What part(s) of the financial system do you consider most responsible for the expansion of credit leading up to the 1929 crash
Minsky and Kindleberger provided a model that can be used to explain the financial crisis of 1929. The mania, panic and crash model provides that there is a bubble that experiences a period of financial distress. In such a model, the price of stock in the market rises to a peak and then it is followed by a gradual decline for some time. The period is then followed by panic and crash. A crash is mainly preceded by expansion of credit. In the 1929 financial crisis, the crash was as a result of an initial booming economy and financial market that lead to the peaking of the market. The Dow had increased six-fold from 1921 to 1929. The market was considered to have officially peaked in September 1929. The rise in the value of shares in the market attracted ordinary working class citizens, and most of them purchased stocks on ‘margin.’ They only paid a small share of the value with their money while the rest was borrowed from the bank or a broker.
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Banks and brokers are responsible for the rapid expansion of credit that led to the eventual crash of the market in October, 1929. A long period of market growth increased the confidence of consumers hence everyone wanted to invest in the financial market. The price of shares was overpriced with banks offering easy credit to potential investors in the stock market. The stability of the market encouraged people to go for credit because they felt they would be able to repay. The stockbrokers encouraged the concept of ‘buying on margin.’ The concept gave an opportunity to ordinary people with less financial capacity to borrow money to get funds from the stockbrokers. They could get loans with as a little as 10 percent of the total share value. The loose application of credit became the common way of buying stocks thus leading to financial ascent. The broker had all the incentives to lend money to potential investors since shares acted as collateral for loans, they made money on volumes of stocks sold, and they also earned interest from lending.
Changes in financial regulation that followed the Great Depression. Which major parts of the U.S. financial system were most changed by these regulations?
Weaknesses in the financial market that led to Great Depression had to be addressed to prevent a similar occurrence in future. There were primary policy goals that were implemented through the New Deal legislation that were aimed at addressing issues in the banking industry and financial sector. There are several acts that were passed in the 1930s to create a regulatory framework that would prevent the financial system from future abuse as well as boom-and-bust financial cycles. They included Glass-Steagall Act of 1933, Securities Act 1933, Investment Company Act of 1940, and Investment Advisors Act of 1940.
Prior to the financial crisis in 1929, many banks had run into a crisis because they failed to take necessary caution while engaging in the stock market. They had even gone ahead to offer loans unethically to industrial companies that had bank officers and directors as investors. The new regulations passed in the 1930s were meant to prevent banks from engaging in insurance and security businesses. The United States financial system that was majorly affected by the changes was the banks. The crisis led to the banks being placed under oversight that was overseen by US Treasury and backed by federal loans. Glass-Steagall Act prevented the mixing of insurance, banking, and security businesses. The act separated investment and commercial banking activities. The separation of activities aimed at preventing the over-involvement of commercial banks in stock market investment. The activities of the banking sector were considered to be the main cause of the financial crash. The commercial banks had taken too much risk with depositors. The acts led to a period of stability in the banking industry.
On balance, do you think the United States financial system had improved performance over about the next four decades after 1933?
The US financial system had improved on its stability after the financial crisis of 1929. The reforms in the industry necessitated by the passage of Emergency Bank Act, Glass-Steagall Act, Investment Company Act, and Investment Advisors Act led to the creation of long term stability in the banking sector. The commercial and investments banks grew to become more independent and profitable. The acts thus led to improved performance in the next four decades. However, in the 1970s, the banking reforms that had been implemented in the 1930s began to receive a backlash. In particular, regulations associated with Glass-Steagall that prevented mixing of security, banking, and insurance business began to be criticized. Banks wanted to start offering a variety of services including those offered by investment banks. They complained that they were losing customers to other financial institutions. The complaints led to government response in which banks were provided with increased freedom to provide customers with new types of financial services.
The stability enjoyed in the four decades, post Great Depression Crisis began to be eroded by the reforms. The period had been characterized by a growth in the financial sector and stability. Further reforms in 1999 to Glass-Steagall Act, through Financial Services Modernization Act, have weakened the regulations. Banks are not only allowed to engage in security and insurance businesses, but also form financial conglomerates with insurance and securities firms. The reforms have been blamed for 2007-2008 financial crisis.
