Massachusetts Housing Loan Loss Reserve Fund: Fill & Download for Free

The purchase of your first home is a significant financial decision, one that requires a careful analysis of the total cost of home ownership. One aspect of the total cost of owning a home is the loan costs, which will impact the total cost of homeownership for years after the closing date. Fortunately, Massachusetts first-time homebuyers have several mortgage programs to consider.The home buyer programs vary by whether there are income limits, loan limits, low down payment options, financial assistance opportunities, down payment assistance, and mortgage insurance requirements or a combination of these factors. Many of these mortgage programs are tailored to help first-time homebuyers overcome common obstacles to obtaining a home loan, such as down payment, closing costs, credit score requirements, and interest rates.The eligibility requirements and rules for the different programs may seem overwhelming to a borrower new to the Massachusetts home-buying process; however, first-time homebuyers should take the time to investigate these mortgage programs with an experienced loan officer and real estate buyer agent to see whether they can reduce the total cost of home ownership. There is more to consider other than interest rates alone, and not every borrower will qualify for every mortgage program.MassHousing First-time Home Buyer ProgramsMassHousing supports affordable homeownership for Massachusetts residents with modest incomes. Although all MassHousing homebuyer programs have income limits, many home buyers are surprised by how much income they can earn and still qualify.An act of the Massachusetts Legislature created MassHousing in 1966 as an independent public authority, and MassHousing made its first loan in 1970. It is a self-sustaining agency, and it does not use taxpayer dollars in its programs.MassHousing has several mortgage programs, which have different features, eligibility requirements and benefits to borrowers seeking their first home loan. Borrowers must complete an approved first-time homebuyer class (also referred to as homebuyer counseling) before closing on the loan; however, in many cases it makes sense to attend a free first-time homebuyer workshop to learn about the entire process before choosing a lender, committing to a buyer agent, or looking at homes. Homebuyers should wait until they know precisely which loan program they intend to use before paying for a home-buying class. For many first-time homebuyers, a free home-buying workshop is a good way to start the home-buying process. Borrowers also are required to participate in landlord counseling before the purchase of two-to-four unit properties.MassHousing works with community banks, credit unions, and mortgage companies. Not all lenders can provide MassHousing loan products, but many lending institutions throughout Massachusetts offer MassHousing mortgages.MassHousing MortgageMore than 50,000 families have used a simple, straightforward MassHousing mortgage to buy their first home. MassHousing home loans have a variety of benefits for first-time homebuyers that are not available with most other loan programs, and MassHousing allows for maximum income limits as high as $145,530 (as of July 25, 2018). The income limits vary by county. The maximum income limit ($145,530) is available in Essex, Middlesex, Norfolk, Plymouth, and Suffolk counties. The income limit in Worcester County is $115,830, $116,370 in Barnstable County, and $108,810 in Bristol County.There are also mortgage loan limits based on the type of property a home buyer purchases. For single-family homes and condominiums, the maximum loan amount is $484,350 and $620,200 for a two-unit property. A loan of up to $749,650 is available for a three-unit home and $931,600 for a four-unit property. Properties must have a minimum of 600 square feet.MassHousing Mortgage loans, which have competitive interest rates and fixed-rate terms, allow for 97 percent financing without any of your cash required for the down payment on single-family homes and condominiums. In other words, the 3 percent down payment can be a gift from someone else, making it possible to buy a house or condo without substantial savings of your own. Rate locks of 30 to 75 days are available, as well as non-traditional credit considerations, such as limited credit history. Homebuyers must still meet a lender's underwriting requirements.A MassHousing Mortgage loan features MI Plus, which is mortgage insurance that helps a homeowner pay their mortgage, up to $2,000 per month, in case of a job loss for up to six months. There isn't any added cost for MI Plus protection. MassHousing has helped more than 1,000 homeowners pay their mortgage during a period of unemployment. A borrower can use the benefit any six months during the first 10 years of the mortgage, but a borrower is not eligible until six months after the closing.Mortgage insurance typically is required of borrowers that do not have 20 percent to put down as a down payment. It protects the lender in the event of a borrower foreclosure.MassHousing mortgage insurance may be less expensive on a monthly basis – without any up-front fees – than other loan programs, such as FHA loans (see below). Borrowers who earn less than or equal to the area median income are eligible for discounted mortgage insurance premiums.Borrowers can pay mortgage insurance premiums in an upfront, single premium or in a monthly premium. Single premiums may be paid by the lender, a family member, employers, municipalities, non-profits or the borrower. Single premiums not paid by the lender are refundable under a particular MassHousing refund schedule. Monthly premiums are not refundable.MassHousing mortgage interest rates may change daily, so consumers should contact a participating lender for the latest interest rate and terms.MassHousing Mortgage 100 (Down Payment Assistance)First-time homebuyers earning less than 100 percent of the average median income may qualify for the MassHousing Down Payment Assistance program, also referred to as the MassHousing Mortgage 100 program, which provides 3 percent down payment assistance up to $12,000 for single-family homes, condominiums, and planned unit developments. Multi-unit properties are not eligible for down payment assistance for MassHousing Mortgages.MassHousing provides down payment assistance in the form of a 15-year, fixed-rate 1 percent interest rate loan, which becomes due in the event of the sale or refinancing of the property before the end of the 15-year term. With a MassHousing Mortgage that only requires a 3 percent down payment, a homebuyer would not need any money to put down at closing. A borrower would still need money for closing costs; however, depending on how an offer is structured the homebuyer could receive a credit at closing to cover closing costs.To receive the full benefit of the down payment assistance program, homebuyers need a minimum credit score of 680. Borrowers with a credit score of 660 to 679 still qualify but would need a 5 percent down payment. With the 3 percent down payment assistance, the homebuyer would need to put down at closing the remaining 2 percent required.Homebuyers can earn up to $107,800 in Suffolk, Essex, Middlesex, Norfolk, and Middlesex counties and still qualify for down payment assistance. Borrowers income is limited to $80,600 in Bristol County, $85,800 in Worcester County, and $86,200 in Barnstable County.MassHousing Mortgage 100 borrowers are eligible for discounted mortgage insurance premiums.Borrowers do not have to be first-time homebuyers if they are purchasing a home in Boston, Cambridge, Chelsea, Everett, Fall River, Lawrence, Lynn, North Adams, or Somerville. First-time homebuyers must complete an approved homebuyer class before closing.Operation Welcome HomeOperation Welcome Home provides affordable mortgage financing, as well as closing cost and down payment assistance, to help members of the Reserves and National Guard, active-duty military, veterans, and Gold Star Families purchase a home in Massachusetts.MassHousing launched Operation Welcome Home in November 2015, and it has since made various modifications to the loan program, which has flexible underwriting standards, a fixed interest rate, and is serviced by MassHousing.Borrowers must be first-time homebuyers, unless the buyer purchases a property in Boston, Chelsea, Cambridge, Everett, Fall River, Lawrence, Lynn, North Adams, and Somerville. First-time homebuyers must complete an approved homebuyer class before closing. Borrowers also must participate in landlord counseling for the purchase of two-, three-, and four-family homes.Operation Welcome Homes has conventional loan limits up to $484,350 for a one-unit property. The program caps loan limits for two-family homes at $620,200 three-family homes at $749,650, and four-unit properties at $931,600.Borrower income limits are as high as $145,530 in many cities and towns, including Suffolk, Essex, Middlesex, Norfolk, and Plymouth counties; however, the income limits in Worcester ($115,830), Bristol ($108,810), and Barnstable ($116,370) counties are less. Operation Welcome Home allows non-spouse co-borrowers.Operation Welcome Home borrowers also can qualify for MassHousing down payment assistance for up to 3 percent of the purchase price or $12,000, whichever is less. The down payment assistance is a 15-year loan at a 1 percent interest rate. Repayment of the loan is also due upon sale or refinancing of the property before the end of the 15-year note. Unlike regular MassHousing Mortgages, Operation Welcome Home borrowers can receive down payment assistance on multi-unit dwellings.Besides coming up with money for a down payment, many first-time homebuyers struggle to save additional money for closing costs. Operation Welcome Home borrowers can take advantage of a closing cost credit for up to $2,500. The closing cost credit is in addition to MassHousing's Down Payment Assistance.MassHousing offers several mortgage insurance options for Operation Welcome Home loans. MIPlus Mortgage Payment Protection helps repay your loan in case of unemployment. The benefit will cover a borrower’s principal and interest payments up to $2,000 for up to six months. For a member of the Reserves or National Guard, activation or deployment overseas will make them eligible for the unemployment benefit as well. There also are discounted premiums available to qualified borrowers, as well as monthly and one-time premiums available.If you are buying a home in need of repairs, an Operation Welcome Home loan may be used to finance the purchase and the rehabilitation or repair of the purchased property.The primary goal of the program is to make it easier for Massachusetts veterans to obtain a loan with mostly the same features and benefits of a VA Loan. For example, the Operation Welcome Home program will make it easier to purchase a unit in a small condo development. Buying a condominium with a VA loan can be more challenging than with other property types.MassHousing Purchase and Rehabilitation LoanIf you are looking to purchase a Massachusetts home in need of major repair, the MassHousing Purchase and Rehabilitation loan program is an option for first-time home buyers. The mortgage will cover the purchase price of the home, as well as necessary rehabilitation costs. The program is available for one- to four-family houses, but not condominiums.The Purchase and Rehabilitation loan option has the same interest rate structure as the MassHousing Mortgage. The maximum loan amount may not exceed 97 percent of the lesser of the sales price, plus the rehabilitation costs, or the estimated appraised value after the rehabilitation.The minimum rehabilitation cost for all property types is $7,500, and all rehabilitation work must be completed by licensed contractors. Rehabilitation costs include other allowable expenses, such as inspection fees and a required contingency reserve equal to 10 percent of the total rehabilitation cost.MassHousing participating lenders may charge a fee of up to $1,500 based on the cost of the rehabilitation project. In addition, at the time of closing, the borrower will be responsible for the full mortgage monthly payment on the total principal