The 1920s, often called the Roaring Twenties, were a time of unprecedented economic boom in the United States, and nowhere was this more evident than on the New York Stock Exchange. Stock prices experienced a meteoric rise, with the Dow Jones Industrial Average soaring sixfold, from 63 points in August 1921 to a staggering 381 points by September 1929. This period of exuberance led some, like economist Irving Fisher, to famously declare that stock prices had reached “a permanently high plateau.”
However, this extraordinary bull market was not sustainable, and it culminated in a devastating collapse. The Crash Of Wall Street began on Black Monday, October 28, 1929, when the Dow Jones plummeted nearly 13 percent. The following day, infamously known as Black Tuesday, saw another dramatic drop of almost 12 percent. By mid-November, the market had lost nearly half its value, and the downward spiral continued until the summer of 1932. The Dow eventually bottomed out at 41.22, its lowest point of the 20th century, marking an 89 percent decrease from its peak. It would take until November 1954 for the Dow Jones to recover to its pre-crash levels, highlighting the profound and long-lasting impact of the crash of Wall Street.
This financial euphoria of the Roaring Twenties was fueled by widespread optimism and prosperity. American families were experiencing increased wealth, and new technologies like automobiles and telephones became increasingly common. Ordinary citizens began investing heavily in stocks and bonds, encouraged by a burgeoning financial industry. Brokerage houses, investment trusts, and margin accounts made it easier for average individuals to participate in the stock market, often with borrowed money. Margin accounts allowed investors to purchase stocks by putting down only a small percentage of the price, typically 10 percent, and borrowing the rest. The purchased stocks themselves served as collateral for these loans. This influx of borrowed funds into the equity markets further propelled stock prices upward, creating a speculative bubble.
Despite the widespread optimism, some voices of caution emerged, notably from within the Federal Reserve System. Many governors of Federal Reserve Banks and a majority of the Federal Reserve Board expressed concern that stock market speculation was diverting resources from more productive sectors of the economy, such as commerce and industry. The Board argued that the Federal Reserve Act was not intended to support speculative credit. This view was rooted in the Act itself, which authorized reserve banks to accept assets financing agriculture, commerce, and industry as collateral for loans, but explicitly prohibited accepting instruments related to “merely investments or issued or drawn for the purpose of carrying or trading in stocks, bonds or other investment securities,” with the exception of U.S. government bonds and notes. These restrictions, also extended to open market purchases, reflected the “real bills” doctrine, which advocated that central banks should expand the money supply when production and trade grew, and contract it during economic downturns.
Faced with growing speculation, the Federal Reserve decided to intervene. However, the best course of action was a subject of debate. The Federal Reserve Board favored direct action, urging reserve banks to deny credit requests from member banks that were lending to stock speculators. They also issued public warnings about the dangers of speculation. In contrast, George Harrison, the governor of the Federal Reserve Bank of New York, advocated for raising the discount lending rate. This would directly increase the cost for banks borrowing from the Fed and indirectly raise interest rates for all borrowers, including businesses and consumers. While New York repeatedly requested discount rate increases, the Board initially resisted. Finally, in August 1929, the Board conceded, and New York’s discount rate reached 6 percent.
The Federal Reserve’s rate hike had unintended global repercussions. Due to the international gold standard, the Fed’s actions compelled foreign central banks to raise their own interest rates in response. These tighter monetary policies contributed to economic slowdowns around the world, leading to a contraction in international commerce and a global economic downturn.
Despite these measures, the speculative boom on Wall Street continued. Commercial banks and other lenders continued to pour funds into loans for brokers. In September 1929, the market became increasingly volatile, experiencing sharp declines followed by rapid rebounds. Some prominent financial figures, including Charles E. Mitchell, president of the National City Bank (now Citibank) and a director of the Federal Reserve Bank of New York, continued to encourage investors to buy stocks. In a desperate attempt to restore confidence in October, Mitchell and a group of bankers publicly purchased large blocks of shares at high prices. This effort proved futile. Panic selling ensued, and stock prices plummeted, marking the beginning of the crash of Wall Street.
Funds fleeing the collapsing stock market flowed into New York City’s commercial banks, which also found themselves holding substantial stock-market loans. This sudden surge in deposits strained bank reserves at a time when withdrawals were also increasing. To alleviate the pressure, the New York Fed intervened decisively. It purchased government securities, expedited lending through its discount window, and lowered the discount rate. The New York Fed assured commercial banks that it would provide the necessary reserves. These actions injected liquidity into the banking system, easing reserve constraints and enabling banks to remain operational and meet customer demands during the crisis. These measures also prevented short-term interest rates from spiking to levels that could have further destabilized the financial system.
While controversial at the time, with some within the Federal Reserve system criticizing New York’s actions as exceeding its authority, these interventions are now seen as crucial in containing the immediate crisis. Although the stock market crash was severe, the commercial banking system at the epicenter of the storm remained functioning.
However, the crash of Wall Street had significant repercussions for the broader economy. The market collapse triggered fear and uncertainty among investors and consumers alike. Many individuals lost their life savings, worried about job security, and struggled to meet financial obligations. This widespread fear led to a sharp decrease in spending, particularly on big-ticket items purchased on credit, such as automobiles. Companies like Ford Motors experienced declining demand, leading to production cuts and worker layoffs. Unemployment surged, exacerbating the economic contraction that had begun earlier in 1929.
While the initial impact of the 1929 crash seemed to wane within a few months, and economic recovery appeared possible by the fall of 1930, problems in the banking sector transformed what might have been a short recession into the Great Depression, the most severe and prolonged economic downturn in modern history.
The crash of Wall Street and its aftermath provided crucial lessons for economists and central bankers, including leaders within the Federal Reserve. Two key lessons emerged: First, central banks should exercise caution when reacting to equity markets, as identifying and deflating asset bubbles is extremely challenging, and using monetary policy to curb investor exuberance can have unintended and detrimental consequences. Second, when stock market crashes do occur, the playbook developed by the Federal Reserve Bank of New York in the fall of 1929 – providing liquidity to the banking system – can be effective in containing the immediate damage.
These lessons have been debated and refined by economists and historians in the decades following the Great Depression, with Milton Friedman and Anna Schwartz’s “A Monetary History of the United States” (1963) becoming a highly influential work. However, the financial crisis of 2008 has prompted renewed questioning of these conclusions. Economists are again grappling with whether central banks should actively try to prevent asset bubbles and how financial stability concerns should factor into monetary policy, echoing the debates within the Federal Reserve during the Roaring Twenties that preceded the crash of Wall Street.
