1933

Crisis - 1933 - The Securities Act of 1933

There are many theories about what caused the Great Depression: Insufficient money supply, excess money supply,  low government spending, high government spending, being on the gold standard, not adhering to the gold standard...But it is generally accepted that it started with the stock market crash of October 1929, and that the crash was due in some part to concerns about the stocks that were traded. In 1932. the Senate established a commission (later known as the Pecora Commission) to investigate how securities were issued and traded in order to determine appropriate actions to take. 

Securities such as stocks and bonds are a common way for companies to raise money for new projects. Bonds guarantee the holder a specific interest rate on their investments.  An investor might purchase a bond with a face value of $1000 and an interest rate of 5%, and would then receive $50/year over the life of the bond. Bondholders normally have first claims on the company's assets in the case of bankruptcy. Stocks grant the holder a share of the company's earnings. An investor that purchases one share of stock in a company with one million shares outstanding and earnings of one million dollars would, in theory, have a $1 return on his investment. The cost and value of stock shares depend on factors such as the number of shares outstanding, the amount of recent earnings, and how the company intends to distribute earnings to shareholders.  Stockholders are considered the owners of the company, and are normally allowed to vote on significant company matters, such as who will sit on the board of directors.  Stocks and bonds can become worthless, losing the holder their initial investment along with any expected gains. 

Before 1933, companies that issued securities (such as stocks or bonds) had to abide by the laws of the state in which they were incorporated. In some cases, these laws required little documentation, leading to their being referred to derisively as "blue sky laws" (i.e. security holders were guaranteed only that the sky would remain blue.) The congressional commission would eventually reveal practices used by security issuers that enriched them at the expense of their investors. Companies would issue stock to pay off bad loans; allow certain well-connected stockholders to purchase new issues of stock for quick profits; and sell bonds that were obviously going to default as if they were safe investments. The Blue Sky laws didn't prohibit these practices. The ongoing repercussions from the Crash were evidence enough that securities regulation, or its absence, was of interest far beyond the boundaries of individual states. And to the extent that securities trading crossed state lines, Congress had solid constitutional grounds for regulating them.

Similar to Lincoln, Franklin Delano Roosevelt was elected in November but was unable to take direct action until the following March. (Election and succession law was changed in the aftermath, which is why inaugurations now happen in January.) One of the first pieces of legislation Roosevelt signed was the Securities Act of 1933, which attempted to restore confidence in the stock market by ensuring that securities were adequately described to investors.  The Act required that securities be registered with the Federal government before being sold to the public. This gave the issuer the opportunity to describe the company (and by extension, how profits would be generated), how the proceeds would be used, the rights available to the holder (e.g. voting rights), and the extent to which those rights were subordinate to the holders of other securities. 

It would be decades before the stock market would recover its 1929 high point, but that would be on a much more solid base. Investors could now be certain what the securities represented and calculate from that what returns to expect. If financial wizards found other methods to destabilize confidence and the markets, that would be a problem for another day.