amount. Any remaining rehabilitation funds not used will be applied towards the principle of the loan and turned into equity for the home buyer.Massachusetts Housing Partnership ONE MortgageThe Massachusetts Housing Partnership, a public, non-profit affordable housing organization, offers Massachusetts first-time homebuyers who fall into the low- to moderate-income category the "ONE Mortgage" loan program.The Massachusetts Housing Partnership (MHP) and other local housing groups first collaborated in 1989 to create solutions to housing issues faced by low- to moderate-income home buyers. The result of that collaboration was the Soft Second, or "SoftSecond," Loan Program, which had a two-mortgage structure. By 2013, the SoftSecond loan program had helped more than 21,000 families purchase their first home, with more than $2.6 billion in private mortgage financing. Forty-three percent of ONE Mortgage loans are in Massachusetts Gateway Cities.To continue Soft Second's success, MHP has transformed the program from a two-mortgage structure to the One Mortgage Program. One Mortgage offers lower-income home buyers the same affordability and financial security as the SoftSecond, in a more straightforward one home loan structure.According to the Massachusetts Housing Partnerhip, "The program is successful because it breaks down barriers that used to prevent creditworthy families from buying a home: inadequate consumer education, high interest rates and fees, excessive down payment requirements, compulsory mortgage insurance, and a bias against 2- and 3-family properties. Those are barriers that affected everyone trying to buy a home in Massachusetts, especially minority families and those living in historically underserved neighborhoods."Fixed Interest RateAs of February 2019, 47 lenders participated in the One Mortgage Program. Those lenders offer first-time homebuyers a discounted 30-year, fixed-rate mortgage. There are not any points charged by these participating lenders.Low Down PaymentHome buyers must put down a minimum of 3 percent of the purchase price when purchasing a single-family property, condominium or two-family house. For example, a homebuyer would need a $9,000 down payment for the purchase of a $300,000 home. The borrower must occupy the property. Of the 3 percent down payment, 1.5 percent is required to be from the borrower's own savings; however, the remaining amount can be a gift or down payment assistance, as long as there is no requirement for it to be repaid. In other words, the amount of the gift or down payment assistance cannot be a second loan. For the purchase of a three-family home, the One Mortgage Programs requires a minimum down payment of 5 percent of the purchase price. The home buyer must have 3 percent of the 5 percent down payment in his or her own savings to purchase a three-family home.No Private Mortgage Insurance (PMI)The One Mortgage Program does not require home buyers to purchase private mortgage insurance (PMI), sometimes just referred to as mortgage insurance or MI. Not having to obtain costly PMI saves a home buyer hundreds of dollars every month. Conventional loans require PMI until the borrower reaches 20 percent in equity, which can take several years to reach. Presently, FHA loans require PMI for the life of the loan (see below). Without PMI payments every month, home buyers save thousands of dollars over the first several years of the loan alone.Interest SubsidyIncome eligible One Mortgage Program first-time homebuyers may also qualify for a subsidized monthly payment in the initial years of ownership. The state-funded interest subsidy is designed to decrease your monthly payments over the first seven years, increase your purchasing power, and help you qualify for the ONE Mortgage if you don’t otherwise.For borrowers to qualify for a subsidy, household income must fall below 80% Area Median Income (AMI) for the community in which you are purchasing, and you must demonstrate financial need. Borrowers who have a down payment greater than 20 percent of the purchase price and borrowers who are purchasing three-family properties are not eligible for subsidy.The interest subsidy is automatically wrapped into your ONE Mortgage application, and there is no need to apply for it separately. Upon closing your loan, your lender will arrange to have your interest subsidy applied to your account every month.Borrowers do need to pay back the subsidy. The interest subsidy is secured by a second mortgage held by MHP and is recapturable upon sale or transfer of the property. The subsidy mortgage term is 30 years, and borrowers pay 0 percent interest upon repayment.First-time Home Buyer Program EligibilityThe following are some of the criteria that households must meet to be eligible for the One Mortgage Program.1. The borrower must be a first-time home buyer, which is defined as someone who has not owned a home in the three years prior to applying for the One Mortgage Program.2. The borrower must complete an approved pre-purchase homebuyer education class. The classes are offered in dozens of locations around the state. Some organizations offer classes online. A mortgage professional or your buyer agent will be able to assist with information about available classes. By all means, attend a free home-buying workshop to get started; however, it is strongly suggested that you not pay for a required homebuyer class before you know exactly which loan program your lender says you qualify for.3. Home buyers must meet household income guidelines for the program. The income limits as of April 2018 vary by community and household size. Borrowers purchasing within the City of Boston are required to obtain an "Income Eligibility Certificate" from the Massachusetts Affordable Housing Alliance (MAHA) before an MHP reservation is issued. Borrowers whose total household income does not exceed 100 percent of area median income qualify for the One Mortgage Program, and those borrowers with income below 80 percent of the area median income may be eligible for an MHP subsidy. For example, a household of three purchasing in Quincy, MA may have a household income up to $97,020. Suffolk County (Boston, Chelsea, Revere, Winthrop) has the same income limits. If that same family/household of three has a household income below $77,616, they may be eligible for a subsidy. The income limit for a four-person household in North Attleboro is $80,600, in Braintree, it's $107,800, and in Tewksbury, it's $105,400. A one-person household can make as much as $66,500 in Haverhill and $75,460 in Stoughton. A two-person household in Natick can earn $86,240 while the same household in Bridgewater in capped at $67,280.4. Borrowers must have less than $75,000 in liquid assets, excluding retirement accounts, such as 401K and 403B accounts, to qualify.5. As detailed above, home buyers must have a minimum of 3 percent down payment of the purchase price. Of the 3 percent, 1.5 percent is required to be from the borrower's own savings. For the purchase of a three-family home, the minimum down payment requirement is 5 percent, with 3 percent from the home buyer's own savings.6. The borrowers must meet the credit and underwriting requirements of the participating One Mortgage Program lender they choose.7. The home buyer must agree to use the home purchased as a primary residence through the term of the loan.After closing, One Mortgage Program home buyers must complete a post-purchase homeowner workshop called HomeSafe. Home buyers have one year after the closing on their home to complete the workshop. Topics discussed at the HomeSafe workshop include home maintenance and repairs, insurance, lead paint, budgeting, homeowner discounts, rehab grants, tenant management and other topics of value to homeowners.FHA Home Loan ProgramThe main benefits of FHA loans, which are insured by the Federal Housing Administration, are the low down payment, lenient credit score requirements and the acceptance of a higher debt-to-income ratio. You do not have to be a first-time home buyer to obtain a FHA loan, and FHA loans do not have any income limits. In addition, borrowers, if they qualify, may be able to purchase a more expensive house using a FHA loan than allowed with the MassHousing mortgages and the Massachusetts Housing Partnership ONE Mortgage Program, both of which have loan limits based on property type.Borrowers are permitted to purchase single-family homes, condos and multi-family homes with FHA loans. The Federal Housing Administration does not actually lend any money, so home buyers must use a FHA participating lender. FHA allows down payments of as little as 3.5 percent, all of which may be a gift; however, any reserve funds a lender may require cannot be from a gift.Although FHA allows for credit scores of 580 or higher for 96.5 percent financing and 500 to 579 for 90 percent financing, most lenders will only provide FHA loans to borrowers with a credit score of 620 or higher in order for the loans to be eligible for sale in the secondary mortgage market.FHA Loans Are More ExpensiveWhat makes FHA loans less attractive than other mortgages is that the total cost of borrowing is higher than other first-time home buyer mortgage options. First, borrowers must pay an "Up Front Mortgage Insurance Premium," which is 1.75 percent of the loan. For example, a $300,000 loan will require an up-front payment, which is usually rolled into the loan amount, of $5,250. In addition, FHA loans require an annual insurance premium that is collected in monthly installments, and FHA mortgage insurance, despite a recent reduction (effective January 27, 2017) in MI costs, typically costs more than mortgage insurance for other types of loans.What's the least attractive part of a FHA loan? Since June 3, 2013, borrowers must pay the mortgage insurance for the life of the loan, no matter how much equity the buyer builds up in the property. Typically, once an homeowner can show that the remaining mortgage amount is 80 percent or less of the current value, the borrower no longer has to pay mortgage insurance, but, with FHA loans, the mortgage insurance is permanent. For Massachusetts first-time home buyers with credit scores of 680 or higher, there are other mortgage programs available that are less expensive than FHA. For those home buyers that have income that exceeds the limits of the MassHousing and Massachusetts Housing Partnership mortgages, even conventional loans that require a minimum 5 percent down payment and mortgage insurance likely will be less expensive than FHA for the borrower.Other First-time Home Buyer Loan ProgramsThere are some other loan programs that are not just for first-time home buyers that Massachusetts home buyers may want to consider. The U.S. Veterans Administration provides a home loan guaranty benefit, the U.S. Department of Agriculture has what are referred to as rural development home loans, and local housing authorities and nonprofit organizations have various mortgage down payment assistance and grant programs. The eligibility requirements for the above-mentioned programs are narrow, making most home buyers ineligible.VA Home LoanThe U.S. Veterans Administration helps service members, veterans and eligible surviving spouses become homeowners by providing a home loan guaranty benefit and other housing-related programs to buy, build, repair, retain, or adapt a home for "personal occupancy."VA Home Loans are provided by private lenders, such as banks and mortgage companies; however, the VA guarantees a portion of the loan, enabling the lender to provide more favorable terms. Veterans often can purchase a home without any down payment and without mortgage insurance.To be eligible, a borrower must have a good credit score, sufficient income, a valid Certificate of Eligibility (COE), and meet certain service requirements. The length of a borrower's service or service commitment and/or duty status may determine his or her eligibility for specific home loan benefits.USDA Rural Development LoanThe United States Department of Agriculture has what are referred to as rural development home loans. USDA loans have income restrictions, and the house must be located in designated rural areas. There are a number of locations in Massachusetts that are in USDA eligible rural areas. USDA