NOTE: There is an initial cause of stock market collapse (cited here) but there is also the prolonging of the Great Depression (for later writing) — because the stock market did not recover until 1954.
Reality Check:
If I gave you the option to buy a corporate bond which yields 6% annually (completely pays for itself within 17 years), or a stock share in an opaque enterprise which yielded 0.87% dividends (completely pays for itself in 115 years) — which do you choose?
Rational people choose the first option, because the return on investment is 7 times higher — and only fools opt for investments whose payoffs are so comparatively low — that is, unless new information reveals something “special” about the second one.
Public Utility Holding Companies
That second kind of an investment involves public utilities and a special layer of investment called Public Utility Holding Companies (PUHC’s), where prices were so distorted in the late 1920’s that one of them reached a price-earnings ratio of over 100:
Only a portion of total earnings comes back immediately as a dividend, so, in the case of American Power & Light, it really is so that you’d expected to have to wait 105 years before the price which you paid for the stock got completely covered by future earnings.
Who buys an investment which is projected to take 105 years to pay for itself — especially when corporate bonds completely pay for themselves every 17 years?
There are only two “good” reasons to do so:
you are committing fraud and embezzlement (obtaining unseen gains)
you got duped by someone else who was committing fraud and embezzlement
Samuel Insull, a leading operator of PUHC’s, was brought up on charges of fraud and embezzlement, only they could never make those charges stick.
Rigged System
The game was rigged so that government-enforced utility monopolies could not only realize steep profit, but benefit from shady, pyramid-scheme financing — or covert Ponzi Borrowing — the main cause of the Great Depression.
NOTE: regular (non-covert) Ponzi Borrowing just means that you must rely on the appreciation of the asset in order to cover the cost of buying it in the first place (because you are not even wealthy enough to even cover the mere interest payments on the loan that you haphazardly took out)
In 1951, it was brought out that Professor Dewing had “called it” in January of 1928, over a year before the stock market collapse:
Notice how, by January 1928, a decoupling of price vs. risk meant that the true level of invested capital was not getting priced into the utilities markets — but that the unwary public could still be relied upon to fund these “over-valued” enterprises by buying stocks.
The “bankers and promoters” knew something that the public did not know.
Public utilities themselves are the service providers, but PUHC’s provided extra financing for them. There were up to 5 layers, or shells, of ownership, with each layer reporting the earnings of the layer below it (as if earnings were 5 times higher than actual).
Here is a telling quote:
Assume that a utility purchases an asset that costs $1,000,000 and that asset is financed with 40% stock ($400,000). A utility holding company owns the utility stock and is also financed with 40% stock ($160,000). A second utility holding company owns the first and it is financed with 40% stock ($64,000). An investment trust owns the second holding company’s stock and is financed with 40% stock ($25,600). An investor buys the investment trust’s common stock using 50% margin and investing $12,800 in the stock. Thus, the $1,000,000 utility asset is financed with $12,800 of equity capital.
—Harold Bierman, Jr., Cornell University
And here are selected, chronological headlines from the New York Times:
https://www.nytimes.com/1929/02/03/archives/stock-of-utilities-continue-to-soar-gain-of-943000000-added-in.html
STOCK OF UTILITIES CONTINUE TO SOAR; Gain of $943,000,000 Added in January to $1,780,000000 Made Last Year. VARIOUS CAUSES FOR RISE Increased Earnings, Recapitalization, Expansion and Consolidations Affect Securities. Utilities at Highest Points. Consolidations Expected. Price Movements on Exchanges.
https://www.nytimes.com/1929/05/13/archives/utilitys-holdings-up-24000000-in-11-days-gain-in-stocks-of-united.html
UTILITY'S HOLDINGS UP $24,000,000 IN 11 DAYS; Gain in Stocks of United Corporation Shown in Notice of Rights by American Superpower.
https://www.nytimes.com/1929/07/20/archives/63000000-profit-in-holding-company-common-stock-of-insull-utility.html
$63,000,000 PROFIT IN HOLDING COMPANY; Common Stock of Insull Utility Investments Rose From 15 to 94 Since June 30. MORE FOR INSULL'S GROUP Appreciation of His Securities and Those of His Friends Put at $94,000,000.
https://www.nytimes.com/1929/07/28/archives/utility-holdings-shift-in-huge-deals-wall-street-keeps-close-watch.html
UTILITY HOLDINGS SHIFT IN HUGE DEALS; Wall Street Keeps Close Watch as Many Financial and Physical Structures Are Changed. EXPANSION IS THE KEYNOTE Smaller Systems Are Being Acquired or Sought by larger Ones as Rumors Fly. Utility Map Changing. Two Schools of Utility Thought.
