Financial History Issue 129 (Spring 2019) | Page 21

FIGURE 2: Days of Labor to Purchase Average NYSE Share, 1920–1996 Sources: Average prices for December 1925–1999 are calculated on the basis of data from CRSP US Stock Database, Center for Research in Security Prices (CRSP), Booth School of Business, University of Chicago. Wage data: Robert A. Margo, “Hourly and Weekly Earnings of Production Workers in Manufacturing: 1909–1995,” table Ba4361-4366, in Historical Statistics of the United States, Earliest Times to the Present: Millennial Edition, ed. Susan B. Carter, Scott Sigmund Gartner, Michael R. Haines, Alan L. Olmstead, Richard Sutch and Gavin Wright (New York: Cambridge University Press, 2006). Note: The y-axis is the amount of labor, measured in days, the average worker would need to work in order to buy the average share traded on the New York Stock Exchange. earners saw their ownership share rise from 24% to 44%. But perhaps the most remarkable change occurred at the end of the 1920s. Between 1927 and 1930, the number of individuals owning stock almost doubled. Means estimates that 10 million people owned stock by 1930. Own- ership of corporate America became more diversified across class as well. Means opined that the shift was of “almost revo- lutionary proportions, and of great social significance.” There are often brakes on investors’ ability to engage in speculative activity, and one of the most common is limit- ing their ability to buy stocks on margin. Indeed, a central theme of any historical reckoning of the striking frothiness of the late 1920s is the degree to which investors bought stocks on margin. When investors buy on margin, they pay a fraction of the cost of the purchase and borrow the rest of the money using the value of whatever shares they buy as collateral. Lenders bet that the value of the securities will remain sufficiently high to cover their loans. This leverage can greatly magnify the effect of investor optimism, as smaller amounts of new investment can be used to drive up prices. Across most histories and studies of bubbles, such leverage is highlighted as an important factor in driving up prices. Buying on margin was common through- out the early 20th century (and a subject of some of the reforms instituted by the NYSE during the 1910s), but in the 1920s it reached an unprecedented scale. What is particularly surprising is the extent to which margin loans were made by novices in 1928 and 1929. This is depicted in Figure 1: from 1927 through the crash and into 1930, the predominant source of funds was not the New York city banks (which would be expected to have the highest level of expertise) or the out- side banks (which might be expected to be informed, though not quite as much as the local New York city banks), but the nebu- lous “others.” Just over half of these funds came from outside corporations, which sought to park idle funds in the hands of investors who were paying interest rates well above 10%, while the rest came from abroad, both from individuals and from investment trusts. From 1926 through 1930, New York banks loaned $25 million on margin ($342 million in 2016 dollars) and out-of-state banks loaned $16 million ($218 million in 2016 dollars), but other lenders loaned more than $48 million, equivalent to $641 million in 2016, so more than both other groups combined. Not only were nov- ices investing, we can also conclude that stock market speculation in the late 1920s was also backed by a new and likely inexperienced class of margin lenders. The democratization of investment had worked on more than one level. Money markets allowed industrial firms to park idle capital in the hands of market specu- lators, even as the firms themselves were ill equipped to understand the risks involved in the practice. The Great Depression put the kibosh on market democratization for decades. The conservatism of individuals scarred by the events of the 1930s helped depress owner- ship levels to a fraction of the population until the 1950s. That is, despite the series of reforms in the 1930s that successfully increased market transparency—includ- ing the creation of the Securities and Exchange Commission (SEC)—market participation did not increase for 30 years. At this point, the memory of the Great Crash was fading, and a new generation of investors began looking at the stock market. The introduction of mutual funds helped: these bundled offerings mitigated some of the psychological biases described earlier and allowed investors to delegate decision making to expert fund man- agers, while simultaneously diversifying holdings. Around the same time, Merrill Lynch instigated a brokerage house campaign aimed at making stock investing more accessible to ordinary people. The his- tory of this period includes important additional changes: growing incomes and decreasing transactions costs made stocks more affordable to all, and perhaps most important, the standardization and regu- lation afforded by the SEC may have increased investor confidence. By the mid- 1950s, the number of new investors again began to increase. Fortunately, and thanks in no small measure to the regulatory reforms of the 1930s, for the post–World War II period, there is much better data on the number of shareholders. This is helpful in identify- ing the arrival of novices based on spe- cific trends in the data. There are several estimates of the » continued on page 27 www.MoAF.org  |  Spring 2019  |  FINANCIAL HISTORY  19