rural development loans allow for 100 percent financing, and are available through participating lenders.Qualifying debt-to-income ratios are 29 percent for housing costs and 41 percent for total debt. Lenders may request an exception to exceed these ratios when strong compensating factors are identified.There isn't any maximum purchase price, and home buyers may purchase a variety of property types, including existing homes, new construction, modular homes, planned unit developments (PUD's), eligible condominiums and new manufactured homes.Freddie Mac Home Possible Advantage MortgageThe Home Possible Advantage mortgage only requires a 3 percent down payment and offers a fix-rate, conventional mortgage for first-time homebuyers, as well as other qualified borrowers with limited down payment savings. Homebuyers must meet minimum credit score requirements. The entire 3 percent down payment can come from personal funds, local grant programs or gift funds.A Home Possible Advantage mortgage can be used to purchase a single-family home, a condominium and for a refinance of an existing mortgage, without any "cash out" at the time of the refinance. Fixed-rate mortgage loans are available in 15-, 20- and 30-year terms. You must use the home as your primary residence, and you may not have any ownership interest in another residential property as of the date of the note, which is the contract between the lender and the borrower.First-time homebuyers must participate in an approved borrower education program, which your lender can help identify, to qualify for the Home Possible Advantage mortgage. Freddie Mac offers a free online tutorial that meets the education requirements.The Home Possible Advantage mortgage does not have income limits for homes located in designated low- to moderate-income or under served communities, as defined by Freddie Mac. Freddie Mac provides an online eligibility tool where consumers and lenders can enter a zip code to determine what, if any, income limits may be in place for a particular location.For example, a search on August 24, 2016, on Freddie Mac's eligibility tool indicated that there was not any income limit for Lawrence, Massachusetts or Boston's East Boston neighborhood; however, Plymouth, Massachusetts and Boston's South End neighborhood both had an income limit of $126,900.Fannie Mae HomeReady MortgageThe HomeReady mortgage only requires a 3 percent down payment and offers a fixed-rate, conventional mortgage for first-time homebuyers, as well as other qualified low- to moderate-income borrowers with limited down payment funds. Gift funds can be used as a source of funds for down payment and closing costs, with no minimum contribution required from the borrower’s own funds.A HomeReady mortgage can be used to purchase a single-family home, a condominium or multi-unit dwelling. Fixed-rate mortgage loans are available in 10-, 15-, 20- and 30-year terms, and there are adjustable-rate mortgage options too. You must use the home as your primary residence, but unlike other loan programs, you may have any interest in another residential property.Homebuyers must participate in an approved borrower education program, which your Massachusetts lender can help identify, to qualify for the HomeReady mortgage. One option is to participate in the online Framework homeownership education course. The Framework cost is $75.The HomeReady mortgage does not have income limits for homes located in low-income census tracts. Fannie Mae provides an online eligibility tool where consumers and lenders can enter property addresses to determine what if any, income limits may be in place for a particular address. In Massachusetts, there are 1,478 census tracts, and 33 percent do not have income limits. Non-borrower household income is not counted toward income eligibility limits.For example, a search on December 1, 2016, on Fannie Mae's eligibility tool appears to indicate that there was not any income limit for most of Boston's East Boston neighborhood; however, in areas outside of the 484 low-income census tracts, the income limit appears to be $94,000 for most of the Greater Boston area. Borrowers should check income limits for specific addresses.Local Housing Authorities, Organizations and LendersFirst-time home buyers will want to check with local housing authorities in the cities and towns that they want to buy a home in to see whether there may be home buyer down payment assistance and grants available to borrowers that qualify. These types of mortgage programs change often, so home buyers will want to obtain information directly from the source of such programs because information online and from other sources may become outdated quickly. These programs are extremely limited and usually only made available to low-income homebuyers.The Massachusetts Department of Housing and Community Development annually awards funds to certain communities and not-for-profit agencies that operate local first-time home buyer programs. Funds are used to offer down payments and closing costs assistance loans to first-time home buyers that are income eligible.Some local banks offer attractive loans to first-time home buyers that plan to purchase in a particular community or communities.First-time home buyers may want to schedule an in-person meeting with a real estate buyer agent who is willing to take the time to explain the home-buying process and various mortgage options available.Lender-paid Mortgage Insurance OptionNo home buyer wants to pay mortgage insurance (MI), commonly referred to as private mortgage insurance or PMI, but saving enough money for a 20 percent down payment to avoid PMI, especially in the high-cost real estate markets, is easier said than done.All home buyers, not just first-time homebuyers, have an alternative to loan programs that place income and other limitations on borrowers. Lender paid mortgage insurance (LPMI) is an option for Massachusetts home buyers who do not have enough money saved for the 20 percent down payment needed to avoid mortgage insurance, but want to reduce their monthly mortgage payments.With an LPMI option, a borrower's mortgage lender pays the mortgage insurance premium upfront in a lump sum and passes on the cost to the borrower in the form of a higher interest rate. The interest rate for LPMI loans are often one-quarter to one-half a percent higher, but interest rates sometimes can be outside of that range, either lower or higher. The borrower then does not have to make monthly mortgage insurance payments.Most home buyers don’t realize that even with the slightly higher interest rate that comes with an LPMI loan, the monthly mortgage payment may be lower than what the amount would be with the standard monthly PMI cost. Private mortgage insurance, both regular and lender-paid, gets more expensive with higher loan-to-value ratios or lower credit scores.LPMI also helps borrowers trying to stretch their buying power. A borrower typically qualifies for a slightly larger loan amount with an LPMI mortgage than with a monthly PMI mortgage because of the lower monthly payment.Another appealing feature of LPMI is that since borrowers are paying a higher interest rate, and mortgage interest may be tax deductible on federal income taxes, a borrower may have a larger tax deduction than he or she would with a PMI loan. Unfortunately, PMI is no longer an IRS allowable deduction so by rolling the cost of the mortgage insurance into the interest rate a borrower may have a bigger tax deduction. Homeowners should consult with their accountant or tax adviser. Recent changes in the tax could limit this deduction depending on other factors.

Pandemic Recovery: V, U, or L?In just a few months, the COVID-19 pandemic decimated the U.S. economy. In the first quarter of 2020, growth declined by 5%. In the second quarter, it plummeted by 31.4%, but then rebounded in the third quarter to 33.4%.1 In April, during the height of the pandemic, retail sales plummeted 16.4% as governors closed nonessential businesses.2 Furloughed workers sent the number of unemployed to 23 million that month.3 By December, the number of unemployed declined to a still-horrendous 10.7 million.4The Congressional Budget Office (CBO) predicts a modified U-shaped recovery.The Congressional Budget Office (CBO) predicted the third-quarter data would improve, but not enough to make up for earlier losses. The economy won't return to its pre-pandemic level until the middle of 2022, the agency forecasts.5 Unfortunately, the CBO was right. For example, the GDP rate for the third quarter of 2020 was 33.4%, but it still was not enough to recover the prior decline in Q2.6The Federal Debt Will IncreaseOn Oct. 1, 2020, the U.S. debt exceeded $27 trillion.7 The COVID-19 pandemic added to the debt with the CARES Act and lower tax revenues. The U.S. debt-to-gross domestic product ratio rose to 127% by the end of Q3—that's much higher than the 77% tipping point recommended by the International Monetary Fund.8The debt level is not sustainable if interest rates were to rise.Higher interest rates would increase the interest payments on the debt. That's unlikely as long as the U.S. economy remains in recession. The Federal Reserve will keep interest rates low to spur growth.How It Affects YouDisagreements over how to reduce the debt may translate into a debt crisis if the debt ceiling needs to be raised. In the long term, balancing the budget means spending cuts because Trump has cut taxes. Social Security pays for itself, and Medicare partially does, at least for now.As Washington wrestles with the best way to address the debt, uncertainty arises over tax rates, benefits, and federal programs. Businesses react to this uncertainty by hoarding cash, hiring temporary instead of full-time workers, and delaying major investments.Extreme Weather Threatens the Financial SystemExtreme weather, such as heatwaves, hurricanes, and wildfires, could increase by 50% in North America by 2100.9 It could cost the U.S. government as much as $112 billion per year, according to a report by the U.S. Government Accountability Office (GAO).10The Federal Reserve has warned that climate change threatens the financial system.11 Extreme weather is forcing farms, utilities, and other companies to declare bankruptcy. As those borrowers go under, it will damage banks' balance sheets just like subprime mortgages did during the financial crisis.Global warming destabilizes the climate and creates extreme weather.12Munich Re, the world's largest reinsurance firm, warned that insurance firms will have to raise premiums to cover higher costs from extreme weather. That could make insurance too expensive for most people.13Over the next few decades, temperatures are expected to increase by between 2 and 4 degrees Fahrenheit.14 Warmer summers mean more destructive wildfires. Trees weakened by drought and pests have increased the intensity of these fires. Higher temperatures have even pushed the dry western Plains region 140 miles eastward. As a result, farmers used to growing corn will have to switch to hardier wheat.15A shorter winter means that many pests, such as the pine bark beetle, don't die off in the winter. The U.S. Forest Service estimates that 100,000 beetle-infested trees could fall daily over the next 10 years. These dead trees increase the intensity of wildfires.16How It Affects You​Droughts kill off crops and raise beef, nut, and fruit prices. Millions of asthma and allergy sufferers must pay for increased health care costs. Longer summers lengthen the allergy season. In some areas, the pollen season is now 25 days longer than in 1995.17 Pollen counts are projected to more than double between 2000 and 2040.18Most areas of the country are experiencing more frequent and longer heatwaves. This leads to illness and death, as well as damaged crops and dead livestock, plus power outages.19Almost 40% of the U.S. population could be flooded from rising sea levels.20 Rising sea levels cause hurricanes and storms to push farther inland. By 2100, global sea levels could rise at least 1 foot above what they were in 2000.21Health Care Costs Will Continue to IncreaseNational health care expenditures will increase by 5.4% a year to exceed $6 trillion by 2028. These costs will rise from 17.7% in 2018 to almost 20% of total