How did the stock market crash in 1929 provoke a banking crisis?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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The stock market crash of October 1929 caused a banking crisis largely because of the amount of money that had been borrowed to buy stocks.

During the 1920s, banks loaned out large amounts of money to people who wanted to use the money to buy stocks "on the margin."  The people would provide something like 10% of the stock's value and then borrow the other 90% from an investment firm or bank.  The banks were eager to loan because they had needed to offer high interest rates to attract depositors.

As long as the stock prices continued to rise, this was fine.  People would pay the loans back with profits from their stock sales.  But when the stock prices fell, the banks lost their money because people who had borrowed could not repay the loans.  When the banks lost their money, they failed.

The failure of the banks, caused by excessive lending to people who were buying stocks on the margin, is why the stock market crash provoked a banking crisis.

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