Causes of the Great Depression: Bank Failures and the 1929 Stock Market Crash

Causes of the Great Depression: Bank Failures and the 1929 Stock Market Crash

The Great Depression was a severe economic crisis in the United States (U.S.) that began in 1929 and lasted until 1939. It was marked by the sharp decline of all economic indicators. The rate of unemployment and inflation reached unprecedented levels. Millions of workers lost their jobs along with their assets. The financial and agricultural sectors spiraled downward, and the value of the American dollar declined steadily (Kupperberg 3). The economic difficulty was also felt throughout Europe, Asia, and South America. The Great Depression was caused by a plethora of factors including the stock market crash of 1929, high tariffs on European imports, bank failures, unequal distribution of income and wealth among citizens and corporates, and drought conditions (Kupperberg 14). This paper will focus on two of the most significant causes of the crash, that is, bank failures and the 1929 Wall Street Crash.

The decade that followed the First World War was a period of boom in the United States. Americans had great post-war optimism, and there was a drastic change in their lifestyles. There was a new wave of consumerism (Gow 9). The newly introduced concept of hire purchase or buying on credit enabled families to afford goods such as radios, washing machines, refrigerators, and cars that were previously unaffordable. Due to the advancements in technology, industrialization, and the expanding middle class, economists referred to the period as the Roaring Twenties (Gow 12). Believing that the stock market was the safest investment that promised quick returns, Americans invested heavily in stocks. There was an economic boom primarily driven by the aggressive share purchase.

The Dow Jones Industrial Average rose steadily from 120 points in 1924 to 380 points in 1929 representing a 400% increase (Gow 17). However, the stock prices were primarily driven by over-exuberance and false expectations of investors. The over-use of credit was extended to buying stocks. A new concept of buying shares on margin was introduced. An investor could pay only 10-20% of the value of the shares and borrow 80-90% of the stock value (Gow 18). By buying on the margin, people would also exploit the financial leverage effect which significantly increased the return on investment. Banks also invested depositor’s money in stocks. Share prices rose rapidly and steadily, and many stocks became overpriced. Concerned about the booming share prices, the Federal Reserve raised the interest rates to as much as 6% from 1929 to 1929 (Romer).  The tightening of the monetary policy caused investors to panic, and they started selling their shares. Since everyone was selling and no one was buying, the stock prices collapsed. The Dow Jones Industrial Average dropped by 250 points in three days (Gow 26). Many investors who had purchased shares on debt became bankrupt and were no longer able to repay the debts. The stock market crash initiated the Great Depression in the U.S.

The crash was also accompanied by bank runs or bank failures. As a result of the stock market collapse, there was a banking panic in the United States, as depositors lost confidence in the liquidity of banks (Wicker 10). Millions of people started demanding their deposits, and banks were forced to hastily liquidate loans, mostly at a loss, to raise the required cash. On the one hand, banks had no money to lend, and on the other hand, there was a massive default on loans as borrowers could not raise the money. As a result, many banks went bankrupt. Out of the country's 25,000 banks, 11,000 had collapsed by 1933 (Kupperberg 44). The bank failures deepened the economic crisis during the depression.

The Great Depression was primarily caused by the stock market crash and the failure of banks between 1929 and 1933. The effects of the depression spread globally and caused economic hardships in many countries. However, it had invaluable lessons for investors, financial institutions and the government. Investors learnt the need to diversify their investments. The government realized the importance of financial market regulation, as well as the need to intervene in the economy through fiscal and monetary policies to prevent economic failure (Kupperberg 79).


Works Cited

Kupperberg, Paul. Critical Perspectives on the Great Depression. The Rosen Publishing Group, 2004.

Romer, Christina D. "The Great Depression." Econometrics Laboratory, UC Berkeley, Britannica Educational Publishing, 20 Dec. 2003, Accessed 24 Feb. 2019.

Gow, Mary. The Stock Market Crash of 1929: Dawn of the Great Depression. Enslow Publishers, 2003.

Wicker, Elmus. The Banking Panics of the Great Depression. Cambridge UP, 2000.

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