U.S. economic output over the next decade.22 One reason is the aging U.S. population and rising enrollment in Medicare.National health spending is expected to grow at an average rate of about 5.5% from 2021 to 2023, versus a 5.2% increase for 2020.22In 2019, the uninsured no longer had to pay the Obamacare tax. The Congressional Budget Office (CBO) projected that 13 million people could drop coverage by 2027.23 As healthy people leave the insurance system, it will raise costs for insurance companies. They will transmit those costs to the insured, further raising health care costs.How It Affects YouAs people drop insurance, they are less likely to get preventive care. Low-income families without insurance might use the hospital emergency room for primary care. Hospitals transfer that cost to Medicaid and insurance companies. It could make health care more expensive for everyone.Be aware that without regulation, many personal health insurance policies may not provide as much coverage as Obamacare plans. People who buy them could end up paying more out of their own pockets.Oil and Gas Prices Will Remain LowThe production of crude oil is expected to rise to 14 million barrels per day by 2022 and remain near this level through 2045.24 Shale oil has driven this growth since 2010.25 Demand is expected to remain subdued thanks to increased use of alternative energy.26In 2019, the U.S. exported more oil than it imported for the first time since 1973.27 U.S. oil exports are expected to increase through 2033.28How It Affects YouGas prices are expected to remain below $3 a gallon through at least 2030.26 Lower gas prices can also drive down the price of groceries, which benefit from lower transportation costs.US and Chinese Economies Will Be More IntertwinedChina became the world's largest economy in 2014. As of September 2019, China's economic growth has been at its slowest since 1990.29 But the nation is now so large that it will continue to affect the U.S. economy much more than in the past.In December 2019, the U.S. and China reached an agreement on Phase One of the trade deal in which China has committed to purchasing a substantial amount of U.S. goods and services in the next several years. The U.S. will keep 25% tariffs on $250 billion worth of Chinese exports and 7.5% tariffs on $120 billion of Chinese imports.30If China’s exports decline, it could buy fewer U.S. Treasury notes. Because China is the second biggest purchaser of U.S. debt, as its demand for Treasurys declines, interest rates could rise.Any changes China makes as part of its economic reform will affect the U.S. dollar's value. China has maintained a fixed peg to the dollar for its currency, the yuan. It is loosening this peg in its bid to allow the yuan to become a global currency.How It Affects YouSlowdowns in China’s growth could impact the U.S. economy in unprecedented ways. Higher interest rates may increase the cost of loans for U.S. businesses and consumers. They may also increase the interest on the debt. The U.S. government may have to divert more funds to pay off that interest.A slowdown in Chinese exports may also increase prices for U.S. consumers. “Made in America” means higher costs because U.S. workers get paid more for their work than those in China.The Dollar Will Remain SolidThe U.S. dollar value hit a high of 126.5 on March 23, 2020, as the pandemic sent investors scurrying to the dollar's safety. By Jan. 8, 2021, it had fallen to 111.7.31There are several factors that could weaken the dollar, but its role as the world's reserve currency will keep its value solid. It's used more than any other currency for international transactions.The Federal Reserve has promised to keep interest rates at effectively zero for several years. That could turn off currency investors, who would prefer a higher rate of return for their dollar-based investments.Investors may have switched to the stock market, which has skyrocketed since the pandemic.Foreign investors may become more concerned about the U.S. debt. They fear that the U.S. wants the dollar to decline so that the relative value of its national debt is less. They may diversify their portfolios with more non-dollar-denominated assets, such as the euro.How It Affects YouA weak dollar makes imports more expensive, contributing to inflation. It also lowers export prices, spurring economic growth. The dollar's value will continue to experience dips and swells, affecting everything you buy.Inflation Will Remain SubduedCore inflation will remain around 2%, according to the most recent forecast by the Federal Reserve.32 In December, inflation increased by 0.4%, with the core inflation rate increasing by 0.1%.33The most important role of the Fed is managing public expectations of inflation. Once the public expects inflation, it becomes a self-fulfilling prophecy. The Fed can maintain confidence in the economy by demonstrating moderation, resulting in less extreme changes in public economic behavior. The Fed knows this is how former Fed Chair Paul Volcker ended the stagflation of the 1970s. By keeping interest rates high, he reassured the public the Fed was committed to preventing inflation.34How It Affects YouFood prices may rise temporarily due to the pandemic. In the long term, they should drop, thanks to lower oil and gas prices.The cost of living will remain about where it is today. You don't have to worry as much as you did in the past about inflation eating away at your retirement savings.The Housing Market Will Remain StrongHome prices will continue to rise in the long term, thanks to low interest rates and low inventory.The COVID-19 pandemic will affect the housing market through 2021, according to the National Association of Realtors (NAR). After an initial dip in the early months of the pandemic, housing prices bounced back and rose significantly before declining by 2.5% in November 2020.35 Homes for Sale, Mortgage Rates, Virtual Tours & Rentals | realtor.com® expects sales prices to increase by 5.7% in 2021. Inventory is also expected to be low throughout much of 2021, and this constraint in supply will support home prices.36Once a COVID-19 vaccine is widely distributed, housing demand will return to pre-pandemic levels. One reason is that the Fed has promised to keep interest rates at historic low levels through 2023.32 This will keep mortgages very affordable until then.The other reason is that it will take years for homebuilders to restore supply to pre-pandemic levels. In November 2020, there was only a 4.1-month supply of houses in the United States.37How It Affects YouLow mortgage rates make this a good time to get a fixed-interest mortgage. As many workers look for larger homes, smaller condos and townhomes may become more affordable.Some people are concerned that the real estate market is in a bubble that could lead to another collapse. As long as the Fed holds rates steady, it's more likely that the housing market will remain strong.The US Will Be Involved in Fewer Ground WarsThe $27 trillion debt and federal budget sequestration that's reduced spending on some items mean that the U.S. really can't afford to wage large ground wars anymore.7In March 2019, the government increased the Fiscal 2020 national security budget to $750 billion.38 The Department of Defense said that this increase will strengthen its competitive edge and help the military succeed by prioritizing innovation and modernization in war for decades to come.39Some critics say this spending is not needed, given the lessened presence of the U.S. military around the world. Cyberwarfare has become more of a threat. It's fast, difficult to grasp, far-reaching in the digital landscape, and dangerous.How It Affects YouMoney spent on defense increases America's debt. It also takes away from such key areas as health care and education.Defense spending is not the best job creator. According to a University of Massachusetts-Amherst study, defense spending only creates 8,555 jobs per $1 billion spent. The same amount of spending on mass transit created 19,795 jobs.40Key TakeawaysThe economy has been devastated by the COVID-19 pandemic.GDP fell 31.4% in Q2 before rebounding 33.4% in Q3, but it still wasn't enough to recover the decline.The recovery will depend on the widespread distribution of a vaccine.The Federal Reserve and other experts predict the economy will remain subdued until 2021 or 2022.Extreme weather caused by climate change is likely to worsen.Health care costs will continue to rise.

The 1929 Stock Market CrashHarold Bierman, Jr., Cornell UniversityOverviewThe 1929 stock market crash is conventionally said to have occurred on Thursday the 24th and Tuesday the 29th of October. These two dates have been dubbed “Black Thursday” and “Black Tuesday,” respectively. On September 3, 1929, the Dow Jones Industrial Average reached a record high of 381.2. At the end of the market day on Thursday, October 24, the market was at 299.5 — a 21 percent decline from the high. On this day the market fell 33 points — a drop of 9 percent — on trading that was approximately three times the normal daily volume for the first nine months of the year. By all accounts, there was a selling panic. By November 13, 1929, the market had fallen to 199. By the time the crash was completed in 1932, following an unprecedentedly large economic depression, stocks had lost nearly 90 percent of their value.The events of Black Thursday are normally defined to be the start of the stock market crash of 1929-1932, but the series of events leading to the crash started before that date. This article examines the causes of the 1929 stock market crash. While no consensus exists about its precise causes, the article will critique some arguments and support a preferred set of conclusions. It argues that one of the primary causes was the attempt by important people and the media to stop market speculators. A second probable cause was the great expansion of investment trusts, public utility holding companies, and the amount of margin buying, all of which fueled the purchase of public utility stocks, and drove up their prices. Public utilities, utility holding companies, and investment trusts were all highly levered using large amounts of debt and preferred stock. These factors seem to have set the stage for the triggering event. This sector was vulnerable to the arrival of bad news regarding utility regulation. In October 1929, the bad news arrived and utility stocks fell dramatically. After the utilities decreased in price, margin buyers had to sell and there was then panic selling of all stocks.The Conventional ViewThe crash helped bring on the depression of the thirties and the depression helped to extend the period of low stock prices, thus “proving” to many that the prices had been too high.Laying the blame for the “boom” on speculators was common in 1929. Thus, immediately upon learning of the crash of October 24 John Maynard Keynes (Moggridge, 1981, p. 2 of Vol. XX) wrote in the New York Evening Post(25 October 1929) that “The extraordinary speculation on Wall Street in past months has driven up the rate of interest to an unprecedented level.” And the Economistwhen stock prices reached their low for the year repeated the theme that the U.S. stock market had been too high (November 2, 1929, p. 806): “there is warrant for hoping that the deflation of the exaggerated balloon of American stock values will be for the good of the world.” The key phrases in these quotations are “exaggerated balloon of American stock values” and “extraordinary speculation on Wall Street.” Likewise, President Herbert Hoover saw increasing stock market prices leading up to the crash as a speculative bubble manufactured by the mistakes of the Federal Reserve Board. “One of these clouds was an American wave of optimism, born of continued progress over the decade, which the Federal Reserve Board transformed into the stock-exchange Mississippi Bubble” (Hoover, 1952). Thus, the common viewpoint was that stock prices were too high.There is much to criticize in conventional interpretations of the 1929 stock market crash, however. (Even the name is inexact. The largest losses to the market did not come in October 1929 but rather in the following two years.) In December 1929, many expert economists, including Keynes and Irving