IB History Political Factors Including Failures of Regulation Notes

Political regulation: Weak rules turned financial risk into systemic collapse

The political problem behind the crash

1. Republican administrations treated limited regulation as a condition for prosperity.
   1. Warren Harding, Calvin Coolidge, and Herbert Hoover expected private enterprise to correct most economic problems.
   2. This laissez-faire approach reduced scrutiny of banks, securities markets, holding companies, and corporate accounting.
2. The policy did not cause every weakness, but it allowed private risks to become public losses.
   1. Political leaders praised high stock prices as evidence of national success.
   2. That confidence discouraged early action against speculation and excessive credit.

Tax policy strengthened inequality and speculation

1. Treasury Secretary Andrew Mellon shaped the Revenue Acts of 1921, 1924, and 1926.
   1. The top marginal income-tax rate fell from 73 per cent in 1921 to 25 per cent by 1925.
   2. Supporters argued that lower taxes would release capital for productive investment.
   3. A large share instead entered shares, property, and other speculative assets.
2. Income growth remained uneven across social classes.
   1. Mass production increased the supply of goods faster than many households could increase consumption.
   2. Credit purchases temporarily concealed the gap between output and purchasing power.

Securities markets operated without federal safeguards

1. The federal government imposed no comprehensive national regulation on the sale of securities before 1933.
   1. Companies could issue shares with limited disclosure of debts, earnings, or conflicts of interest.
   2. Investment trusts borrowed money to purchase other securities, multiplying gains during the boom and losses during the collapse.
2. Margin buying allowed investors to control shares after paying only a fraction of their price.
   1. Brokers supplied the remaining money through call loans that lenders could demand at short notice.
   2. Falling prices forced investors to sell, which drove prices lower and created further forced sales.
3. The crash exposed regulatory failure, but the Depression deepened because the financial system transmitted those losses into banking, trade, and employment.

Banking rules left depositors exposed

1. The United States had about 25,000 banks in 1929, many of them small single-office institutions.
   1. State and federal laws restricted branch banking, so local banks could not spread risk across regions.
   2. Rural banks remained heavily dependent on farm mortgages and local commodity prices.
2. The federal government provided no deposit insurance before 1933.
   1. Rumours could therefore trigger a bank run even when a bank still held valuable long-term assets.
   2. Between 1930 and 1933, more than 9,000 United States banks suspended operations.
3. Bank failures destroyed savings and reduced the credit available to farms, firms, and households.

Federal Reserve decisions intensified contraction

1. The Federal Reserve kept interest rates relatively low during much of the mid-1920s.
   1. Low rates supported international recovery but also encouraged borrowing and asset speculation in the United States.
2. The Federal Reserve raised rates in 1928 and 1929 to restrain speculation.
   1. The change arrived late and restricted legitimate business borrowing alongside speculative credit.
3. After the crash, officials allowed the money supply to contract rather than acting decisively as lender of last resort.
   1. The defence of the gold standard discouraged aggressive monetary expansion.

1. Monetary policy turned a severe recession into a prolonged banking and employment crisis.

Protectionism exported the crisis

1. The Fordney-McCumber Tariff of 1922 raised barriers against many imported goods.
2. The Smoot-Hawley Tariff of 1930 increased duties on thousands of products after the crash.
   1. President Hoover signed the measure despite warnings from economists and trading partners.
   2. Other governments retaliated against United States exports.
3. Trade contraction harmed Canada and Latin American economies that depended on selling commodities to foreign markets.
   1. Protectionism was not the original cause of the Wall Street Crash, but it made recovery more difficult across the hemisphere.

Canada shows why institutions mattered

1. Canada entered the Depression with close financial and trading links to the United States and Britain.
   1. Falling demand for wheat, timber, minerals, and newsprint rapidly reduced export income.
2. Canadian banks were larger and operated national branch networks.
   1. No major Canadian bank failed during the Depression, unlike thousands in the United States.
3. Banking stability did not prevent mass unemployment or regional distress.
   1. The comparison shows that stronger banking structure reduced one transmission mechanism without removing dependence on world trade.

