Student Question
How did buying on margin contribute to the Great Depression?
Quick answer:
Buying on margin, the practice of buying stocks with borrowed money, significantly contributed to the Great Depression. In the late 1920s, many investors used this method, hoping for continued stock price increases. However, this led to inflated stock prices, creating an unsustainable bubble. When the bubble burst on Black Tuesday, stock prices plummeted, leaving these investors unable to repay their loans. The resulting large-scale bankruptcies and bank failures precipitated the Great Depression.
Buying on margin helped bring about the Great Depression because it helped to cause Black Tuesday when the stock market crashed.
Buying on margin is the practice of buying stock without paying the full price. A person who is buying on margin pays a small percentage of the price of the stock and borrows the money to pay for the rest. The person hopes that the stock’s price increases so that they will be able to pay off the loan. Many people bought stocks on the margin in the late 1920s because they thought stock prices would keep going up forever.
Because people were buying on the margin and because they were overconfident about the prospects for the stocks, they were willing to pay inflated prices for the stocks. This made stock prices go up more than they should have. Eventually, the bubble burst and stock prices dropped.
When the stock prices dropped, all the people who had borrowed to buy on the margin were in trouble. They could not repay their loans because the stock prices had not risen. When they could not repay their loans, they went broke. Because so many people could not repay loans, banks failed. This all helped to bring about the Great Depression.
Get Ahead with eNotes
Start your 48-hour free trial to access everything you need to rise to the top of the class. Enjoy expert answers and study guides ad-free and take your learning to the next level.
Already a member? Log in here.