Anda di halaman 1dari 9

s0840867

BUSINESS SCHOOL INVESTMENT AND SECURITIES MARKETS

Topic: Critical book review of The Great Crash1929: The classic account of financial disaster by J.K.Galbraith

Student: Aidyn Sadibekov Deadline: 12.00 noon 17/11/2010

Content Introduction Causes of Great Crash Great crash Consequences Similarities of Great Crash of 1929 and Banking crisis in 2008 Conclusion Bibliography 3 3 4 6 7 8 9

Sadibekov Aidyn

Great Crash in 1929

s0840867

Introduction
John Kenneth first time published the book The Great Crash in 1929 telling the overview of the stock market crash before the Great American Depression. According to John K., the boom of commodity is mainly caused by speculation. Once unregulated market bubble at peak it will crash with a serious consequences for everyone involved. Nowadays the book is fundamental for all people of business world, because financial disaster explained there have a cyclical effect. In other words, in time the immunity to speculation wears off, as a result in future world should expect another commodity or stock boom followed by another crash. The reason for republishing The Great crash of 1929 in 2009 is due, to Financial crisis world experiencing in recent years. Despite of the difference in time of almost 80 years between two economic recessions, there are many similarities in causes and consequences.

Causes of Great Crash


Powers of greed was driving force of American speculative culture. Strong individuals with pervasive sense of confidence and optimism created delusional trust hence everyone was investing in the stock market. As a result massive demand caused scarce of common stock. Unit trusts or trust companies are intermediates between investors and companies. In times of stock shortage in US unit trust companies changed their initial philosophy of existence, transferring into highly risking financial instruments. Magic of investment trusts utopian idea of investments instruments, which promised great benefits as a result dramatically motivated speculation. Unit Trust were attractive because: Created reputation or brand of Investment trust by advertising expertise of its managers; Leverage of the trust, and geometrical sequence benefits; Purchase and then reissue of own company shares example Golden, Sachs Corporate structure or Consolidation age. Merges of small companies into large industrial giants, therefore huge packs of attractive corporate bonds could be issued. However due to huge liabilities on bonds, all incomes went to repay debts. Therefore new investments did not have source of finance and liquidity ratio fell. To conclude, that corporate pyramids dramatically increased risks cause once company

-3-

Sadibekov Aidyn

Great Crash in 1929

s0840867

will have low income it will fail on coverage of debt repayments and will go bankruptcy. Poor economical decisions made by government of USA. Both fiscal and monetary policies had a lack of diverse intellectual approach. Government in power focused on sort-term by pleasing voters to gain popularity towards following election instead of working on stability of the countrys economy in the long-term. Government was going along with players of the market wished to believe in the performance of the boom. Players such as bankers, government, investors, brokers, investment trusts and government representatives etc. Therefore due to fact that market powers were popular government ignored minority theories and opinions warning of stock crash and potential economical distress. Bad banking structure Loans that were good become foolish after prices collapsed. The risk assessment of bank loans was very poor. The fundamental reason for providing loans was based on increasing or stable prices of Stock Market, in other words banks was way too understanding towards speculators. Large number of independent bank units, negative of reputation of single unit spreads to Bank name as a whole.

Great crash
Pre crash Warnings Stock market does not reflect industrial situation. Normally stock market reflect industrial situation while in 1929 vice verse situation appeared when stock market where effecting industries and economy overall. US government discouraging imports and encouraging exports policy. That politics created absurd situation internationally. Most of the countries who was trading with US created huge trade deficit to US that they could not possibly repay. Therefore US decided to lower imports so that lead to decrease in production and other economical indicators. Therefore people had expectations of crash, when production, prices, incomes and all other indicators fell. 22 September, New York newspapers published articles with headline Overstaying a bull market, which basically made an analysis of Boston Edison and Clarence Hatry. Clarence Hatry enterprises Collapsed in England 1929 and Boston

-4-

Sadibekov Aidyn

Great Crash in 1929

s0840867

Edison was refused to split stocks by Massachusetts Department of Public Utilities, moreover they started investigation of overvalued stocks of Boston Edison. Stock market Crash and rescue ideas Change of mindset, when margins of stock went lower than debt that had to be paid for it, hence speculators was being asked for more cash. Therefore the risk loan assessing of banking system of that time failed. Reverse leverage and geometrical effect of Unit trusts. The leverage effect which was gaining great return during rising prices had even higher effect when stock prices were falling, making unit trusts worthless. Moreover it had even greater effect if Unit Trusts had shares of other Trust companies in the portfolio. Therefore Unit trusts equities during crash were worthless and it was hard to sell them. The negative effect from unit trusts equities were driving good stock out. The stock of the established companies of industrial markets suppose to be stable if not overall panic of falling prices of stock caused by Unit Trusts equities. To recover the stock market, Organised support believe was proposed. The idea is that powerful people will organise to keep prises of stock at reasonable level. People such as Cutten, Durant, Raskob, banker Charles Mitchell, investment trusts etc, in other words those who will lose most from stock crash. Another phenomenon was psychological power of words. Almost all of the officials at that time have started to talk about fundamentals in order to make words more convenient. To conclude the stock crash rapidly destroyed reputation of everyone who supported market powers at times of boom, therefore ideas to recover market were meaningless.

