A risky game

(Blog n°2)

Last week's topic covered the first ever financial crisis, the Tulipomania crisis. While its effects were relatively restricted compared to a more recent crisis, it still asked the question of ethic in finance by noticing a gap between the actual value of the shares and their prices on the stock market. Such a gap did also exist during the 1929 American crisis, such as presented by the documentary 1929: The Great Crash. This relatively more recent example leads to ask about the mechanisms that conducted to the collapse of an entire economy.

Nevertheless, more than an economy, it is rather a whole culture that is involved in the financial exchanges at the end of the first World War. Therefore, both cultural and behavioral factors initiate this crisis.

• Firstly, common people are involved in the financial world by the state. Indeed, the US government (as the other belligerent governments) issues “liberty bonds” to raise funds for the war. By buying these bonds, US citizens are using securities for the first time and became quickly used to it.
• Secondly, the post-war situation allows the first consumption boom in the history. People become used to massively buy products and moreover, by credits. “Buy now, pay later” is the norm in terms of buying.
• Finally, the mentalities in Wall street evolve and see in the common people an opportunity to rise fund for the market. This was earlier considered as too risky, but the amounts of money owned by private individuals offer a great advantage to the stock exchange.

So, citizens begin to invest in the stock exchange. They buy shares as they were buying cars or sofas: by credit. A whole financial play culture emerges, based on “buying on margin” exchanges: borrowed money helped people to buy more shares. Fortunes are created, some new financial stars raised, becoming popular because of their stupendous wealth created in a few times.

However, this speculative movements implies an offset between the market prices and the actual values of the issuing companies. The market corrects itself on October 24^th, 1929, the “Black Thursday”. Despite the banks attempts to inject liquidities in the market to stabilize the prices, it finally collapses, leading to the bankruptcy of a huge part of the population.

Furthermore, the shares having been paid with borrowed money, the afraid banks ask the borrowers for cash, alternatively they would sell the shares owned by those people. The shares are sold, the prices collapse, so more shares are sold, leading to a vicious loss of value spiral, to the failure of two thousand banks in the year 1931, and to a major human disaster.

One more time, the analysis of a financial crisis highlights the fundamental link between the market and the rest of the society. The responsibility of this crisis was shared between the bankers, the politics, and the people. All of them suffered from the consequences of the crisis they initiated by their behaviors. Apart from the human and political crisis following this financial one, the biggest challenge remains in the lack trust initiated by such a phenomenon. Therefore, trust  will need a further reflexion.