Fisher, felt that the financial crisis had ended and by April 1930 the Standard and Poor 500 composite index was at 25.92, compared to a 1929 close of 21.45. There are good reasons for thinking that the stock market was not obviously overvalued in 1929 and that it was sensible to hold most stocks in the fall of 1929 and to buy stocks in December 1929 (admittedly this investment strategy would have been terribly unsuccessful).Were Stocks Obviously Overpriced in October 1929?Debatable — Economic Indicators Were StrongFrom 1925 to the third quarter of 1929, common stocks increased in value by 120 percent in four years, a compound annual growth of 21.8%. While this is a large rate of appreciation, it is not obvious proof of an “orgy of speculation.” The decade of the 1920s was extremely prosperous and the stock market with its rising prices reflected this prosperity as well as the expectation that the prosperity would continue.The fact that the stock market lost 90 percent of its value from 1929 to 1932 indicates that the market, at least using one criterion (actual performance of the market), was overvalued in 1929. John Kenneth Galbraith (1961) implies that there was a speculative orgy and that the crash was predictable: “Early in 1928, the nature of the boom changed. The mass escape into make-believe, so much a part of the true speculative orgy, started in earnest.” Galbraith had no difficulty in 1961 identifying the end of the boom in 1929: “On the first of January of 1929, as a matter of probability, it was most likely that the boom would end before the year was out.”Compare this position with the fact that Irving Fisher, one of the leading economists in the U.S. at the time, was heavily invested in stocks and was bullish before and after the October sell offs; he lost his entire wealth (including his house) before stocks started to recover. In England, John Maynard Keynes, possibly the world’s leading economist during the first half of the twentieth century, and an acknowledged master of practical finance, also lost heavily. Paul Samuelson (1979) quotes P. Sergeant Florence (another leading economist): “Keynes may have made his own fortune and that of King’s College, but the investment trust of Keynes and Dennis Robertson managed to lose my fortune in 1929.”Galbraith’s ability to ‘forecast’ the market turn is not shared by all. Samuelson (1979) admits that: “playing as I often do the experiment of studying price profiles with their dates concealed, I discovered that I would have been caught by the 1929 debacle.” For many, the collapse from 1929 to 1933 was neither foreseeable nor inevitable.The stock price increases leading to October 1929, were not driven solely by fools or speculators. There were also intelligent, knowledgeable investors who were buying or holding stocks in September and October 1929. Also, leading economists, both then and now, could neither anticipate nor explain the October 1929 decline of the market. Thus, the conviction that stocks were obviouslyoverpriced is somewhat of a myth.The nation’s total real income rose from 1921 to 1923 by 10.5% per year, and from 1923 to 1929, it rose 3.4% per year. The 1920s were, in fact, a period of real growth and prosperity. For the period of 1923-1929, wholesale prices went down 0.9% per year, reflecting moderate stable growth in the money supply during a period of healthy real growth.Examining the manufacturing situation in the United States prior to the crash is also informative. Irving Fisher’s Stock Market Crash and After (1930) offers much data indicating that there was real growth in the manufacturing sector. The evidence presented goes a long way to explain Fisher’s optimism regarding the level of stock prices. What Fisher saw was manufacturing efficiency rapidly increasing (output per worker) as was manufacturing output and the use of electricity.The financial fundamentals of the markets were also strong. During 1928, the price-earnings ratio for 45 industrial stocks increased from approximately 12 to approximately 14. It was over 15 in 1929 for industrials and then decreased to approximately 10 by the end of 1929. While not low, these price-earnings (P/E) ratios were by no means out of line historically. Values in this range would be considered reasonable by most market analysts today. For example, the P/E ratio of the S & P 500 in July 2003 reached a high of 33 and in May 2004 the high was 23.The rise in stock prices was not uniform across all industries. The stocks that went up the most were in industries where the economic fundamentals indicated there was cause for large amounts of optimism. They included airplanes, agricultural implements, chemicals, department stores, steel, utilities, telephone and telegraph, electrical equipment, oil, paper, and radio. These were reasonable choices for expectations of growth.To put the P/E ratios of 10 to 15 in perspective, note that government bonds in 1929 yielded 3.4%. Industrial bonds of investment grade were yielding 5.1%. Consider that an interest rate of 5.1% represents a 1/(0.051) = 19.6 price-earnings ratio for debt.In 1930, the Federal Reserve Bulletin reported production in 1920 at an index of 87.1 The index went down to 67 in 1921, then climbed steadily (except for 1924) until it reached 125 in 1929. This is an annual growth rate in production of 3.1%. During the period commodity prices actually decreased. The production record for the ten-year period was exceptionally good.Factory payrolls in September were at an index of 111 (an all-time high). In October the index dropped to 110, which beat all previous months and years except for September 1929. The factory employment measures were consistent with the payroll index.The September unadjusted measure of freight car loadings was at 121 — also an all-time record.2 In October the loadings dropped to 118, which was a performance second only to September’s record measure.J.W. Kendrick (1961) shows that the period 1919-1929 had an unusually high rate of change in total factor productivity. The annual rate of change of 5.3% for 1919-1929 for the manufacturing sector was more than twice the 2.5% rate of the second best period (1948-1953). Farming productivity change for 1919-1929 was second only to the period 1929-1937. Overall, the period 1919-1929 easily took first place for productivity increases, handily beating the six other time periods studied by Kendrick (all the periods studies were prior to 1961) with an annual productivity change measure of 3.7%. This was outstanding economic performance — performance which normally would justify stock market optimism.In the first nine months of 1929, 1,436 firms announced increased dividends. In 1928, the number was only 955 and in 1927, it was 755. In September 1929 dividend increased were announced by 193 firms compared with 135 the year before. The financial news from corporations was very positive in September and October 1929.The May issue of the National City Bank of New York Newsletter indicated the earnings statements for the first quarter of surveyed firms showed a 31% increase compared to the first quarter of 1928. The August issue showed that for 650 firms the increase for the first six months of 1929 compared to 1928 was 24.4%. In September, the results were expanded to 916 firms with a 27.4% increase. The earnings for the third quarter for 638 firms were calculated to be 14.1% larger than for 1928. This is evidence that the general level of business activity and reported profits were excellent at the end of September 1929 and the middle of October 1929.Barrie Wigmore (1985) researched 1929 financial data for 135 firms. The market price as a percentage of year-end book value was 420% using the high prices and 181% using the low prices. However, the return on equity for the firms (using the year-end book value) was a high 16.5%. The dividend yield was 2.96% using the high stock prices and 5.9% using the low stock prices.Article after article from January to October in business magazines carried news of outstanding economic performance. E.K. Berger and A.M. Leinbach, two staff writers of the Magazine of Wall Street, wrote in June 1929: “Business so far this year has astonished even the perennial optimists.”To summarize: There was little hint of a severe weakness in the real economy in the months prior to October 1929. There is a great deal of evidence that in 1929 stock prices were not out of line with the real economics of the firms that had issued the stock. Leading economists were betting that common stocks in the fall of 1929 were a good buy. Conventional financial reports of corporations gave cause for optimism relative to the 1929 earnings of corporations. Price-earnings ratios, dividend amounts and changes in dividends, and earnings and changes in earnings all gave cause for stock price optimism.Table 1 shows the average of the highs and lows of the Dow Jones Industrial Index for 1922 to 1932.Table 1Dow-Jones Industrials Index Averageof Lows and Highs for the Year192291.0192395.61924104.41925137.21926150.91927177.61928245.61929290.01930225.81931134.1193279.4Sources: 1922-1929 measures are from the Stock Market Study, U.S. Senate, 1955, pp. 40, 49, 110, and 111; 1930-1932 Wigmore, 1985, pp. 637-639.Using the information of Table 1, from 1922 to 1929 stocks rose in value by 218.7%. This is equivalent to an 18% annual growth rate in value for the seven years. From 1929 to 1932 stocks lost 73% of their value (different indices measured at different time would give different measures of the increase and decrease). The price increases were large, but not beyond comprehension. The price decreases taken to 1932 were consistent with the fact that by 1932 there was a worldwide depression.If we take the 386 high of September 1929 and the 1929-year end value of 248.5, the market lost 36% of its value during that four-month period. Most of us, if we held stock in September 1929 would not have sold early in October. In fact, if I had money to invest, I would have purchased after the major break on Black Thursday, October 24. (I would have been sorry.)Events Precipitating the CrashAlthough it can be argued that the stock market was not overvalued, there is evidence that many feared that it was overvalued — including the Federal Reserve Board and the United States Senate. By 1929, there were many who felt the market price of equity securities had increased too much, and this feeling was reinforced daily by the media and statements by influential government officials.What precipitated the October 1929 crash?My research minimizes several candidates that are frequently cited by others (see Bierman 1991, 1998, 1999, and 2001).The market did not fall just because it was too high — as argued above it is not obvious that it was too high.The actions of the Federal Reserve, while not always wise, cannot be directly identified with the October stock market crashes in an important way.The Smoot-Hawley tariff, while looming on the horizon, was not cited by the news sources in 1929 as a factor, and was probably not important to the October 1929 market.The Hatry Affair in England was not material for the New York Stock Exchange and the timing did not coincide with the October crashes.Business activity news in October was generally good and there were very few hints of a coming depression.Short selling and bear raids were not large enough to move the entire market.Fraud and other illegal or immoral acts were not material, despite the attention they have received.Barsky and DeLong (1990, p. 280) stress the importance of fundamentals rather than fads or fashions. “Our conclusion is that major decade-to-decade stock market movements arise predominantly from careful re-evaluation of fundamentals and less so from fads or fashions.” The argument below is consistent with their conclusion, but there will be one major exception. In September 1929, the market value of one segment of the market, the public utility sector, should be based on existing fundamentals, and fundamentals seem to have changed considerably in October 1929.A Look at the Financial PressThursday, October 3, 1929, the Washington Post with a page 1 headline exclaimed “Stock Prices Crash in Frantic Selling.” the New York Times of October 4 headed a page 1 article with “Year’s Worst Break Hits