Understanding Finance from scratch

Chapter 34: The Financial Crisis No One Can Escape—Know a little about the truth about the financial crisis every day (1)
The Crash of 1929: The Prelude to a Decade of Depression
Tuesday, October 1929, 10, was the darkest day for the American economy and stockholders.At 29 o'clock in the morning, as soon as the New York Stock Exchange opened, violent selling orders swept in, "Sell! Sell! Sell!" All stocks became hot potatoes, regardless of price or cost, as long as they were sold, Brokers were "thrown" dizzy, the trading floor was in chaos, followed by the Dow Jones Index plummeting, the stock index fell from the highest point of 10 points to 386 points, a drop of 298%.This is the "worst day" in the 22-year history of the New York Stock Exchange. Starting with this day known as "Black Tuesday", the United States and the world have entered a 112-year period of economic depression.

On October 10, the stock market crashed completely.On the same day, 29 shares of U.S. Steel Corporation were sold at $65 per share, but no buyer could be found, so its stock price began to fall, like an infectious disease, and then the stocks of one company after another began to fall. advent.Stocks were trash, numbers meant nothing, and a coal company boss fell dead in his broker's office looking at a falling dashboard.Countless former "millionaires" woke up penniless.Some rich people who sailed out to sea found that they had become penniless poor when they came back.It was not just the stock price that jumped off the building at that time.

So, what caused this stock market crash?

In 1929, the U.S. stock market crashed, followed by the "Great Depression", a recession that lasted 10 years and spread to all industrialized countries.The stock market crash was only the prelude to the depression, but it left its deepest imprint on investors at the time.

The price of stocks, real estate, and art has a cyclical process: When optimism and its market effects become the norm, prices will rise very high, and then fall to the bottom for various reasons.Prices always fall faster than they rise.

The 20s was a good time for the United States, but no one could have foreseen that the storm was approaching quietly—everyone believed that the situation was going well and was blindly optimistic, including Mr. President of the United States;

Excessive speculation in the real estate market has led to a hot and false boom in the real estate market;
The easing of monetary policy by the Federal Reserve System in the United States has led to a large influx of funds into the stock market, thereby driving up stock prices;

Big names fuel the stock market;

The election of President Hoover further fueled the stock market boom;

The margin trading system made more and more funds flow to Wall Street.

During the boom of the stock market, the offices of stockbrokers are packed to the brim all day long, and people prefer to stay in and watch the stock prices move rather than care about what is going on.

So did anyone have a premonition of the coming of this storm?The answer is yes.

Poole's Business Investing Weekly had mentioned the great stock scam in the fall of 1928, and the Business and Financial Times changed its old style and began to report bad news extensively. The "New York Times" also published reports that the stock market has risen too high and the stock market is bound to crash, and has repeatedly announced that the stock market has actually crashed.The U.S. stock market was closed several times in June 1928, December 6, and February 12.But unfortunately, investors who are skeptical of the stock market's trend still can't sniff out any clues, because the stock price continues to rise.

In addition, in 1929, the U.S. economy had begun to go into trouble, and the benefits of industrial production, cargo transportation, and building construction were gradually declining.However, this depression is not too severe, and it is reasonable to assume that the economy will improve before the stock market crashes.Galbraith pointed out that when the stock market crashed, no one predicted that the Great Depression was coming.

On September 1929, 9, it was discovered that Hartley, a British entrepreneur, was a top-notch liar. He forged stocks and issued unauthorized stocks.Some people believe that the scandal has weakened the confidence of the investing public in the New York stock market, and it is also the fuse of the stock market crash.Another explanation is that the Massachusetts branch of public utilities rejected Addison's application for a stock split in early October and declared that the stock price had soared too high, causing panic among the investing public.

But neither signs nor timing adequately explained the cause of the stock market crash.It really doesn't matter how the stock market crash started, because anything can undo the investment boom, which is the nature of the investment boom.

Despite the "retracement" in the stock market, there were no clear signs of a crash in September and October.Broker financing to customers jumped $9 million in September, the most in a single month.The reclusive financial expert Krujer gave an interview to the "Saturday Evening Post", which excited the investing public, only to find out later that it was all a big scam.On October 10 of the same year, Professor Fisher delivered a famous speech, pointing out that "the stock market has risen to a fairly stable state. I expect the stock market to hit new highs within a few months, and the trading volume will be better than it is now."

Still, another piece of bad news came out of the stock market a few days later.Media outlets such as The New York Times, which take a pessimistic view of the current state of the stock market, are constantly careful to warn the investing public that the stock market is about to crash.On October 10 of the same year, the trading volume of the stock market on Monday slightly exceeded 21 million US dollars, which was the third largest single-day trading volume of the US stock market over the years.After several consecutive days of huge trading volume, the stock market quotation board cannot display the real-time price. At noon, it can only report the stock price 600 hour ago. By the end of the day, the difference has widened to only 1 hour and 1 minutes. previous share price.This timing difference is fine in a bull market when stock prices are rising sharply, but it is not the case when prices start to decline.This lack of real-time market information not only makes investors more nervous, but also prompts investors to sell stocks faster.

