After the crash, the aura of omnipotent genius attached to leading market operators and New York bankers disintegrated almost as fast as stock prices had fallen. Rarely has press coverage and public perception changed more abruptly, with deference and respect quickly replaced by hostility and ridicule. Men who had been assumed only weeks earlier to be veritable titans of finance were suddenly denounced as ineffectual at best, mendacious at worst.

Even more abasing was the treatment meted out to the academic advocates of the New Era, and no prominent member of the academic community suffered as much as Professor Irving Fischer of Yale. Fischer’s unfortunate utterance a few days before the crash–that stocks were on a “permanently high plateau”–would come back to haunt him again and again.

Struggling to salvage his reputation, Fischer wrote a book defending his viewpoint, published in 1930 under the title The Stock Market Crash–and After. There he reiterated the arguments of the New Era advocates–that the systematic application of science to industry, and continued consolidations leading to economies of scale, had increased corporate profits and fully justified the 1920s stock market boom. He pointed out that corporate earnings had grown at an annual rate of 9% from 1922 through 1927, while dividends had increased at a rate of 6.8%. After 1927, the rate of increase in earnings was even faster; comparing the first nine months of 1929 with the comparable period in 1928, Fischer found an increase in earnings of 20%. According to Fischer, “This record is eloquent in justification of a heightened level of common stock prices during 1929.”

Fischer tried to explain what had gone wrong with the market. He attributed the decline to “the psychology of panic. It was mob psychology, and it was not, primarily, that the price level was unsoundly high… the fall in the market was largely due to the psychology by which it went down because it went down.”

The Commercial and Financial Chronicle observed acidly, “The learned professor is wrong as he usually is when he talks about the stock market.” According to the Chronicle, the “mob” didn’t sell–it got sold out. Speculators owning stock on margin were forced to sell when the value of the shares collateralizing their loans declined; this selling, in turn, sent prices lower, which forced other margined speculators to sell, and so on.

Fischer agreed that excessive leverage exacerbated the crash; there was too much margin debt employed by speculators, and there were too many leveraged vehicles like the investment trusts. But Fischer resolutely refused to concede that stocks, in general, were overvalued in 1929. Instead, he said, the problem was to be found in the “unsound financing of sound prospects.”

Fischer has repeatedly been denigrated by critics of presumed “over-speculation”. While these critics freely admit that leverage played an important role in the market collapse, they view that leverage as simply another symptom of the speculative excess of the time. Much was made of the fact that Fischer lost most of his personal wealth as a result of his speculative activities, and rumors abounded that the Yale endowment fund, to which Fischer was an advisor, was badly hurt by the crash. (This was not true; apparently, the Yale endowment fund pursued a fairly conservative investment strategy in 1929.)

But what of Fischer’s basic argument–that enhanced productivity and the rapid growth of corporate profits justified the high level of stock prices in 1929? Since his reasoning is very similar to that frequently heard in the booming years at the turn of the twenty-first century, it bears closer examination. Such is the mystique associated with the 1929 crash that even today scholars still debate its causes and the question of whether or not the market was badly overvalued before the collapse. While the results of the ongoing debate are not definitive (and probably will never be), Fischer and his fellow New Era advocates fare much better in retrospect than they did in their own time.

The “revisionist” (pro-New Era advocates) interpretation of the 1929 crash did not begin to gain credence until several decades after the crash. Writing in the Business History Review in 1975, Gerald Sirkin cited data going back to 1800, from which he identified a major change in the nature of the growth process in the American economy beginning early in the twentieth century. According to Sirkin, before 1900 most growth in the economy was generated by providing more capital to business, but after 1900 much of the economy’s growth resulted from increases in productivity, which enhanced the return on capital earned by business and accelerated the rate of increase in corporate earnings. This evidence provides a statistical justification for the arguments of New Era proponents like Irving Fischer.

Specifically analyzing market valuations in 1929, Sirkin concluded the market P/E ratios were justified by the growth of earnings in the late 1920s. While some stocks were overvalued, he found that the overvaluation was concentrated in only approximately 20% of stocks, leaving the overall market fairly priced. Sirkin writes that the data do not present a picture of “speculative orgy” in “a time of madness.” Instead, in his words, most stocks were “cold sober,” although a few did show signs of “over-indulgence.” His conclusion: “not much of an orgy.”

To be continued

Credits: Much of this article is extracted from B. Mark Smith’s Toward Rational Exuberance, 2004.

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