Stock Market.” The article on the first page of the Times cited three contributing factors:A large broker loan increase was expected (the article stated that the loans increased, but the increase was not as large as expected).The statement by Philip Snowden, England’s Chancellor of the Exchequer that described America’s stock market as a “speculative orgy.”Weakening of margin accounts making it necessary to sell, which further depressed prices.While the 1928 and 1929 financial press focused extensively and excessively on broker loans and margin account activity, the statement by Snowden is the only unique relevant news event on October 3. The October 4 (p. 20) issue of the Wall Street Journal also reported the remark by Snowden that there was “a perfect orgy of speculation.” Also, on October 4, the New York Timesmade another editorial reference to Snowden’s American speculation orgy. It added that “Wall Street had come to recognize its truth.” The editorial also quoted Secretary of the Treasury Mellon that investors “acted as if the price of securities would infinitely advance.” The Timeseditor obviously thought there was excessive speculation, and agreed with Snowden.The stock market went down on October 3 and October 4, but almost all reported business news was very optimistic. The primary negative news item was the statement by Snowden regarding the amount of speculation in the American stock market. The market had been subjected to a barrage of statements throughout the year that there was excessive speculation and that the level of stock prices was too high. There is a possibility that the Snowden comment reported on October 3 was the push that started the boulder down the hill, but there were other events that also jeopardized the level of the market.On August 8, the Federal Reserve Bank of New York had increased the rediscount rate from 5 to 6%. On September 26 the Bank of England raised its discount rate from 5.5 to 6.5%. England was losing gold as a result of investment in the New York Stock Exchange and wanted to decrease this investment. The Hatry Case also happened in September. It was first reported on September 29, 1929. Both the collapse of the Hatry industrial empire and the increase in the investment returns available in England resulted in shrinkage of English investment (especially the financing of broker loans) in the United States, adding to the market instability in the beginning of October.Wednesday, October 16, 1929On Wednesday, October 16, stock prices again declined. the Washington Post (October 17, p. 1) reported “Crushing Blow Again Dealt Stock Market.” Remember, the start of the stock market crash is conventionally identified with Black Thursday, October 24, but there were price declines on October 3, 4, and 16.The news reports of the Post on October 17 and subsequent days are important since they were Associated Press (AP) releases, thus broadly read throughout the country. The Associated Press reported (p. 1) “The index of 20 leading public utilities computed for the Associated Press by the Standard Statistics Co. dropped 19.7 points to 302.4 which contrasts with the year’s high established less than a month ago.” This index had also dropped 18.7 points on October 3 and 4.3 points on October 4. The Times (October 17, p. 38) reported, “The utility stocks suffered most as a group in the day’s break.”The economic news after the price drops of October 3 and October 4 had been good. But the deluge of bad news regarding public utility regulation seems to have truly upset the market. On Saturday, October 19, theWashington Post headlined (p. 13) “20 Utility Stocks Hit New Low Mark” and (Associated Press) “The utility shares again broke wide open and the general list came tumbling down almost half as far.” The October 20 issue of the Post had another relevant AP article (p. 12) “The selling again concentrated today on the utilities, which were in general depressed to the lowest levels since early July.”An evaluation of the October 16 break in the New York Times on Sunday, October 20 (pp. 1 and 29) gave the following favorable factors:stable business conditionlow money rates (5%)good retail traderevival of the bond marketbuying power of investment trustslargest short interest in history (this is the total dollar value of stock sold where the investors do not own the stock they sold)The following negative factors were described:undigested investment trusts and new common stock sharesincrease in broker loanssome high stock pricesagricultural prices lowernervous marketThe negative factors were not very upsetting to an investor if one was optimistic that the real economic boom (business prosperity) would continue. The Timesfailed to consider the impact on the market of the news concerning the regulation of public utilities.Monday, October 21, 1929On Monday, October 21, the market went down again. The Times (October 22) identified the causes to bemargin sellers (buyers on margin being forced to sell)foreign money liquidatingskillful short sellingThe same newspaper carried an article about a talk by Irving Fisher (p. 24) “Fisher says prices of stocks are low.” Fisher also defended investment trusts as offering investors diversification, thus reduced risk. He was reminded by a person attending the talk that in May he had “pointed out that predicting the human behavior of the market was quite different from analyzing its economic soundness.” Fisher was better with fundamentals than market psychology.Wednesday, October 23, 1929On Wednesday, October 23 the market tumbled. TheTimes headlines (October 24, p.1) said “Prices of Stocks Crash in Heavy Liquidation.” The Washington Post (p. 1) had “Huge Selling Wave Creates Near-Panic as Stocks Collapse.” In a total market value of $87 billion the market declined $4 billion — a 4.6% drop. If the events of the next day (Black Thursday) had not occurred, October 23 would have gone down in history as a major stock market event. But October 24 was to make the “Crash” of October 23 become merely a “Dip.”The Times lamented October 24, (p. 38) “There was hardly a single item of news which might be construed as bearish.”Thursday, October 24, 1929Thursday, October 24 (Black Thursday) was a 12,894,650 share day (the previous record was 8,246,742 shares on March 26, 1929) on the NYSE. The headline on page one of the Times (October 25) was “Treasury Officials Blame Speculation.”The Times (p. 41) moaned that the cost of call money had been 20% in March and the price break in March was understandable. (A call loan is a loan payable on demand of the lender.) Call money on October 24 cost only 5%. There should not have been a crash. The Friday Wall Street Journal (October 25) gave New York bankers credit for stopping the price decline with $1 billion of support.the Washington Post (October 26, p. 1) reported “Market Drop Fails to Alarm Officials.” The “officials” were all in Washington. The rest of the country seemed alarmed. On October 25, the market gained. President Hoover made a statement on Friday regarding the excellent state of business, but then added how building and construction had been adversely “affected by the high interest rates induced by stock speculation” (New York Times, October 26, p. 1). A Times editorial (p. 16) quoted Snowden’s “orgy of speculation” again.Tuesday, October 29, 1929The Sunday, October 27 edition of the Times had a two-column article “Bay State Utilities Face Investigation.” It implied that regulation in Massachusetts was going to be less friendly towards utilities. Stocks again went down on Monday, October 28. There were 9,212,800 shares traded (3,000,000 in the final hour). The Times on Tuesday, October 29 again carried an article on the New York public utility investigating committee being critical of the rate making process. October 29 was “Black Tuesday.” The headline the next day was “Stocks Collapse in 16,410,030 Share Day” (October 30, p. 1). Stocks lost nearly $16 billion in the month of October or 18% of the beginning of the month value. Twenty-nine public utilities (tabulated by the New York Times) lost $5.1 billion in the month, by far the largest loss of any of the industries listed by the Times. The value of the stocks of all public utilities went down by more than $5.1 billion.An Interpretive Overview of Events and IssuesMy interpretation of these events is that the statement by Snowden, Chancellor of the Exchequer, indicating the presence of a speculative orgy in America is likely to have triggered the October 3 break. Public utility stocks had been driven up by an explosion of investment trust formation and investing. The trusts, to a large extent, bought stock on margin with funds loaned not by banks but by “others.” These funds were very sensitive to any market weakness. Public utility regulation was being reviewed by the Federal Trade Commission, New York City, New York State, and Massachusetts, and these reviews were watched by the other regulatory commissions and by investors. The sell-off of utility stocks from October 16 to October 23 weakened prices and created “margin selling” and withdrawal of capital by the nervous “other” money. Then on October 24, the selling panic happened.There are three topics that require expansion. First, there is the setting of the climate concerning speculation that may have led to the possibility of relatively specific issues being able to trigger a general market decline. Second, there are investment trusts, utility holding companies, and margin buying that seem to have resulted in one sector being very over-levered and overvalued. Third, there are the public utility stocks that appear to be the best candidate as the actual trigger of the crash.Contemporary Worries of Excessive SpeculationDuring 1929, the public was bombarded with statements of outrage by public officials regarding the speculative orgy taking place on the New York Stock Exchange. If the media say something often enough, a large percentage of the public may come to believe it. By October 29 the overall opinion was that there had been excessive speculation and the market had been too high. Galbraith (1961), Kindleberger (1978), and Malkiel (1996) all clearly accept this assumption. the Federal Reserve Bulletin of February 1929 states that the Federal Reserve would restrain the use of “credit facilities in aid of the growth of speculative credit.”In the spring of 1929, the U.S. Senate adopted a resolution stating that the Senate would support legislation “necessary to correct the evil complained of and prevent illegitimate and harmful speculation” (Bierman, 1991).The President of the Investment Bankers Association of America, Trowbridge Callaway, gave a talk in which he spoke of “the orgy of speculation which clouded the country’s vision.”Adolph Casper Miller, an outspoken member of the Federal Reserve Board from its beginning described 1929 as “this period of optimism gone wild and cupidity gone drunk.”Myron C. Taylor, head of U.S. Steel described “the folly of the speculative frenzy that lifted securities to levels far beyond any warrant of supporting profits.”Herbert Hoover becoming president in March 1929 was a very significant event. He was a good friend and neighbor of Adolph Miller (see above) and Miller reinforced Hoover’s fears. Hoover was an aggressive foe of speculation. For example, he wrote, “I sent individually for the editors and publishers of major newspapers and magazine and requested them systematically to warn the country against speculation and the unduly high price of stocks.” Hoover then pressured Secretary of the Treasury Andrew Mellon and Governor of the Federal Reserve Board Roy Young “to strangle the speculative movement.” In his memoirs (1952) he titled his Chapter 2 “We Attempt to Stop the Orgy of Speculation” reflecting Snowden’s influence.Buying on MarginMargin buying during the 1920’s was not controlled by the government. It was controlled by brokers interested in their own well-being. The average margin requirement was 50% of the stock price prior to October 1929. On selected stocks, it was as high as 75%. When the crash came, no major brokerage firm was bankrupted, because the brokers managed their finances in a conservative manner. At the end of October, margins were lowered to 25%.Brokers’ loans received a lot of attention