In the end, disaster still came, and the wealth on paper was wasted.

Now we look back and reflect on the past. At the beginning of 1929, when the stock market was booming, the most realistic choice was to consciously plan the stock market to fall. If we let it go, serious disasters will occur in the future——

(1) At that time, the Federal Reserve adopted two traditional control methods with little effect: selling government securities in the open market and collecting cash, but with little effect.The main reason: commercial banks are not included in this list, and they can provide cash for the stock market as usual; they cannot persist in selling for a long time, etc.

The increase in the rediscount rate (the interest rate on which commercial banks borrow from the Federal Reserve Bank in their respective jurisdictions) was delayed until the summer of 1929 due to opposition from all parties, missing the best period.

(2) The Federal Reserve System itself does nothing.For the purpose of prudence, it did not ask to increase the margin ratio; for the hot market, its concern is not to restrict investment, but to shirk responsibility.

(3) Market panic spread due to the silence of the Federal Reserve Board. On March 1929, 3, the stock market crashed.Mitchell's National City Bank's inconsistency has attracted a lot of criticism.As a result, the US government and the Federal Reserve authorities all chose a non-intervention policy.

Looking back now, what caused the stock market crash in 1929?

(1) The gold standard loosened money and stimulated speculation.From a stock market standpoint, 1927 was a historic year.According to a long-accepted view, it was during this year that the seeds of the apocalyptic disaster were sown.The responsibility lies with a generous but foolish act of internationalism.Britain resumed the gold standard that maintained the relationship between gold, the US dollar and the British pound before World War I.Then, gold flowed into the United States continuously from Britain and Europe.A corollary of the government's massive purchases of outstanding securities was that banks and individuals who sold government securities held spare cash.The money made available by the Federal Reserve's loose monetary policy was either invested in common stocks or (and this is more important) helping others finance the purchase of common stocks.In this way, people have funds and rush into the stock market.

The idea that the actions of the Federal Reserve in 1927 were to blame for the speculation and stock market crash that followed has never really been shaken.What makes this argument attractive is that it is simple and understandable, and it absolves the American people and the American economy of all serious guilt.However, this explanation clearly assumes that as long as capital can be raised, people will always speculate.This explanation only proves that people have returned to believing in incredible nonsense when it comes to economic matters.

(2) Investment trusts magnify the speculative fever. In the late 20s, the most famous speculative product was investment trust or investment company stock, and their issuance plan could better meet the public's demand for common stock.An investment trust is not the creation of a new business or the expansion of an existing business, but an arrangement designed to allow shareholders to hold stock in an existing company through the establishment of a new company.

In an investment trust, leverage works like this: By issuing debt, preferred and common stock, it buys a mix of different types of common stock.While the common stock purchased in this way rose in price (always assuming stock price action), the prices of the bonds and preferred stock in the trust remained essentially unchanged.Because the prices of bonds and preferred stocks are fixed, derived from a specified rate of return.All or most of the profits from the appreciation of the portfolio of securities held by the investment trust are allocated to the common stock of the investment trust.As a result, the price of the investment trust's common stock miraculously rose.

The subprime mortgage crisis: the wind started at the end of Qingping
2007 was a year when gold rose sharply, a year when the U.S. dollar depreciated rapidly, and it was also a year when the world economy was hit hard. This year, the US subprime mortgage crisis broke out and began to flood.In the second week of September 2008, the fifth wave of the subprime mortgage crisis swept through. Lehman Brothers, the fourth largest investment bank in the United States with a history of 9 years, could no longer struggle. On September 158, local time, it announced its application Bankruptcy protection, the Dow plummeted 9 points on the 14th.

So how did the subprime mortgage crisis come about?How does it affect the U.S. economy?

"A lovely butterfly in the Brazilian rainforest, gently flapping its wings, may cause a storm in Florida, USA." This is the famous butterfly effect, and in 2006, a butterfly effect in the American financial circle directly Opened the door to a financial crisis that dragged the world down.

Since the end of 2006, with the slowdown of housing price growth and the slight increase of loan default rate in the United States, there have been sporadic doubts about the real estate bubble in the United States.This questioning voice began to amplify in early 2007, and began to gain the attention of the media and society.

At that time, the mainstream voice in American society did not deny that there was a real estate bubble.They believe that U.S. real estate prices may be overestimated by 15% to 20%, but this is normal. This kind of bubble is also within the controllable range when the macro economy is improving, and it is difficult for the property market to collapse due to the impact of demand.At that time, observers generally did not consider the possible impact of the decline in house prices on US investment banks. They believed that even if the price of the real estate market fell, it would mainly affect the construction sector and some mortgage providers.

