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Faculty Viewpoints

What We Talk about When We Talk about Stock Market Crashes

In an excerpt from his new book, Yale SOM’s Robert Shiller examines how the stock market rise of the 1920s, the crash of 1929, and the Great Depression that followed came to be seen as a tale of recklessness and divine punishment—and how that narrative still shapes our understanding of the stock market.

Messengers from brokerage houses crowd around a newspaper after the stock market crash on October 24, 1929. Photo: by Eddie Jackson/NY Daily News Archive via Getty Images.

Messengers from brokerage houses crowd around a newspaper after the stock market crash on October 24, 1929. Photo: by Eddie Jackson/NY Daily News Archive via Getty Images.

The word crash quickly became associated with the one-day stock market drop on October 28, 1929, along with a slightly smaller drop on October 29, 1929, and it became inextricably linked to the Great Depression that followed. Crash calls to mind reckless or drunk drivers or race cars pushing their limits, and the crash narrative typically implies that a period of exceptional boom, of crazy optimism and maybe even reckless and immoral behavior, preceded the crash. The narrative of human folly expressed in a stock market boom followed by a horrendous stock market crash is still very much with us today.

The atmosphere of speculation in the 1920s was unsurprisingly associated with a technological advancement: the Trans-Lux Movie Ticker (also called the ticker projector). First mentioned in the news in 1925, and proliferating after that in brokerages, clubs, and bars, the ticker projector was invented amidst the public excitement about the stock market. The projector showed the latest trades in the stock market on a screen large enough to be seen by a substantial audience. Watching the information displayed by the projector was like watching a movie, or, as we would say today, like watching a large flat-screen television. A crowd could gather at one of the tickers, thus encouraging the contagion of stock market stories. According to an Associated Press account in 1928, the movie ticker brought in “wild trading”:

This has whetted the speculative appetite of thousands and created many new ones, the thrill of seeing one’s stock quoted at advancing prices on a heavy turn-over being akin to that of the race track devotee who sees the horse on which he has placed his bet come thundering down the home stretch in advance of the field.

The persistence of this narrative helps explain the public fascination in subsequent decades, and even today, with domestic stock price indexes, which the news media display constantly. People widely believe that the stock market is a fundamental indicator of the economy’s vitality.

Economists still puzzle over the stock market crash of October 28, 1929, a date on which no sudden important news occurred other than the crash itself. Just as baffling, though less discussed, is the exponential growth of stock values over most of the decade of the 1920s that preceded it. The year 1929 saw the most dramatic upswing ever, with more than a fivefold increase between December 1920 and September 1929. By June 1932, the value of the market had fallen back down to below its December 1920 level.

Earnings per share also increased dramatically over the 1920s, but the puzzle is why the stock market responded so heavily to these earnings increases. It is more normal for the stock market to react hesitantly to such upswings in earnings, which are exceptionally volatile from year to year and could even fall to zero in a single year. But surely the stock market should not fall to zero because of one bad year. Nor, normally, should it rise to match earnings in one spectacular year.

The crash of 1929 is not best thought of as a one- or two-day event, though the narrative usually suggests that it was. The combined October 28–29, 1929, crash brought the Standard & Poor’s Composite Index down only 21%, a fraction of the decline over the next couple of years, and this drop was half reversed the next day, October 30, 1929. Overall, the closing S&P Composite Index dropped 86% from its peak close on September 7, 1929, to its trough close on June 1, 1932, over a period of less than three years. The October 1929 one-day drops are talked about most often, but much more noteworthy was the stock market’s irregular but relentless decline, day after day, month after month, despite the protestations of businessmen and politicians who said the economy was sound.

This narrative was especially powerful in its suddenness and severity, focusing public attention on a crash as never before in America. Certainly, the October 1929 one-day drops set records, and records always make for good news stories. In addition, there was something about the timing of this story that caused an immediate and lasting public reaction. In his 1955 intellectual history of the 1930s, Part of Our Time: Some Ruins and Monuments of the Thirties, Murray Kempton wrote:

And it is also hard to re-create that storm which passed over America in 1929, which conditioned the real history of the 1930s…The image of the American dream was flawed and cracked; its critics had never sounded so persuasive.

