Rev. Erudite Redneck, B.S., B.S., M.A., M.Div.

By The Erudite Redneck

Housing bubble, schmousing bubble. The housing-investment-construction mania enveloping some major markets in this country is a symptom, not the disease itself. What we got on our hands here is a credit bubble.

Housing bubbles will deflate locally -- and despite what the experts say, I think the jury is still out on repercussions nationally. Because housing investment capital -- and I'm talking about single-family housing -- is not local, not any more. Money from all over the country and the world is landing in Oklahoma City, of all places, to snatch up everyday houses in everyday neighborhoods.

I think we're looking at a train wreck that will make the savings-and-loan crisis look like a dry run for greed. It'll be bigger than the political parties. Whoever has control of Congress will have to do something, once again, to save us from ourselves.

Perfect timing, y'all -- y'all who decided to make bankruptcy tougher than ever. Hoo boy. Better build some more bridges, 'cause we're going to need 'em to put the homeless under.

Here's something I wrote in summer 2001. It's not about housing. It's about bubbles. It would behoove anyone to listen to the old man, Galbraith. It's a historiographical book view of some of Galbraith's works.

--ER

John Kenneth Galbraith committed an act of investigative and explanatory journalism with The Great Crash 1929, his seminal account of the speculative excess that led to the crash on Wall Street and the beginnings of the decade-long Great Depression. Galbraith puts events and, more important, prevailing thought in context in the straightforward manner of a seasoned newsman. It’s no wonder. For sources, Galbraith drew heavily on the New York Times, Wall Street Journal and other general and financial press of the time. The Great Crash, continuously available since first published in 1954, is no shrill siren; like many of Galbraith’s works, it is meant as a cautionary tale, a history of irrational action and stubborn inaction, an explanation of steps and missteps leading to the crash, presented with hope – but not much -- that mistakes can be avoided next time.

There will be a “next time,” Galbraith writes -- in The Great Crash and in other works in which he addresses, even in passing, speculative episodes. These include Economics in Perspective – A Critical History, his 1987 history of Western economic thought; A Short History of Financial Euphoria, a short 1990 work where the predictable recurrence of speculation is his theme; and even Name Dropping – From FDR On, published in 1999, his little diary of reminiscences from his own government service. This article will explore complementary themes in each work, especially as they amplify Galbraith’s historical narrative and interpretations of the stock market crash of 1929.

Galbraith’s framework for explaining the 1929 stock market crash, other devaluations of securities, currency, tulip bulbs – and all other results of speculative “insanity,” as he calls it time and again – hangs on a few commonalities:

All participants in the leveraging-buying frenzy believe that there is something new in the world, whether a new product, such as Holland’s tulips during the Tulipomania of the 1630s, or a new financial instrument, such as the leveraged buy-outs and “merger mania” that precipitated the crash of October 1987. Participants as well as bystanders trust what they perceive as a particular genius at work on the part of leading decision-makers. This supposed genius is associated directly with the accumulation of wealth, which draws more investors who attain a measure of their own wealth, which fuels speculation even further. A crash is inevitable, when doubt appears, followed by anger directed at the leading “brilliance,” soul-searching by those drawn in, and intense scrutiny of the supposed new financial instruments and practices. 1

In The Great Crash, Galbraith constructs the following framework to explain the stock market crash: The “something new” was the institution of leverage, the holding of common stock controlling enterprises with huge debt loads. He points particularly to the development of investment trusts created not to conduct business, but for the singular purpose of holding stock, often in other investment trusts. Such a financial structure speeds the accumulation of wealth as speculation proceeds, and reverses just as fast when the speculative spell is broken. The “genius” that drew so many investors to stocks during the 1920s was the supposed and largely untested “wisdom” of bankers of the day, made more alluring by the booming economy of the 1920s in general. The crash of Oct. 29, 1929, was followed by congressional investigation, castigation of leading financial decision-makers and Wall Street cheerleaders and eventual governmental reform of the stock markets. 2

Understanding Galbraith’s view of speculation, particularly the American brand, and government’s response, requires an introduction to his theories of economics and history – and some of his thoughts on the development of economic thought in the United States.

