Reasons for the economic crisis of 1929–33: Banking, finance and the Wall Street Crash

The US banking system was weak:

• Thousands of small banks.had very little money to protect against losses.
• Rural banks invested heavily in farms and many failed when farmers could not pay back their debts.
• Banks invested customers' savings in the stock market making them vulnerable when share prices fell.

Bank failures caused "runs" on banks:

• People rushed to withdraw their money leading to further banking collapses.

Many Americans build up large debts buying products they could not immediately afford and borrowing money to buy shares.

Confidence in the value of shares fell in 1929:

• Panic selling triggered the Wall Street Crash.
• Many people were left with huge debts or lost their savings.

The crash ending the economic boom of the 1920s.

The US banking system was made up of thousands of small banks. There were over 30,000 commercial banks in 1920. Around three-quarters of these were state-chartered banks.

• State rules were less strict that federal (national) rules
• State banks were allowed to operate without having enough of their own money to protect them from significant losses.
• Some small banks had so little money that the loss of a single large account, or the failure of customer to pay back a larger debt could lead to bankruptcy.

Some state-chartered banks were allowed to open different branches but national banks could only have one branch in the state.This made it easier for people to use smaller banks with less money to back them up.

• Some states insured banks themselves, meaning that the state would pay for losses. But states themselves had limited funds to cover this.
• Banks in rural areas often invested in farms. When farms began to fail, so did the banks, and depositors lost their money.

As well as banks, there were thousands of savings and loan institutions. These mostly invested people's deposits in residential mortgages. These were vulnerable to any drop in house prices or failures in mortgage payments.

During the 1920s, hundreds of banks failed each year. Most were in the Midwest and agricultural areas in the South.

As the economic boom grew, banks invested savers’ money in the stock market in the hope of making a larger profit. When financial conditions worsened in the late 1920s, people began to withdraw their savings from banks. The banks could not cope with the demand as they had used customer’s money to invest in the stock market and had subsequently lost it as share prices fell.

The collapse of one bank often led to a ‘run’ on other banks (people running to withdraw savings from their own bank in case their bank collapsed leaving them without their money), resulting in a banking collapse.

By the end of 1932, 20% of banks had declared bankruptcy and had closed down. Less than 15,000 banks remained in operation (half the number of banks operating in 1920).

Without an efficient banking system, the economy could not function.

The US economic consumer ‘boom’ of the 1920s was financed by the easy availability of credit.

Credit was the easiest way for banks to make money. Bankers encouraged people to take out loans to enable them to buy new consumer goods and to speculate on the stock market. Regular payments to the bank, plus interest, were made over a period until the loan was paid off.

By 1929, $7 billion of goods were sold on credit. This included 75% of all cars and half of all major household appliances.

Credit enabled consumers to buy goods they could not afford otherwise .

This system worked, as long as people were in employment and their wages remained reasonably high, so that they were able to make their loan repayments.

During World War One, the US government sold war bonds to fund the war effort. Ordinary people got used to the idea of making investments.

Their interest continued in the 1920s, especially when they saw wealthy people making huge profits from buying and selling shares.

To finance this many took out loans and bought the shares on credit. With share prices rising, it seemed like an easy way to make money. Shareholders often ignored the risk that they would make a loss. As long as everyone believed in the rising value of shares, everyone was making a profit. This in turn made it look like the American economy was doing well.

Banks and big businesses were buying shares ‘on the margin’, which meant they paid only a fraction of the full price at the time of purchase, intending to sell on the shares at a profit before the rest of the payment became due.

However, this ‘get rich quick’ culture meant that investors were forcing up share prices with money they did not really have. And the value of shares was rising beyond the value of the businesses they invested in.

When share prices fell, many investors owned worthless shares and did not have the funds cover the payments they owed.

Between 1927 and 1929, there was a buying frenzy.

• Almost 20 million Americans owned shares, pushing the value of shares up to unrealistic prices.
• When the stock market crashed they were ruined.

Although the American economy had some problems through the 1920s, in 1929 a series of events caused the stock market to collapse.

During his presidential election campaign in 1928, Herbert Hoover promised to introduce higher tariffs on imported goods.

Many investors believed this would help American businesses by reducing foreign competition and increasing profits. This gave people confidence in American companies and people bought more shares, causing share prices to rise.

However, some politicians were concerned other countries would increase tariffs on American goods, reducing international markets.

The US Senate voted to block Hoover's tariff plans. This worried investors and many began selling their shares. This caused prices to fall and confidence to weaken.

Although the economy was slowing down and some industries were no longer growing as quickly as before, share prices continued to rise.

Some experienced investors realised that many shares were worth more than the companies behind them, meaning they were overvalued. As confidence fell, large numbers of people started selling their shares in September 1929, leading to further price drops.

The situation became much worse in October 1929 when panic selling spread across the stock market.

As prices continued falling, investors feared losing all their money. They rushed to sell their shares before prices dropped even further. This created a chain reaction , with more and more people selling.

• Monday, 21 October 1929: Investors instructed their brokers to sell their shares before their value dropped.
• Wednesday, 23 October 1929: In the last hour of trading, an increase in selling caused the overall stock market to lose 4.6% of its value. This worried investors who decided to sell their shares the next day.
• Thursday, 24 October 1929 (Black Thursday): Around 12.8 million shares were sold, causing prices to crash. Several leading bankers bought shares at higher prices than they were worth in an attempt to end the panic.
• Monday, 28 October 1929: Shares began to fall again. The banks did not come to the rescue. They said it was not their responsibility to protect stock market prices.
• Tuesday, 29 October 1929 (Black Tuesday): Panic continued, and about 16 million shares were sold, many at very low prices. This marked the complete collapse of the stock market.

As a result, many investors lost their fortunes. People who had borrowed money to buy shares were left with large debts, and some lost their savings. The Wall Street Crash ended the economic boom of the 1920s.

The US banking system was weak:

• It was made up of thousands of small banks.
• Many had very little money to protect against losses.
• Some state-chartered banks did not have funds to guarantee people's savings.

Rural banks were especially vulnerable:

• They invested heavily in farms.
• When farmers struggled to pay debts, many banks failed too.

Banks increasingly invested customers' savings in the stock market.

• This made them vulnerable when share prices fell.

Bank failures caused "runs" on banks:

• People rushed to withdraw their money.
• This led to further banking collapses.

Easy credit allowed Americans to build up large debts buying cars, appliances, and other goods they could not immediately afford.

Many people also borrowed money to buy shares, believing stock prices would continue rising and make them rich.

• Share prices became unrealistically high because investors were buying shares with borrowed money rather than real wealth.

Confidence in the value of shares fell in 1929:

• Panic selling triggered the Wall Street Crash.
• Many people were left with huge debts
• Others lost their savings.

The crash ending the economic boom of the 1920s.