That storm was not fully unexpected. In October 1928, during the presidential election campaign and a year before the 1929 crash, Alexander Dana Noyes, financial editor of the New York Times, wrote:

An observant traveler, returning from a recent tour of the United States, remarked that conversation on the trains and in the hotel sitting-rooms, after directing itself in a perfunctory way to the political campaign, would always turn with real animation to the stock market… In a succession of utterances by individual financers [sic] and at bankers’ conferences, the prediction has been publicly made that the end of the speculative infatuation cannot be far off and that an inflated market is riding for a fall.

Clearly, evidence of speculation was available to the public, which read about it in the news and talked about it on train cars. For example, in the year before its 1929 peak, the U.S. stock market’s actual volatility was relatively low. But the implied volatility, reflecting interest rates and initial margin demanded by brokers on stock market margin loans, was exceptionally high, suggesting that the brokers who offered margin loans were worried about a big decline in the stock market.

So the evidence of danger was there in 1929 before the market peak, but it was controversial and inconclusive. A high price-earnings ratio for the stock market can predict a higher risk of stock market declines, but it is not like a professional weather forecast that indicates a dangerous storm is coming in a matter of hours. Most people will heed that kind of storm warning. However, in 1929 a great many people did not heed the warning communicated by the high price-earnings ratio. After the crash, many of them must have remembered the warnings and wondered why they had not listened.

How did the 1929 crash narrative achieve such strength? Ideas about morality may have played a role. The 1920s had been a time not only of economic superabundance but also of chicanery, selfishness, and sexual liberation. Some critics viewed these aspects of the culture negatively, but they were unable to make a case against this putative immorality until the stock market crashed.

Sermons preached on the Sunday after the crash, November 3, 1929, talked about the crash, attributing it to moral and spiritual transgressions. The sermons helped frame day-of-judgment narratives about the Roaring Twenties. Google Ngrams shows that the term Roaring Twenties was rarely used in the 1920s. Use of the term, which sounds a bit judgmental, did not become common until the 1930s, when the broad moral story line in the Great Depression gradually morphed into a national revulsion against the excesses and pathological confidence of the 1920s.

Murray Kempton describes a narrative that began on the day of the 1929 crash, referring to the “myth” of the 1920s and the “myth” of the 1930s:

The myth of the twenties had involved the search for individual expression, whether in beauty, laughter, or defiance of convention; all this was judged by the myth of the thirties as selfish and footling and egocentric. It did not seem proper at the time to say that the twenties were not quite so simple, and their values were mixed, some good and some bad.

Thus the stock market crash was viewed as a dividing line between the self-centered, self-deceiving 1920s and the intellectually and morally superior, albeit depressed, 1930s. Even today, the narrative notion that a stock market crash is a kind of divine punishment remains with us.

Though much time has passed since the 1929 crash, and much of the zeitgeist of the 1930s is lost to us now, the feeling lingers that the United States might experience another stock market crash. This continuing economic narrative is a lasting legacy of 1929, and it probably serves to amplify end-of-boom drops in the stock market and drops in confidence. Moreover, any awareness that some people frame their thinking in terms of such a narrative might lead to expectations that others will also display such amplifying reactions. As of this writing, in 2019, the stock market crash story is not contagious, but it remains a part of public thinking and might return with a mutation or change in the economic environment.

Policymakers might take a lesson from both the real estate bubble narratives and the stock market crash narratives: during economic inflections, there is real analytical value to looking beyond the headlines and statistics. We should also consider that certain stories that recur with mutations play a significant role in our lives. Stories and legends from the past are scripts for the next boom or crash.

Excerpted from NARRATIVE ECONOMICS: How Stories Go Viral and Drive Major Economic Events by Robert J. Shiller. Copyright © 2019 by Robert J. Shiller. Published by Princeton University Press. Reprinted by permission.

Department: Faculty Viewpoints