Galbraith’s grand theory of economics is tied up in government – that alone set him and his mentor, John Maynard Keynes, apart from the classical economists who prevailed in the early part of the 20th century -- and is spelled out in Economics in Perspective: “The separation of economics from politics and political motivation is a sterile thing. It is also a cover for the reality of economic power and motivation. And it is a prime source of misjudgment and error in economic policy.” 3 Throughout his works is this idea, whether spelled out or not: Government can, and should, act to smooth out the rough edges of economic life, particularly the excesses of capitalism’s near worship of the “free market.” Galbraith, a Canadian whose earliest memories include his family’s reading of the Toronto Globe, “the bible of the committed Liberals of Ontario,”4 has always been an unabashed yet pragmatic liberal. The thread extends from his youth to his graduate school days in the early 1930s at the University of California at Berkeley; to his service in President Franklin Delano Roosevelt’s administration, which started in 1934 in the Department of Agriculture and culminated during World War II in the executive Office of Price Administration; to his service in Germany as a director of the United States Strategic Bombing Survey under President Harry Truman; to service with Truman’s State Department, when he had charge of German, Japanese, Austrian and South Korean economic affairs in the years just after the war; to his later service as American Ambassador to India under President John F. Kennedy; to State Department service under President Lyndon B. Johnson; and throughout his long academic and writing career. 5

Galbraith’s grand theory of economic history is spelled out as plainly as his view of economics alone. It, too, is tied up in government:

It is sufficiently clear that economics does not exist apart from context – apart from the contemporary economic and political life that gives it form or the interests, implicit or explicit, that shape it to their need. Economic ideas, as Keynes averred, do guide policy. But the ideas are also the offspring of policy and of the interests which it serves. The long reach of history establishes another truth. That is the way change in economic life and institutions bears on all economic thought. Economics is not, as often believed, concerned with perfecting a final and unchanging system. It is in a constant and often reluctant accommodation to change. Failure to recognize this is a formula for obsolescence and for accumulating error. Of this, too, the history tells. 6

It is the very lack of context for economics in early American history – economics as a studied discipline, not as a practical framework for exchanging resources – that Galbraith uses to explain the nation’s leaders’ almost religious reverence for classical economic ideas after the turn of the 19th century – and which they clung to almost as fervently the first years after the crash of 1929. Galbraith asserts that for the first 152 years of the nation’s existence, not even classical economic ideas – Adam Smith’s “Invisible Hand” directing competition and the interplay of supply and demand7 -- held much sway in the everyday affairs of Americans, not even in the universities. There was instead “an ardent discussion of a range of eminently practical economic topics,” he wrote in Economics in Perspective. “These included the tariff, monopoly, the social behavior and defense of the very rich, and most urgently of all … the diverse questions pertaining to money.” 8 No sooner had American universities established professorships in economics, at the end of the 19th century – with studies derived largely from British classical orthodoxy – did American academics start to rethink classical economics as the only discipline of economic study. A few were watching the development of the welfare state in Germany, and later in Britain.9 Dissenters from classical orthodoxy remained outside the mainstream of American economic thought, however, even when classical economists simply stood aside after the stock market crash of 1929, expecting the crisis to work itself out, and through the presidency of Herbert Hoover. Then, of course, came FDR and his “New Deal,” which welcomed any pragmatic approach to dealing with the calamity.10

The financial catastrophe only started with the stock market crash, which, removed from the effects of the Great Depression that followed, has meaning only for people interested in the workings of the financial markets themselves. It is the Depression, then, that provides the underlying importance of Galbraith’s meticulous financial history in The Great Crash. The effect of the Depression, after all, was on all Americans, not just those participating in the financial markets. Historian Jonathan Hughes puts human faces on the economic legacy of the crash:

The Great Depression was a time when hamburgers were two for 5 cents, and people could not afford to buy them; when men would work for 10 cents an hour, and employers could not profit from their labor; when the (surviving) banks were filled with idle reserves and borrowing did not occur, although interest rates were below 1 percent per annum; when agricultural produce rotted in the fields, and people went hungry.

How the United States got to such a state is the story of The Great Crash, a story with themes repeated in all his writing about speculation. But not even Galbraith pretends that knowledge of the facts alone provide any protection from their recurrence.

The Great Crash has sort of an hourglass feel: broad themes at both ends and narrow, detailed reporting in the middle.