https://www.nytimes.com/1929/09/20/archives/2172000000-deal-in-utilities-talked-union-of-electric-investors-and.html
$2,172,000,000 DEAL IN UTILITIES TALKED; Union of Electric Investors and Electric Bond and Share Proposed. EACH A HOLDING COMPANY Wall Street Regards Plan as Preliminary to Merger With Other Big Concerns. Operations of Companies. Common Stock Holdings. No American Superpower Deal
https://www.nytimes.com/1929/09/22/archives/huge-new-concerns-interest-wall-st-united-states-electric-power-and.html
HUGE NEW CONCERNS INTEREST WALL ST.; United States Electric Power and Public Utility Holding Corporations Closely Related. SAME GROUPS BEHIND BOTH Utilities Throughout Country and Abroad Will Constitute Fields of Operation.
https://www.nytimes.com/1929/10/17/archives/asks-care-in-buying-shares-in-utilities-committee-at-investment.html
ASKS CARE IN BUYING SHARES IN UTILITIES; Committee at Investment Bankers Convention Advises Against Uninformed Purchasing. FEDERAL CONTROL DECRIED Report Advocates Leaving Power Company Supervision With the State Authorities. TIPSTER WARNING SOUNDED Committee Tells of Tricks by Which Appeals Are Made to the Public. Question of Futures Involved. Attacks Couzens Power Bill.
https://www.nytimes.com/1929/10/17/archives/charges-utilities-withhold-data-trade-commission-in-report-to.html
CHARGES UTILITIES WITHHOLD DATA; Trade Commission, in Report to Senate, Says Investigation Is Being Delayed. MERGER FIGURES HELD UP Walsh of Montana Says He May Ask Legislation to Define the Authority for Inquiry. Text of Report to the Senate. "Pertinent Records" Withheld.
https://www.nytimes.com/1929/11/01/archives/says-business-now-has-outgrown-law-senator-sackett-in-louisville.html
SAYS BUSINESS NOW HAS OUTGROWN LAW; Senator Sackett, in Louisville, Asserts New-Type Corporations Nullify Old Curbs. TRACES POST-WAR GROWTH Rail and Utility Holding Companies and Chain Banks Come Under No Legal Restriction, He Says.
https://www.nytimes.com/1929/11/08/archives/utility-inquiry-body-bars-giving-holdings-members-of-legislative.html
UTILITY INQUIRY BODY BARS GIVING HOLDINGS; Members of Legislative Body Vote Down Move to Reveal Their Stock Interests. SEEN AS A TEST BALLOT Governor's Three Appointees Favor Proposal, While Four Republicans Disapprove.
https://www.nytimes.com/1929/11/15/archives/urges-wider-power-for-utility-board-van-namee-says-it-should-have.html
URGES WIDER POWER FOR UTILITY BOARD; Van Namee Says It Should Have Access to Books of Holding Companies. SEVERAL TILTS AT HEARING Stone Protests Against Bonbright's Request In Policy on WaterRights as Waste of Time.
https://www.nytimes.com/1932/10/10/archives/find-samuel-insull-in-hotel-at-athens-searchers-trace-his-flight-by.html
FIND SAMUEL INSULL IN HOTEL AT ATHENS; Searchers Trace His Flight by Train and Plane From Milan as Son Returns to Paris. EXTRADITION IS IN DOUBT But Chicago Prosecutor Seeks the Financier's Deportation to Italy and Arrest There.
In other words, the Great Depression was not caused by the failure of the free market, it was caused by a new kind of Ponzi Borrowing:
Covert Ponzi Borrowing set up as a Pyramid Scheme.
Thought Experiment
If Communism were tested in a laboratory to find out whether it puts food on the table, but during the experiment, it was discovered that thieves were robbing the treasury blind, we couldn’t conclude that Communism failed.
That’s because too much crucial crime was involved (crime which could tip the scales).
For the same reason — because of the crucial crime involved — it cannot be a rational conclusion that the Great Depression was a “market failure.” Only when crime has been brought down to manageable levels can you reliably investigate the merit of economic systems.
Reference
[Price Earnings Ratio exceeding “100”] — THE STOCK MARKET CRASH OF 1929: IRVING FISHER WAS RIGHT! https://www.nber.org/system/files/working_papers/w8622/w8622.pdf
[quote about having less than 2% equity behind a utility asset] — The 1929 Stock Market Crash. Harold Bierman, Jr., Cornell University. https://eh.net/encyclopedia/the-1929-stock-market-crash/
[1951 speech by Chairman of the SEC, showing how a professor “called” the Great Depression more than a year prior — but nobody listened] — https://www.sec.gov/news/speech/1951/062551mcdonald.pdf
[PUHC’s paid 0.87% dividends] — The Valuation Levels Prior to the 1929 Crash Were Absurd. https://www.joshuakennon.com/the-valuation-levels-prior-to-the-1929-crash-were-absurd/
Great article and research. Thanks
You forgot one reason someone might by a 100 PE stock - greater fool theory. They think a greater fool will pay them more for it in the future. But yes pretty much every financial disaster is ignited by some "innovative new financial product", usually sold to the gullible public. And there's always a Ponzi scheme in there somewhere. CMOs in the 2000s, internet stocks in the 90s, Bernie Madoff, etc etc. It ALWAYS really is too good to be true.