1929 And All That: Revisiting the New Deal Securities Reforms
The conventional notion that the stock market's infamous crash in October 1929 was caused by its own corrupt habit of withholding critical information from investors, or flat out lying about it, is "demonstrably false," according to professor Paul G. Mahoney, who went on to demonstrate the point in a lecture to a packed house in Caplin Pavilion January 29.
The standard explanation exists because President Franklin D. Roosevelt needed a villain to blame for the agony of the Great Depression, Mahoney said. Wall Street was a plausible culprit and it neatly suited Roosevelt's New Deal agenda for proving the social instrumentality of the federal government. Securities reforms convinced the public, to this day, that markets that are not strictly regulated are indeed dangerous.
In fact, before the crash companies issued audited financial statements and banks in particular read them closely. The crash itself was not a single catastrophe but a deteriorating series of declines, interrupted by a healthy rebound in stock values that even convinced such savvy investors as John Maynard Keynes to buy in heavily. And, in fact, investors at the time of the crash, taken as a whole, can be shown to have acted with a sober understanding of stock values.
Financial historians have advanced three basic theories for the state of the stock market at the time of the crash. One argues that stocks were fairly priced given earnings expectations for 1929 and that policy blunders by the Federal Reserve steered the nation into deflation. A second implicates the Fed but points to its earlier actions creating unsustainable levels of credit in the economy. The third, Keynes's, argues that human nature had caused a bubble in prices, a state in which values become detached from anticipated future earnings.
"None of these explanations involves chicanery or misbehavior by financial intermediaries or poor disclosure by companies," Mahoney said. Rather it was contemporary policymakers and the press who were misguided about stock prices and in their misunderstanding is the root of subsequent market regulation. Indeed, scholars now see informational efficiency as characteristic of markets as far back as London's in the 1600s "The classic picture of investors as an impetuous, imprudent and unsophisticated lot who were saved from themselves only by the intervention of an enlightened group of regulators is not merely wrong -- it's absurd," Mahoney said.
He posited three likely factors behind regulatory growth. One is public choice: legislators "sell" regulation to producers at the expense of consumers. Mahoney's current research explores public choice explanations for securities regulation. A second, related factor is the tendency of expanding government power to coincide with the increasing cartelization of its economy. The Securities and Exchange Commission clearly established the government as a gatekeeper whose decisions can mean prosperity or extinction for a business. After its creation Wall Street would never ignore Washington as it had so blithely before the Crash of '29. The third factor is human nature itself. Research in cognitive psychology, Mahoney noted, finds that people commonly make elementary logical errors. Could public opinion be persistently illogical too? "Is the entire regulatory state as we know it the consequence of human irrationality?" Mahoney asked.
Mahoney spoke as part of the Law School's Chair Lecture Series, in which new holders of endowed academic chairs lecture on an area of their expertise. Already the holder of the Albert C. BeVier Research Professorship and the School's associate academic dean, Mahoney is now the holder of the Brokaw Professorship in Corporate Law as well.