On the broad first end, Galbraith writes about the general economic mood of the country in the 1920s, especially the proneness of people who had money to seize upon ways to get more fast – a “get rich quick” mentality. He points to land speculation in mid-1920s Florida as a harbinger of future “speculative make-believe.” He details the New York Federal Reserve Banks’ creation of “easy money” by lowering the discount rate from 4 to 3.5 percent in 1927 in response to pleas from Europe to ease strain there, a helplessness caused by Britain’s return to the gold standard in 1925. This creation of money for investment, and for loaning for investment, did not lead directly to the crash, Galbraith writes, but it certainly exacerbated the trend. Galbraith outlines the role of “big men” in business, those, like John J. Raskob, a director of General Motors and chairman of the Democratic National Committee, one of the “genius” business leaders of the time, whose off-hand remarks could move millions of investment dollars. Galbraith explains the attraction of buying stocks on margin: Margin buyers get full title to the stock, minus the burden of actually paying for them, by leaving them as collateral with the broker for the loan that paid for them.

In the narrow middle, Galbraith refines his history to a day-by-day, hour-by- hour – at times, to-the-minute -- account of events on Wall Street immediately before the crash and immediately after. In plain language – especially accessible for an economist, a trait present in all his works -- he reduces the nut of the debacle to a few tight pages:

Monday, October 21, was a very poor day. Sales totaled 6,091,870, the third greatest volume in history … Tuesday brought a somewhat shaky gain. … By Wednesday, October 23, the effect of this cheer was somehow dissipated. Instead of further gains there were heavy losses. … Thursday, October 24, is the first of the days which history – such as it is on the subject – identifies with the panic of 1929. Measured by disorder, fright and confusion, it deserves to be so regarded. That day 12,894,650 shares changed hands, many of them at prices which shattered the dreams and the hopes of those who had owned them. … At twelve-thirty the officials of the New York Stock Exchange closed the visitors gallery on the wild scenes below... It was eight and a half minutes past seven that night before the ticker finished recording the day’s misfortunes. … On Friday and Saturday trading continued heavy – just under six million on Friday and over two million at the short session on Saturday. Prices, on the whole, were steady … Monday, October 28, was the first day on which this process of climax and anticlimax ad infinitum began to reveal itself. It was another terrible day. … On this day there was no recovery. … Tuesday, October 29, was the most devastating day in the history of the New York stock market, and it may have been the most devastating day in the history of markets.12

Galbraith then returns to broad themes. He relies on vital statistics from the Bureau of the Census to bust the myth that the crash caused a rise in suicide among the financial elite and as well as the everyday investor – the image of the despondent trader perched on the ledge of a Wall Street investment house. He does note several suicides of prominent men of the day: J.J. Riordan, well-known New York banker and Democrat; investor-swindler Ivar Kruger; the head of Rochester Gas and Electric Co., who took gas; “another martyr (who) dipped himself in gasoline and touched himself off.”13 Galbraith details the “most spectacular embezzlement of the period,” the looting of Union Industrial Bank of Flint, Mich., estimated at $3,592,000.14. He explains “short selling” – borrowing shares of a declining stock, selling them, then buying them back at a lower price to repay the lender that provided the original stock and pocketing the difference -- which takes advantage of falling stock prices and pushes them down further.15 He waxes eloquent on general themes surrounding the people involved, not merely their financial instruments:

Far more important than the rate of interest and the supply of credit is the mood. Speculation on a large scale requires a pervasive sense of confidence and optimism and conviction that ordinary people were meant to be rich. People must also have faith in the good intentions and even in the benevolence of others, for it is by the agency of others that they will get rich. … Finally, a speculative outbreak has a greater or less immunizing effect. The ensuing collapse automatically destroys the very mood speculation requires. It follows that an outbreak of speculation provides a reasonable assurance that another outbreak will not immediately occur. With time and the dimming of memory, the immunity wears off. A recurrence becomes possible.16


