John Kenneth Galbraith sat before a Senate Committee Hearing to explain his version of the events that led to the ’29 crash. I’ve referred to this hearing before. A number of prominent financial minds were called to offer their view of the market in 1955.
Galbraith was there to offer some historical context. As it turns out, his statement to the Committee is one of the better explanations for stock market euphoria that I’ve read.
Greed and fear are only part of it. While explaining the lifecycle of a bubble, Galbraith, adds that investors end up “fooling themselves.” Confirmation bias kicks in after taking a position. They look for things that confirm their beliefs and shun anything that goes against it. Simply, they see what they want to see.
It reinforces the need to be openminded, avoid filter bubbles, and seek disconfirming evidence. Then ask one simple question: What could go wrong? If no answers come to mind, try harder.
But absent that, and armed with an optimistic story, you have the ingredients for a bubble. And as Galbraith points out later in his statement, only a small portion of the total investors is needed to get the ball — prices — rolling and maintain it, at least, for awhile, before it all comes crumbling down.
Anyways, here’s Galbraith:
The economic consequences of a speculative boom are twofold. There is a distortion of economic values during the period of speculation itself. Attention ceases to be on making goods and becomes centered on making money. Under extreme circumstances all else is forgotten. An observer noted that at the height of the frenzy that has come to be known as the South Sea Bubble, “Statesmen forgot their politics, lawyers the bar, merchants their traffic, physicians their patients, tradesmen their shops, debtors of quality their creditors, divines the pulpit, and even the women themselves their pride and vanity” (quoted by Viscount Erleigh, The South Sea Bubble (New York: Putman 1933), p. 11).
The more serious consequences are from the breaking of the speculative bubble. Economic activity is likely to be adversely affected. The livelihood of people to whom the market is a distant and remote phenomenon may suffer. These are matters to which I shall return.
The great speculative episodes of the past have all had certain features in common. All — the stock market boom of 1928-29, the Florida land boom of the mid-twenties, the Iowa land boom following World War I, the various railroad and land booms of the last century, the classic Mississippi and South Seas bubbles — have, in the beginning, been grounded on some element of reality. Industrial activity was rising in the late twenties as were corporate earnings. Taxes were being reduced. This was the reality behind the 1928-29 stock market boom. The Florida climate, on which the Florida boom was based, is very good most of the time. John Law, visiting Louisiana and the lower Mississippi Valley after 238 years would find much to substantiate the brilliant prospects which were painted to French investors in 1717.
However, it is also a feature — the critical feature — of the speculative episode that, after a time, the market loses touch with reality. Speculation acquires a dynamic of its own. The factors behind the original revaluation of the asset are no longer important. What becomes important is the single fact that prices are rising. Because they are rising and money can be made, more and more people are encouraged to try and get a share in the capital gains. By doing so they keep prices going up. The original cause of the price rise eventually becomes the merest excuse for optimism. People use it — the promise of a new era, the superior quality of Florida sunshine, a sound and conservative, or middle-of-the-road administration — but only to explain the capital gains they are making or hope to make.
The boom will continue as long as the supply of new people with new money lasts. Temporary setbacks may actually encourage more people to come in to the market on the assumption that they are picking up bargains. The end may in practice be attributed to various causes — the 1926 hurricanes were thought to have ended the Florida boom, and many have suggested that the failure of Clarence Hatry, the English promoter, precipitated the crash of 1929. In fact, the end always comes for the same fundamental reason. The supply of new buyers has become inadequate to keep prices going up. The man who is seeking capital gains has no interest in a stable market. When prices level out he sells. Others then sell to avoid losses. Prices break. Because the helter-skelter rush to get out of the bust is always a good deal more violent than the boom.
Such is the pure model of the speculative orgy. There are other commonplace features. Since the speculator is interested only in capital gains, he finds it onerous to have put up the whole purchase price. Accordingly, he will seek some way of trading in the assets which give him the capital gains but avoids putting up the capital. In land speculation this is usually accomplished by trading in binders or on the basis of downpayments. In the stock market the purpose is served by margin trading. It follows that the extent of use of these devices — in the case of the stock market the volume of brokers’ loans — is a valuable index of the amount of speculation.
The mood which speculation engenders is also much the same in different episodes. It is not so much one in which people are fooled as one in which they insist on fooling themselves. One result is that any suggestion that values are unreal — that things are less than wonderful — is fiercely resisted. Reassurance — explanations as to why things are sound — soon partakes of the proportions of minor industry. Support is gained from those who speak with most knowledge and authority. Shortly before the 1929 crash Prof. Irving Fisher of Yale University, a notable figure in American economic thought, reached his memorable conclusion that stocks were on a new high plateau. At about the same time Charles E. Mitchell, the then highly influential chairman of the National City Bank, declared that the “industrial condition of the United States is absolutely sound.” He complained that too much attention was being paid to the volume of brokers’ loans. There were hundreds of other such statements. All we received with approval. By constrast, Paul M. Warburg, a conservative bank and a lone voice of dissent, was bitterly assailed when he criticized the current orgy of “unrestrained speculation” and predicted that, were it not stopped, there would be a collapse and depression.
It need hardly be suggested that this tendency toward reassurance poses an interesting problem for a committee such as this. The assertion that all is well can, under some circumstances, be a valuable index of the opposite.