How The Great Depression Impacts The Way We Invest Today

Triggered by the Stock Market Crash of 1929, the Great Depression was the worst economic disaster in US history. The market reforms and regulations enacted during the Great Depression established the foundation for how we trade and invest today.

THE STOCK MARKET CRASH OF 1929

The bull market of the “Roaring Twenties” was the first time ordinary Americans had participated in the stock market. Stocks were touted as the surefire way to riches, especially when you could buy them on a 90% margin. By mid-1929, 300 million shares of stock were being held on margin. This was exacerbated by overzealous and sometimes fraudulent representations by salesmen and brokers that had enticed novice buyers into pouring money into the market.

On October 29, 1929, the market crashed. An estimated $14 billion in stock value vanished overnight. With their life savings gone, American families could no longer afford anything but bare necessities. Businesses dependent on consumer demand failed, increasing the number of unemployed and homeless. Banks and brokers failed as the stock they had taken as loan collateral became worthless.

Crowd gathering on Wall Street after the 1929 crash - Wikipedia

GOVERNMENT REACTION

Among the emergencies facing the new Franklin Roosevelt administration in 1933 was the need to protect investors and reduce financial crimes by regulating the purchase and sales of stocks.

SECURITIES ACT OF 1933

The Securities Act of 1933 was the first major regulation of stocks by the Federal government. Sometimes called the “Truth in Securities” law, it was written to protect stock investors from puffery, misrepresentation, and fraud.

It required companies to provide independently audited, complete disclosures of their finances to investors through prospectuses. Companies also had to file registration statements with the Federal Trade Commission whenever they issued stock.

BANKING ACT OF 1933 (GLASS-STEAGALL)

The Glass-Steagall Act aimed to curtail bank failures by forcing banks to separate their commercial and investment operations and limit the amount of stocks and bonds they could accept as loan collateral.

To reduce bank runs, the Act created the Federal Deposit Insurance Corporation. This Federal agency guaranteed deposits of up to $5,000 at insured banks to assure the public that their money was safe. (The FDIC-insured limit is $250,000 now.)

Glass-Steagall stabilized the banking system by setting standards for banks that wished to be insured by the FDIC. Banks soon discovered that being FDIC-insured was the only way to attract depositors, incentivizing them to join the program. Being FDIC-insured is still a major selling point in the financial services sector.

SECURITIES EXCHANGE ACT OF 1934

The Securities Exchange Act of 1934 regulated stock exchanges for the first time. It created the Securities and Exchange Commission to register, regulate, and oversee stock trading. This included exchanges, brokers, and agents involved in the securities market. The SEC oversees and enforces Federal securities law to ensure transparency in the stock market. It investigates and prosecutes entities involved in securities fraud.

The Act also requires companies to submit independently audited financial reports (10-Qs) quarterly and again for the full fiscal year (10-Ks). (This differs from the Securities Act of 1933, which only required audited reports to issue stock.) These reports provide some of the most important information for investors considering investing in a company.

Separately from the SEC, stock exchanges require member companies to submit 10-Qs and 10-Ks in a timely manner or risk being delisted.

Today’s Foundation

The securities laws passed during the Great Depression established the foundation of modern financial markets - regulation, transparency, and trust in investor protections have enabled the US stock market to become a major engine of wealth for investors at home and abroad.