in England, as they did in the United States. The Financial Timesreported the level and the changes in the amount regularly. For example, the October 4 issue indicated that on October 3 broker loans reached a record high as money rates dropped from 7.5% to 6%. By October 9, money rates had dropped further to below .06. Thus, investors prior to October 24 had relatively easy access to funds at the lowest rate since July 1928.the Financial Times (October 7, 1929, p. 3) reported that the President of the American Bankers Association was concerned about the level of credit for securities and had given a talk in which he stated, “Bankers are gravely alarmed over the mounting volume of credit being employed in carrying security loans, both by brokers and by individuals.” The Financial Times was also concerned with the buying of investment trusts on margin and the lack of credit to support the bull market.My conclusion is that the margin buying was a likely factor in causing stock prices to go up, but there is no reason to conclude that margin buying triggered the October crash. Once the selling rush began, however, the calling of margin loans probably exacerbated the price declines. (A calling of margin loans requires the stock buyer to contribute more cash to the broker or the broker sells the stock to get the cash.)Investment TrustsBy 1929, investment trusts were very popular with investors. These trusts were the 1929 version of closed-end mutual funds. In recent years seasoned closed-end mutual funds sell at a discount to their fundamental value. The fundamental value is the sum of the market values of the fund’s components (securities in the portfolio). In 1929, the investment trusts sold at a premium — i.e. higher than the value of the underlying stocks. Malkiel concludes (p. 51) that this “provides clinching evidence of wide-scale stock-market irrationality during the 1920s.” However, Malkiel also notes (p. 442) “as of the mid-1990’s, Berkshire Hathaway shares were selling at a hefty premium over the value of assets it owned.” Warren Buffett is the guiding force behind Berkshire Hathaway’s great success as an investor. If we were to conclude that rational investors would currently pay a premium for Warren Buffet’s expertise, then we should reject a conclusion that the 1929 market was obviously irrational. We have current evidence that rational investors will pay a premium for what they consider to be superior money management skills.There were $1 billion of investment trusts sold to investors in the first eight months of 1929 compared to $400 million in the entire 1928. the Economist reported that this was important (October 12, 1929, p. 665). “Much of the recent increase is to be accounted for by the extraordinary burst of investment trust financing.” In September alone $643 million was invested in investment trusts (Financial Times, October 21, p. 3). While the two sets of numbers (from the Economist and the Financial Times) are not exactly comparable, both sets of numbers indicate that investment trusts had become very popular by October 1929.The common stocks of trusts that had used debt or preferred stock leverage were particularly vulnerable to the stock price declines. For example, the Goldman Sachs Trading Corporation was highly levered with preferred stock and the value of its common stock fell from $104 a share to less than $3 in 1933. Many of the trusts were levered, but the leverage of choice was not debt but rather preferred stock.In concept, investment trusts were sensible. They offered expert management and diversification. Unfortunately, in 1929 a diversification of stocks was not going to be a big help given the universal price declines. Irving Fisher on September 6, 1929 was quoted in the New York Herald Tribune as stating: “The present high levels of stock prices and corresponding low levels of dividend returns are due largely to two factors. One, the anticipation of large dividend returns in the immediate future; and two, reduction of risk to investors largely brought about through investment diversification made possible for the investor by investment trusts.”If a researcher could find out the composition of the portfolio of a couple of dozen of the largest investment trusts as of September-October 1929 this would be extremely helpful. Seven important types of information that are not readily available but would be of interest are:The percentage of the portfolio that was public utilities.The extent of diversification.The percentage of the portfolios that was NYSE firms.The investment turnover.The ratio of market price to net asset value at various points in time.The amount of debt and preferred stock leverage used.Who bought the trusts and how long they held.The ideal information to establish whether market prices are excessively high compared to intrinsic values is to have both the prices and well-defined intrinsic values at the same moment in time. For the normal financial security, this is impossible since the intrinsic values are not objectively well defined. There are two exceptions. DeLong and Schleifer (1991) followed one path, very cleverly choosing to study closed-end mutual funds. Some of these funds were traded on the stock market and the market values of the securities in the funds’ portfolios are a very reasonable estimate of the intrinsic value. DeLong and Schleifer state (1991, p. 675):“We use the difference between prices and net asset values of closed-end mutual funds at the end of the 1920s to estimate the degree to which the stock market was overvalued on the eve of the 1929 crash. We conclude that the stocks making up the S&P composite were priced at least 30 percent above fundamentals in late summer, 1929.”Unfortunately (p. 682) “portfolios were rarely published and net asset values rarely calculated.” It was only after the crash that investment trusts started to reveal routinely their net asset value. In the third quarter of 1929 (p. 682), “three types of event seemed to trigger a closed-end fund’s publication of its portfolio.” The three events were (1) listing on the New York Stock Exchange (most of the trusts were not listed), (2) start up of a new closed-end fund (this stock price reflects selling pressure), and (3) shares selling at a discount from net asset value (in September 1929 most trusts were not selling at a discount, the inclusion of any that were introduces a bias). After 1929, some trusts revealed 1929 net asset values. Thus, DeLong and Schleifer lacked the amount and quality of information that would have allowed definite conclusions. In fact, if investors also lacked the information regarding the portfolio composition we would have to place investment trusts in a unique investment category where investment decisions were made without reliable financial statements. If investors in the third quarter of 1929 did not know the current net asset value of investment trusts, this fact is significant.The closed-end funds were an attractive vehicle to study since the market for investment trusts in 1929 was large and growing rapidly. In August and September alone over $1 billion of new funds were launched. DeLong and Schleifer found the premiums of price over value to be large — the median was about 50% in the third quarter of 1929) (p. 678). But they worried about the validity of their study because funds were not selected randomly.DeLong and Schleifer had limited data (pp. 698-699). For example, for September 1929 there were two observations, for August 1929 there were five, and for July there were nine. The nine funds observed in July 1929 had the following premia: 277%, 152%, 48%, 22%, 18% (2 times), 8% (3 times). Given that closed-end funds tend to sell at a discount, the positive premiums are interesting. Given the conventional perspective in 1929 that financial experts could manager money better than the person not plugged into the street, it is not surprising that some investors were willing to pay for expertise and to buy shares in investment trusts. Thus, a premium for investment trusts does not imply the same premium for other stocks.The Public Utility SectorIn addition to investment trusts, intrinsic values are usually well defined for regulated public utilities. The general rule applied by regulatory authorities is to allow utilities to earn a “fair return” on an allowed rate base. The fair return is defined to be equal to a utility’s weighted average cost of capital. There are several reasons why a public utility can earn more or less than a fair return, but the target set by the regulatory authority is the weighted average cost of capital.Thus, if a utility has an allowed rate equity base of $X and is allowed to earn a return of r, (rX in terms of dollars) after one year the firm’s equity will be worth X + rX or (1 + r)X with a present value of X. (This assumes that r is the return required by the market as well as the return allowed by regulators.) Thus, the present value of the equity is equal to the present rate base, and the stock price should be equal to the rate base per share. Given the nature of public utility accounting, the book value of a utility’s stock is approximately equal to the rate base.There can be time periods where the utility can earn more (or less) than the allowed return. The reasons for this include regulatory lag, changes in efficiency, changes in the weather, and changes in the mix and number of customers. Also, the cost of equity may be different than the allowed return because of inaccurate (or incorrect) or changing capital market conditions. Thus, the stock price may differ from the book value, but one would not expect the stock price to be very much different than the book value per share for very long. There should be a tendency for the stock price to revert to the book value for a public utility supplying an essential service where there is no effective competition, and the rate commission is effectively allowing a fair return to be earned.In 1929, public utility stock prices were in excess of three times their book values. Consider, for example, the following measures (Wigmore, 1985, p. 39) for five operating utilities.border=”1″ cellspacing=”0″ cellpadding=”2″ class=”encyclopedia” width=”580″>1929 Price-earnings RatioHigh Price for YearMarket Price/Book ValueCommonwealth Edison353.31Consolidated Gas of New York393.34Detroit Edison353.06Pacific Gas & Electric283.30Public Service of New Jersey353.14Sooner or later this price bubble had to break unless the regulatory authorities were to decide to allow the utilities to earn more than a fair return, or an infinite stream of greater fools existed. The decision made by the Massachusetts Public Utility Commission in October 1929 applicable to the Edison Electric Illuminating Company of Boston made clear that neither of these improbable events were going to happen (see below).The utilities bubble did burst. Between the end of September and the end of November 1929, industrial stocks fell by 48%, railroads by 32% and utilities by 55% — thus utilities dropped the furthest from the highs. A comparison of the beginning of the year prices and the highest prices is also of interest: industrials rose by 20%, railroads by 19%, and utilities by 48%. The growth in value for utilities during the first nine months of 1929 was more than twice that of the other two groups.The following high and low prices for 1929 for a typical set of public utilities and holding companies illustrate how severely public utility prices were hit by the crash (New York Times, 1 January 1930 quotations.)1929FirmHigh PriceLow PriceLow Price DividedBy High PriceAmerican Power & Light1753/8641/4.37American Superpower711/815.21Brooklyn Gas2481/299.44Buffalo, Niagara & Eastern Power128611/8.48Cities Service681/820.29Consolidated Gas Co. of N.Y.1831/4801/8.44Electric Bond and Share18950.26Long Island Lighting9140.44Niagara Hudson Power303/4111/4.37Transamerica673/8201/4.30Picking on one segment of the market as the cause of a general break in the market is not obviously correct. But the combination of an overpriced utility segment and investment trusts with a portion of the market that had purchased on margin appears to be a viable explanation. In addition, as of September 1, 1929 utilities industry represented $14.8 billion of value or 18% of