On March 2007, 3, the problems in the US real estate market caused panic in the stock market for the first time, and the Dow Jones index fell 13 points.New Century Financial Corporation, which operates subprime mortgages, was urgently terminated by the New York Stock Exchange on the same day, on the grounds that the US Securities Regulatory Commission believed that it was facing a huge liquidity crisis.Since then, the risks of subprime mortgages have been recognized by people, but people still don't realize that this will bring crisis to major investment banks.

With Standard & Poor's and Moody's downgrading subprime debt ratings and the decline in new home sales in the United States, the subprime mortgage crisis in the United States has intensified. Beginning in July 2007, people's focus on the subprime mortgage crisis shifted to the field of investment banking.

投资银行贝尔斯登旗下对冲基金可能大面积亏损和房贷商亏损的预期是2007年6月25、26日美国股市大跌的主要原因。这些预期都变为了现实，贝尔斯登最终被JP.摩根收购。那么作为中央银行的美联储采取了什么样的挽救行动呢？美联储自2007年9月18日开始了降息行动，但这并不能挽救美国股市的趋势。道琼斯指数于2007年10月9日见顶于14164点，随后进入漫漫熊市。

So, why did the subprime mortgage crisis arise?How did this crisis come about?

We know that if an individual obtains a loan from a bank to buy a house, for the bank, these loans are assets that will earn income in the future.In recent years, American banks have carried out so-called "financial innovation", "packaging" many such loans, customizing them into bonds, named them "subordinated bonds", and selling them to other financial institutions or investors.Because once these bonds are sold, the risk of these loans is shared with other investors, so banks have more incentive to lend to individuals to buy houses.To a certain extent, because loans have become easier, more people are borrowing to buy houses, so housing prices have risen.

In a market where house prices are rising, those mortgage-backed bonds are less risky.Because even if someone cannot repay the loan, the investor can easily dispose of the house.So in this context, these financial institutions and investors are happy to hold such bonds.Therefore, banks will lend more boldly, housing prices will continue to rise, and investors prefer this kind of "subordinated bonds".

In addition to this cycle, for banks, according to accounting standards, loans need to be provisioned, because loans are risky after all.These reserves reduce the funds available to banks and affect their profits.However, if for the same loan, the bank holds subordinated debts corresponding to these loans, there is no need to make a provision, so the funds that the bank can use are greatly increased.So these bonds issued by the bank eventually returned to the bank itself.

Originally, the logic of the subprime debt was that if many people’s loans were bundled into one package, the risk of an individual’s default would be dispersed by others, so the subprime debt reduced the risk of directly facing the borrower.However, because of the logic mentioned above, and because banks can transfer risks to other investors (or themselves), the risk control of banks is not as strong as in the past. Even if individual risks can be dispersed, the overall risk is It cannot be reduced by this trick.Moreover, for the same loan, it was necessary to set aside reserves to prevent risks, but now through securitization, there is no need to set aside reserves. Is it possible that only through securitization, the borrowers who originally planned to default will not default?

At the end of 2006, large-scale mortgage defaults began to appear.In many cases, under the "half-coaxing and half-deception" of the sales representatives of the bank or its agency (you can imagine how motivated these sales representatives were to complete the sales task at that time), they signed a contract based on their income Mortgages that simply cannot be paid off.From this time, two natural results led to the subsequent financial crisis: ①Faced with the large number of defaulted mortgages, banks could only take back these properties and sell them in the real estate market, thus greatly increasing the supply of real estate; ②Banks began to Mortgage loans are more prudent and approvals are stricter, so fewer people get new mortgages, so the demand for real estate becomes smaller.

At the same time, because of rising prices, partly because of high oil prices, the Federal Reserve started raising interest rates to suppress prices.But at the same time, the increased interest rate also makes it difficult for borrowers who provide housing, and reduces everyone's motivation to borrow money to buy a house.It is likely that this also contributed to the subsequent crisis.

Some adverse effects occurred: Some borrowers who were on the verge of repaying the loan began to feel that the original loan agreement was no longer meaningful: "Why do I have to pay back a loan of 18 yuan for a house worth only 25 yuan now?" It turned out that the house price might be worth 28 yuan)?" So these people chose to default instead of continuing to pay for the house, which of course continued to increase the supply of real estate and depress real estate prices; the owners of other real estate originally obtained loans from banks with credit cards and other tools The reason why banks are willing to lend money to them is because they see their real estate appreciation, but once the market value of real estate starts to decline, banks are no longer willing to lend them so much money for consumption, so the cash in the hands of consumers becomes Few; back to the financial crisis, those subprime bonds based on housing loans began to be downgraded from AA to CC by credit rating agencies in the context of a sharp drop in real estate prices and rising default rates, and then downgraded to "junk bonds". ", so the market prices of these subordinated bonds began to plunge!
(End of this chapter)