-5-

Sadibekov Aidyn

Great Crash in 1929

s0840867

Consequences
Consequences of Great Crash are significant because every single American who witnessed that times separated life to before and after that events. The Great Crash followed by the economic recession in the USA. Economic recession decreased many overall economical indicators. For example, decline in volume of production (GNP), dramatically increased levels of unemployment, increase in inequality, decrease in national levels of income etc. Psychological change or reversed mindset of American peoples. During Stock market boom whole country was in great speculative orgy or greed, however after crash people become opposite to speculation with characteristics such as cautious, questioning, misanthropic, suspicious, mean people and immune to speculations. For media in particular psychological pressure on people from stock market crash was important. Newspapers created myth of suicides of many famous people who was involved in trading. However statistical facts suggest that there was no increase in overall suicides, thus newspapers overstated the numbers of suicides by focusing of suicide theme. The Stock market crash changed lives of ordinary people so dramatically therefore most of them had a feeling that they moved to different country. Sense of utter hopelessness, pessimism and lack of enthusiasm were the moods in America and people believed that nothing could be done. Although people were old enough to remember the 30s, for many of them boom of 1929 become myth of good life. The Stock market crash obviously resulted in significant changes in exchange market and banking regulations. The regulatory and decision making powers of Federal Reserve System increased because due to silence from them no-one blamed it for stock crash. Therefore higher responsibilities were burdened on Federal Reserve System for the future times. Other main regulatory changes were implemented in Stock Exchange markets and New York Stock Exchange Market in particular. Those changes were mostly about increased requirements for listed companies and creating practices to evaluate stock of some difficult financial instruments.

-6-

Sadibekov Aidyn

Great Crash in 1929

s0840867

Similarities of Great Crash of 1929 and Banking crisis in 2008


Banks is one of the main source of financial crash. In both 1929 and 2008 crashes Banks had: poor evaluation of risks of loans borrowed; low requirements and rates for loans1, mortgages2; encouraged speculation and where greedy enough to be involved risky investments. The difference is that in 1929 banks credited speculators of equity, while in 2008 banks credited housing speculators. In both scenarios in case of rising prises those loans are more profitable and carried higher risks in case of crash of markets. Government failed to control and create regulation framework of financial instruments. In 1929 US government have not regulated the Stock markets trading instruments, as a result new listed companies of New York Stock Exchange were overpriced and unregulated, for example is equities of Unit Trusts. Similar situation happened in 2008 when Governments did not adjust their regulatory practices to address 21st century financial markets3. As a result securitisation instruments such as adjustable-rate mortgages, collateralized debt obligations, credit default swaps, derivative instruments etc did not have any accounting regulations and could be written in company books at mispriced levels. Negative or low solvency ratios of companies are another reason of financial distress. In 1929 the companies were covering they financial liabilities with income therefore did not have available liquidity. In 2008 the liquidity shortfall in the United States banking system 4 caused bankruptcy of several financial institutions. In both cases there were companies and banks which in spite of being profitable had to declare bankruptcy because of short-term solvency. Leveraging is huge problem that caused crashes in and 2008. The reason is that leveraging is assumed to be good idea in times of boom, debt become cheaper. However when prices drop debt burden or over-leveraging5 and falling price of equity leverage companies significantly, so as a result some companies fully financed by borrowings.

1 2

Federal Reserve System, 2010 PRI's This American Life , 2009 3 Whitehouse archives, 2008 4 Bob Ivry, 2008 5 Stephen L., 2008

-7-

Sadibekov Aidyn

Great Crash in 1929

s0840867

Conclusion
The significance of the book Great Crash 1929 will not diminish over time, because as long as world operate in capitalism driven by powers of the market humanity will have to live with fact that booms and crashes are unavoidable. The financial crisis of 2008 and Great Crash 1929 have similarities in terms of characteristics. However they are completely different matters for ordinary people because as a matter of the fact financial crisis 2008 did not dramatically changed mindset as it did in 1929.

-8-

Bibliography
Books J.K.Galbraith, 2009, The Great Crash1929: The classic account of financial disaster, Publisher Penguin Web-sites: Bob Ivry, 2008, Paulson Seeks Mortgage Value That Eluded Bear, Lehman, Bloomberg official website, viewed 16/11/2010, http://www.bloomberg.com/apps/news? pid=newsarchive&refer=home&sid=aGT_xTYzbbQE Federal Reserve System, 2010, Monetary policy, Board of Governors of the Federal Reserve System, viewed 16/11/2010, http://www.federalreserve.gov/monetarypolicy/openmarket.htm George W. Bush administration Whitehouse archives, 2008, Declaration of the Summit on Financial Markets and the World Economy, viewed on 16/11/2010, http://georgewbush-whitehouse.archives.gov/news/releases/2008/11/20081115-1.html PRI's This American Life , 2009, Giant Pool of Money wins Peabody, Public radio international, viewed 16/11/2010, http://www.pri.org/business/giant-pool-ofmoney.html STEPHEN LABATON, 2008, Agencys 04 Rule Let Banks Pile Up New Debt, New York Times, viewed 16/10/2010, http://www.nytimes.com/2008/10/03/business/03sec.html?_r=2