Galbraith demonstrates the recurrence of speculation in A Short History of Financial Euphoria. The tiny book is one example after another: the wild and bizarre speculation in tulip bulbs in 1630s Holland; John Law’s scheme in 1671-1620, via his Banque Royale, to pay off France’s government debts by selling shares in nonexistent gold investments in Louisiana; the London-based South Sea Company, a joint stock company operating a century later, selling shares in the future of treasures to come from foreign trade but that never materialized, this to pay England’s government debts; and the speculative booms and busts in the American experience, culminating, of course, with a short history of the stock market crash of 1929. In Economics in Perspective, Galbraith provides the broadest context for understanding any financial undertaking within a nation’s wider economy: the underlying philosophies of creating and trading resources, especially means of exchange, particularly money. The book is sweeping in its approach, but Galbraith gives detailed attention to the influences on and left by the leading economic thinkers in Western history. In Name Dropping, Galbraith has fun recalling his personal encounters with some of the most prominent political leaders, economic policy makers and economists of the 20th century – but his underlying ideas about economics and government are ever present, draped, as always, in dry wit. “The universal cause of poverty is a shortage of money among those experiencing it,” he writes in a chapter on his experiences with President Johnson’s War On Poverty. “The obvious – indeed, the only relevant – cure is money, a safety net protecting all from deprivation.”17

Galbraith’s histories of economics, particularly his thinking on the booms and busts of speculation, are relative today, as modern-day financial wizards try to make sense of the crash of technology-related stocks in 2000, especially the nosedive in the Nasdaq, and the effect on the rest of the economy. The long lens of history is the future. But some modern descendents of economic players from the past are present.

That a “bubble” – inflated speculation -- supported the extraordinary rise in technology stocks in the late 1990s is clear. Each of Galbraith’s commonalities was present. The “something new,” of course, was the Internet and the advent of dot-com companies. Only recently, after the bubble burst, has the general public’s fascination begun to moderate. There were “new” financial instruments, as well, which, as Galbraith points out, turn out not to be so new, really, after all. Telecommunications equipment providers such as Lucent, Cisco and Nortel, fearful of losing future consumers of their own next advances, extended generous financing terms to high-tech start-ups. “Telecom start-ups and dot-coms without earnings or credit histories managed to obtain significant credit from their equipment suppliers on terms they could never have obtained from a bank,” Mark Shapiro and Kevin Buehler wrote recently in “Manager’s Journal,” a regular feature in the Wall Street Journal. Shapiro and Buehler even noted the old nature of the “new” way of financing: “Such loans were in effect a discount on the price of equipment.”18

Their default caused a ripple effect similar to the collapse of the joint-stock companies of old and the holding companies of the 1920s. Today, Lucent and other telecommunications suppliers are still working through the effect of the high-tech crash by, among other things, laying off thousands of workers, extending the effects of the crash to everyday people and to the economy in general. Another “new” financial instrument is the 401(k) retirement plan and other employee investment plans, which enable people to send money to the market by payroll deduction, which encourages investment by making it less painful to turn loose of it. Noting that 37 million Americans are enrolled in 401(k) plans, financial columnist Jane Bryant Quinn explained the effects of the vehicle during the high-tech boom: “Many of us actually started to think we knew what we were doing. … Retirement plan investors have grown steadily more aggressive – tilting more of their money toward stocks. The higher stocks rose, the more money people invested there. … The people in charge of corporate plans grew just as excited about stocks as their employees. They added mutual funds to their plans, and not conservative ones. By last year, workers were ‘diversifying’ among growth funds, aggressive growth funds and even technology funds – all of them invested in high tech, to some degree.”19

The publicly perceived “wisdom” accorded industrial and financial leaders in the 1920s was heaped upon the Steve Cases, Bill Gateses and Michael Dells – the technological whiz kids of the 1990s – until very recently. The final stages of the 1990s high-tech bubble is still playing out. Galbraith probably nods knowingly when he sees modern expressions of denial similar to those of leading pundits of the 1920s. They are in today’s newspapers and talk shows. “What went wrong with the dot-coms?” Jack Anderson and Douglas Cohn wondered in a recent newspaper column. “Some analysts equate the dot-com mania with the Tulip Bubble and other famous irrational boom-and-bust scenarios of history. But there is a difference. Those other situations were either out-and-out frauds, or they were unsupported by rational facts. These theories do not describe the Internet and the dot-com boom-and-bust.”20 They don’t even mention the stock market crash of 1929. Galbraith might point out that tulips did have a rational purpose – people did enjoy their beauty if they actually planted the bulbs; that there was underlying value to many of the stocks traded on Wall Street in the 1920s; and there were actual voyages ventured to discover riches in the New World. Anderson and Cohn contradict their own assertion by describing what happened in the 1990s as dot-com “mania.” Galbraith would call it “insanity.” The high-tech thinkers of the 1990s already are being held in lower regard. The news magazines are peppered with tales of investors either angry at dot-com promoters and themselves, or laughing at their gullibility and the entire episode. Some can laugh because while billions of dollars in equity was lost, economic safety nets exist today that didn’t in 1929. The stock market is still generally regarded as overvalued, which means there still is room for it to fall. Whether the government investigates the dot-com bubble, and whether the public’s anger and nervous laughter turns to outright recrimination – the last of the general commonalities Galbraith finds in all speculative episodes -- will depend on how far the economy falls.