Latin American states faced external dependence

1. Many Latin American governments relied on customs revenue and the export of a narrow range of commodities.
   1. Chile depended heavily on nitrate and copper, Brazil on coffee, and Cuba on sugar.
2. Collapsing prices reduced government revenue and foreign-exchange earnings.
   1. Foreign loans became harder to obtain as United States and European banks withdrew capital.
3. Weak social-insurance systems left unemployed workers and rural families with little protection.
   1. Political elites had tolerated dependency during the export boom and possessed limited tools when world demand collapsed.
4. The crisis encouraged stronger state intervention, exchange controls, and import substitution in the 1930s.

Structural mechanisms behind the regulatory failure

1. State “blue sky” laws remained fragmented. Several states required basic securities registration, but enforcement varied and promoters could move questionable offerings across state lines. No federal body imposed one disclosure standard.
2. The Federal Trade Commission had a narrow mandate. Created in 1914, the FTC could challenge unfair business practices but did not supervise stock exchanges or require public companies to publish standardized financial accounts.
3. Stock exchanges largely regulated themselves. The New York Stock Exchange set membership rules, yet private governance could not remove conflicts between brokers, investment banks, company directors, and major clients.
4. Insider trading was not federally prohibited. Corporate officers and connected financiers could trade using information unavailable to ordinary investors. This weakened market transparency and rewarded privileged access.
5. Stock pools manipulated market prices. Groups of traders coordinated purchases, circulated favourable rumours, and then sold into rising demand. These operations created apparent momentum without stronger company performance.
6. Holding companies multiplied financial leverage. A parent company could control several subsidiaries with limited capital of its own. Losses at one level therefore threatened investors and creditors across the wider corporate structure.
7. Public utility pyramids concentrated risk. Utility empires used layers of holding companies and debt to control electricity and transport firms. Complex ownership made liabilities difficult for investors and regulators to trace.
8. Commercial and investment banking overlapped. Banks sold securities, financed brokers, and advised companies whose shares they marketed. The absence of a clear separation created incentives to promote weak investments.
9. The dual banking system divided supervision. State-chartered and nationally chartered banks operated under different regulators and standards. Institutions could choose arrangements that offered weaker oversight or easier expansion.
10. Unit banking increased local exposure. Laws in many states prevented banks from building broad branch networks. A small bank tied to one farming or industrial district could not offset regional losses with income elsewhere.
11. Correspondent banking transmitted pressure. Rural banks kept reserves with larger city banks, which placed funds in New York money markets. A shock in the financial centre could therefore drain liquidity from distant communities.
12. Federal Reserve authority was decentralized. Twelve regional reserve banks and the Federal Reserve Board did not always agree on interest rates or emergency lending. Divided responsibility slowed a coordinated response to bank failures.
13. The real bills doctrine restricted intervention. Many officials believed central-bank credit should support short-term commercial activity rather than rescue institutions holding speculative assets. That view narrowed the lender-of-last-resort role.
14. Liquidationist ideas discouraged relief. Andrew Mellon advised allowing weak firms and investments to fail so markets could correct earlier excesses. The approach underestimated how simultaneous failures could destroy otherwise viable businesses.
15. Hoover favoured voluntary cooperation. His associational approach asked firms, banks, and local charities to coordinate without extensive federal direction. It worked poorly once falling demand overwhelmed private resources.
16. Budget orthodoxy limited fiscal action. Many officials treated balanced budgets as proof of responsible government even during contraction. Tax increases and spending restraint could therefore reduce demand when recovery required support.
17. Tariff politics protected producers selectively. Smoot-Hawley emerged from congressional bargaining in which legislators exchanged support for higher duties. The result defended particular industries while exposing exporters to retaliation.

Political responsibility remains debated

1. Political regulation was an important cause because governments designed the rules within which markets operated.
   1. But regulation alone cannot explain overproduction, agricultural weakness, war debts, commodity dependence, or the global fall in demand.
2. The most convincing interpretation treats political failure as an amplifier of deeper economic imbalances.