stock's value which forced a whole bunch of other margin buyers to sell, which caused more drop in the stock's value, etc, etc.

A lot of this is similar to the current US housing market issues.  Buying a house is usually like buying a stock on margin.  You pay a small fraction of the price and borrow the rest.  What happened in the early 2000s is that for a lot of people that small fraction went from small (20%-ish) down to really small (0%-ish).  When housing prices dipped a little, people found that they owed more on their houses than they were worth (negative equity).

The difference with housing is that, unlike stocks bought on margin, no one forces you to sell when you get negative equity, you just have the joy of having paid too much for your house.  Also, you can't really sell your house when you have negative equity because you won't get enough from the proceeds to pay back the loan, and some people who have floating rates expected to reset to a higher rate in 5 years really need to sell.

If housing was as liquid as the stock market and had margin requirements like the stock market, we would not see a slow deflation of housing prices like we are now.  We would see a housing price crash like stocks did in 1929.