Galbraith ends A Short History of Financial Euphoria by asserting what he has come to know about speculation and admitting what no one can know in a short summary that is expressed in some ways in all of his writings on the subject. The 110-page essay reads as if it were written after the 2000 technology crash; it wasn’t. He penned it a decade ago.

… when a mood of excitement pervades a market or surrounds an investment prospect, when there is a claim of unique opportunity based on special foresight, all sensible people should circle the wagons; it is the time for caution. Perhaps, indeed, there is opportunity. Maybe there is that treasure on the floor of the Red Sea. A rich history provides proof, however, that, as often or more often, there is only delusion and self-delusion. … When will come the next great speculative episode, and in what venue will it recur – real estate, securities markets, art, antique automobiles? To these there are no answers; no one knows, and anyone who presumes to answer does not know he doesn’t know. But one thing is certain: there will be another of these episodes and yet more beyond. Fools, as it has long been said, are indeed separated, soon or eventually, from their money. So, alas, are those who, responding to a general mood of optimism, are captured by a sense of their own financial acumen. Thus it has been for centuries; thus in the long future it will also be.21


ENDNOTES

1. John Kenneth Galbraith, A Short History of Financial Euphoria, (Knoxville, Tenn., Larger Agenda Series, 1990; reprint, New York: Viking Penguin, 1993), 19-22.

2. John Kenneth Galbraith, The Great Crash 1929, (Boston, Houghton Mifflin, 1954; reprint, 1988), xiv-xvi.

3. John Kenneth Galbraith, Economics in Perspective – A Critical History, (Boston, Houghton Mifflin, 1987), 299.

4. John Kenneth Galbraith, Name-Dropping – From FDR On, (Boston, Houghton Mifflin, 1999), 9.

5. Ibid., passim. Galbraith intersperses highlights of his government service and other professional involvements throughout this small book of reminiscences.

6. Galbraith, Economics in Perspective, 299-300.

7. “Each person out for self-betterment, with no thought of others, is faced with a host of similarly motivated persons. As a result, each market actor, in buying or selling, is forced to meet the prices offered by competitors. … The pressures of the marketplace direct the selfish activities of individuals as if by an Invisible Hand (to use Smith’s wonderful phrase) into socially responsible paths. Thus the workings of the competitive system transmute self-regarding behavior into socially useful outcomes. The Invisible Hand – the words that describe the overall process – keeps society on track, assuring that it produces the goods and services it needs.” Robert L. Heilbroner, and Lester C. Thurow, Economics Explained, (New York, Simon & Schuster, Updated Touchstone Edition, 1987), 27-28.

8. Galbraith, Economics in Perspective, 156.

9. Ibid.

10. Ibid., 195.

11. Jonathan Hughes, American Economic History, 2d ed, (Glenview, Ill., and London, Scott, Foresman and Company, 1987), 446.

12. Galbraith, The Great Crash, 96-100, 104-105, 109.

13. Ibid., 130-131.

14. Ibid., 134.

15. Ibid., 148.

16. Ibid., 169-171.

17. Galbraith, Name-Dropping, 153-154.

18. Mark Shapiro and Kevin Buehler, “Manager’s Journal: Vendors Pay the Price for Bad Loans,” Wall Street Journal, 25 June 2001, sec. A, p. 18.

19. Jane Bryant Quinn, “Capital Gains: Rethink Your 401(k) – Now; Your stock-bubble money is gone; Time to look at your retirement strategy from scratch,” Newsweek, 23 July 2001, 49.

20. Jack Anderson and Douglas Cohn, “A rebirth in the Internet,” Edmond (Okla.) Sun, 17 July 2001, p. 6.

21. Galbraith, A Short History, 109-110.

END