A Crash Sparks The Rise of Market Regulation

I'm Andy Temte and welcome to the Saturday Morning Muse! Start your weekend with lessons that are designed to improve financial literacy around the world. Today is November 15, 2025.

Last week, we explored how the telegraph, trans-Atlantic cable, and stock ticker transformed securities markets by democratizing access to information. Regional markets became national, then global. The price of information dropped dramatically, allowing middle-class investors to participate alongside wealthy elites.

But the faster transmission of information created new challenges. Today, we're exploring how investor optimism during the Roaring Twenties and easy credit created conditions for the most devastating market crash in American history—and how that disaster led to the regulatory framework that defines modern securities markets.

The Roaring Twenties: Prosperity and Speculation

Picture America in the mid-1920s. World War I had ended, the economy was booming, and new technologies—automobiles, radios, electrical appliances—were transforming daily life. Corporate profits soared as mass production drove costs down and consumer demand up.

Stock prices reflected this optimism. The Dow Jones Industrial Average, which tracked thirty major companies, rose from 63 in August 1921 to 381 by September 1929—a sixfold increase in eight years. This wasn't entirely irrational. Many companies were genuinely profitable and growing rapidly.

But something dangerous was happening alongside legitimate growth: widespread speculation was fueling unsustainable price increases. Remember from our railroad episode how we distinguished between investors who buy productive enterprises for long-term gains and speculators who chase short-term price movements? By 1929, speculation had become pervasive in American stock markets.

The ability to borrow money to purchase stocks—a practice called margin trading—dramatically amplified both the potential gains and the dangers of speculation. Margin trading creates leverage, meaning investors control more stock than their actual cash would allow. This leverage magnified market movements in both directions.

The margin trading system worked as follows: Investors could buy stocks by putting down just 10% of the purchase price and borrowing the remaining 90% from their brokers. If you had $1,000, you could control $10,000 worth of stock. When prices rose, your gains were magnified tenfold. A 10% price increase on your $10,000 position meant a $1,000 gain on your $1,000 investment - or a 100% return after paying back the $9,000 loan.

This leverage worked beautifully during bull markets. It also created catastrophic vulnerability when prices fell. We'll explore leverage and margin trading in much greater detail in future episodes, but for now, understand that borrowed money amplifies both gains and losses.

The Crash: October 1929

The first cracks appeared in September 1929. Stock prices began declining from their peak, but many investors viewed this as a healthy correction—a temporary pause before the upward march resumed.

Thursday, October 24, 1929—later known as Black Thursday—shattered that optimism. Panic selling overwhelmed the New York Stock Exchange. Nearly 13 million shares traded hands, far exceeding normal volume. Prices plunged as sellers vastly outnumbered buyers.

A consortium of major bankers attempted to stabilize markets by purchasing stocks at above-market prices, creating temporary calm. But the respite was brief. On Monday, October 28, the market dropped another 13%. Tuesday, October 29—Black Tuesday—was worse. Over 16 million shares traded as investors rushed to sell at any price.

The ticker tape, that symbol of market efficiency we celebrated last week, couldn't keep up. By the market's close, the ticker was hours behind actual trading, leaving investors uncertain about their losses until long after trading ended.

By mid-November, the Dow had fallen to 198—nearly half its September peak. Investors who had bought on margin faced devastating losses. Many lost not just their stock market gains but their entire savings.

The Cascade Effect

The crash triggered a cascade of economic destruction. Banks that had loaned money for stock purchases faced massive defaults as borrowers couldn't repay. Many banks failed, wiping out depositors' savings and further contracting the money supply.

Businesses cut production as consumer spending collapsed. Unemployment soared from 3% in 1929 to 25% by 1933. Between 1929 and 1933, industrial production fell by nearly half. The crash had triggered the Great Depression, which would last through the 1930s and require World War II's industrial mobilization to finally end.

What caused this catastrophe? Historians and economists continue debating the precise causes, but several factors clearly contributed. Excessive speculation fueled by easy credit created unsustainably high stock prices. Wealth inequality meant economic growth depended heavily on continued spending by the wealthy, who pulled back sharply when markets crashed. International economic problems, including World War I debts and trade barriers (remember our episode on trade and the disastrous Smoot-Hawley Act), created additional pressures.

Most relevant for our story: the complete absence of regulatory oversight allowed practices that amplified both the bubble and the crash.

The Regulatory Response: Securities Act of 1933

The newly elected Roosevelt administration recognized that restoring confidence in securities markets required fundamental reform. In 1933, Congress passed the Securities Act, establishing the first federal regulation of securities markets.

The Act's core principle was disclosure. Companies issuing new securities had to provide detailed financial information to potential investors. No longer could promoters make wild claims without substantiation. Registration statements had to include balance sheets, income statements, and descriptions of business operations.

The Act also created legal liability for fraudulent statements. Company officers, directors, and underwriters could be sued by investors who suffered losses due to material misstatements or omissions. This gave corporate insiders strong incentives to ensure accuracy.

The Securities Exchange Act of 1934

The 1933 Act addressed new securities issuances, but existing securities still traded in largely unregulated markets. The Securities Exchange Act of 1934 extended federal oversight to secondary markets where existing securities traded.

Most significantly, the Act created the Securities and Exchange Commission—the SEC—as an independent federal agency charged with enforcing securities laws. The SEC was given broad authority to write rules, conduct investigations, and bring enforcement actions against violators.

The Act also regulated stock exchanges, requiring them to register with the SEC and follow rules designed to promote fair trading. Broker-dealers had to register and maintain minimum capital requirements. Market manipulation practices that had been common in the 1920s were explicitly prohibited.

Margin requirements were also reformed. The Federal Reserve was given authority to set minimum margin requirements for stock purchases. No longer could investors buy stocks with just 10% down. Initial margin requirements were set at 50%, significantly reducing leverage in the system.

The Glass-Steagall Act

Congress also addressed the banking system's role in the crash. The Glass-Steagall Act of 1933 separated commercial banking from investment banking. Commercial banks that took deposits and made loans could no longer underwrite or deal in securities.

The logic was straightforward: banks holding depositors' money shouldn't engage in risky securities speculation. The Act aimed to protect depositors from bank failures caused by securities losses.

Glass-Steagall also created the Federal Deposit Insurance Corporation—the FDIC—which insured bank deposits up to $2,500 initially - that limit is $250,000 today. This insurance dramatically reduced the risk of bank runs, since depositors knew their money was protected even if their bank failed.

From Caveat Emptor to Investor Protection

These reforms represented a philosophical shift in how America regulated securities markets. Previously, the principle had been caveat emptor—let the buyer beware. Investors were responsible for investigating securities themselves, with little regulatory protection against fraud or manipulation.

The securities laws passed as part of Roosevelt's New Deal—the name given to his administration's sweeping reforms designed to guide the United States out of the Great Depression—shifted toward investor protection. The government would require disclosure, prohibit fraudulent practices, and create mechanisms for investors to recover losses from those who violated the rules.

This didn't eliminate risk—stocks could still decline, and investors could still lose money on bad investments. But it established a framework where decisions were based on accurate information rather than false promises and manipulation.

Until next week…

Grace. Dignity. Compassion.