the value of the outstanding shares on the NYSE. Thus, they were a large sector, capable of exerting a powerful influence on the overall market. Moreover, many contemporaries pointed to the utility sector as an important force in triggering the market decline.The October 19, 1929 issue of the Commercial and Financial Chronicle identified the main depressing influences on the market to be the indications of a recession in steel and the refusal of the Massachusetts Department of Public Utilities to allow Edison Electric Illuminating Company of Boston to split its stock. The explanations offered by the Department — that the stock was not worth its price and the company’s dividend would have to be reduced — made the situation worse.the Washington Post (October 17, p. 1) in explaining the October 16 market declines (an Associated Press release) reported, “Professional traders also were obviously distressed at the printed remarks regarding inflation of power and light securities by the Massachusetts Public Utility Commission in its recent decision.”Straws That Broke the Camel’s Back?Edison Electric of BostonOn August 2, 1929, the New York Times reported that the Directors of the Edison Electric Illuminating Company of Boston had called a meeting of stockholders to obtain authorization for a stock split. The stock went up to a high of $440. Its book value was $164 (the ratio of price to book value was 2.6, which was less than many other utilities).On Saturday (October 12, p. 27) the Times reported that on Friday the Massachusetts Department of Public Utilities has rejected the stock split. The heading said “Bars Stock Split by Boston Edison. Criticizes Dividend Policy. Holds Rates Should Not Be Raised Until Company Can Reduce Charge for Electricity.” Boston Edison lost 15 points for the day even though the decision was released afterthe Friday closing. The high for the year was $440 and the stock closed at $360 on Friday.The Massachusetts Department of Public Utilities (New York Times, October 12, p. 27) did not want to imply to investors that this was the “forerunner of substantial increases in dividends.” They stated that the expectation of increased dividends was not justified, offered “scathing criticisms of the company” (October 16, p. 42) and concluded “the public will take over such utilities as try to gobble up all profits available.”On October 15, the Boston City Council advised the mayor to initiate legislation for public ownership of Edison, on October 16, the Department announced it would investigate the level of rates being charged by Edison, and on October 19, it set the dates for the inquiry. On Tuesday, October 15 (p. 41), there was a discussion in theTimes of the Massachusetts decision in the column “Topic in Wall Street.” It “excited intense interest in public utility circles yesterday and undoubtedly had effect in depressing the issues of this group. The decision is a far-reaching one and Wall Street expressed the greatest interest in what effect it will have, if any, upon commissions in other States.”Boston Edison had closed at 360 on Friday, October 11, before the announcement was released. It dropped 61 points at its low on Monday, (October 14) but closed at 328, a loss of 32 points.On October 16 (p. 42), the Times reported that Governor Allen of Massachusetts was launching a full investigation of Boston Edison including “dividends, depreciation, and surplus.”One major factor that can be identified leading to the price break for public utilities was the ruling by the Massachusetts Public Utility Commission. The only specific action was that it refused to permit Edison Electric Illuminating Company of Boston to split its stock. Standard financial theory predicts that the primary effect of a stock split would be to reduce the stock price by 50% and would leave the totalvalue unchanged, thus the denial of the split was not economically significant, and the stock split should have been easy to grant. But the Commission made it clear it had additional messages to communicate. For example, the Financial Times (October 16, 1929, p. 7) reported that the Commission advised the company to “reduce the selling price to the consumer.” Boston was paying $.085 per kilowatt-hour and Cambridge only $.055. There were also rumors of public ownership and a shifting of control. The next day (October 17), the Times reported (p. 3) “The worst pressure was against Public Utility shares” and the headline read “Electric Issue Hard Hit.”Public Utility Regulation in New YorkMassachusetts was not alone in challenging the profit levels of utilities. The Federal Trade Commission, New York City, and New York State were all challenging the status of public utility regulation. New York Governor (Franklin D. Roosevelt) appointed a committee on October 8 to investigate the regulation of public utilities in the state. The Committee stated, “this inquiry is likely to have far-reaching effects and may lead to similar action in other States.” Both the October 17 and October 19 issues of the Times carried articles regarding the New York investigative committee. Professor Bonbright, a Roosevelt appointee, described the regulatory process as a “vicious system” (October 19, p. 21), which ignored consumers. The Chairman of the Public Service Commission, testifying before the Committee wanted more control over utility holding companies, especially management fees and other transfers.The New York State Committee also noted the increasing importance of investment trusts: “mention of the influence of the investment trust on utility securities is too important for this committee to ignore” (New York Times, October 17, p. 18). They conjectured that the trusts had $3.5 billion to invest, and “their influence has become very important” (p. 18).In New York City Mayor Jimmy Walker was fighting the accusation of graft charges with statements that his administration would fight aggressively against rate increases, thus proving that he had not accepted bribes (New York Times, October 23). It is reasonable to conclude that the October 16 break was related to the news from Massachusetts and New York.On October 17, the New York Times (p. 18) reported that the Committee on Public Service Securities of the Investment Banking Association warned against “speculative and uniformed buying.” The Committee published a report in which it asked for care in buying shares in utilities.On Black Thursday, October 24, the market panic began. The market dropped from 305.87 to 272.32 (a 34 point drop, or 9%) and closed at 299.47. The declines were led by the motor stocks and public utilities.The Public Utility Multipliers and LeveragePublic utilities were a very important segment of the stock market, and even more importantly, any change in public utility stock values resulted in larger changes in equity wealth. In 1929, there were three potentially important multipliers that meant that any change in a public utility’s underlying value would result in a larger value change in the market and in the investor’s value.Consider the following hypothetical values for a public utility:Book value per share for a utility $50Market price per share 162.502Market price of investment trust holding stock (assuming a 100% 325.00premium over market value)Eliminating the utility’s $112.50 market price premium over book value, the market price of the investment trust would be $50 without a premium. The loss in market value of the stock of the investment trust and the utility would be $387.50 (with no premium). The $387.50 is equal to the $112.50 loss in underlying stock value and the $275 reduction in investment trust stock value. The public utility holding companies, in fact, were even more vulnerable to a stock price change since their ratio of price to book value averaged 4.44 (Wigmore, p. 43). The $387.50 loss in market value implies investments in both the firm’s stock and the investment trust.For simplicity, this discussion has assumed the trust held all the holding company stock. The effects shown would be reduced if the trust held only a fraction of the stock. However, this discussion has also assumed that no debt or margin was used to finance the investment. Assume the individual investors invested only $162.50 of their money and borrowed $162.50 to buy the investment trust stock costing $325. If the utility stock went down from $162.50 to $50 and the trust still sold at a 100% premium, the trust would sell at $100 and the investors would have lost 100% of their investment since the investors owe $162.50. The vulnerability of the margin investor buying a trust stock that has invested in a utility is obvious.These highly levered non-operating utilities offered an opportunity for speculation. The holding company typically owned 100% of the operating companies’ stock and both entities were levered (there could be more than two levels of leverage). There were also holding companies that owned holding companies (e.g., Ebasco). Wigmore (p. 43) lists nine of the largest public utility holding companies. The ratio of the low 1929 price to the high price (average) was 33%. These stocks were even more volatile than the publicly owned utilities.The amount of leverage (both debt and preferred stock) used in the utility sector may have been enormous, but we cannot tell for certain. Assume that a utility purchases an asset that costs $1,000,000 and that asset is financed with 40% stock ($400,000). A utility holding company owns the utility stock and is also financed with 40% stock ($160,000). A second utility holding company owns the first and it is financed with 40% stock ($64,000). An investment trust owns the second holding company’s stock and is financed with 40% stock ($25,600). An investor buys the investment trust’s common stock using 50% margin and investing $12,800 in the stock. Thus, the $1,000,000 utility asset is financed with $12,800 of equity capital.When the large amount of leverage is combined with the inflated prices of the public utility stock, both holding company stocks, and the investment trust the problem is even more dramatic. Continuing the above example, assume the $1,000,000 asset again financed with $600,000 of debt and $400,000 common stock, but the common stock has a $1,200,000 market value. The first utility holding company has $720,000 of debt and $480,000 of common. The second holding company has $288,000 of debt and $192,000 of stock. The investment trust has $115,200 of debt and $76,800 of stock. The investor uses $38,400 of margin debt. The $1,000,000 asset is supporting $1,761,600 of debt. The investor’s $38,400 of equity is very much in jeopardy.Conclusions and LessonsAlthough no consensus has been reached on the causes of the 1929 stock market crash, the evidence cited above suggests that it may have been that the fear of speculation helped push the stock market to the brink of collapse. It is possible that Hoover’s aggressive campaign against speculation, helped by the overpriced public utilities hit by the Massachusetts Public Utility Commission decision and statements and the vulnerable margin investors, triggered the October selling panic and the consequences that followed.An important first event may have been Lord Snowden’s reference to the speculative orgy in America. The resulting decline in stock prices weakened margin positions. When several governmental bodies indicated that public utilities in the future were not going to be able to justify their market prices, the decreases in utility stock prices resulted in margin positions being further weakened resulting in general selling. At some stage, the selling panic started and the crash resulted.What can we learn from the 1929 crash? There are many lessons, but a handful seem to be most applicable to today’s stock market.There is a delicate balance between optimism and pessimism regarding the stock market. Statements and actions by government officials can affect the sensitivity of stock prices to events. Call a market overpriced often enough, and investors may begin to believe it.The fact that stocks can lose 40% of their value in a month and 90% over three years suggests the desirability of diversification (including assets other than stocks). Remember, some investors lose all of their investment when the market falls 40%.A levered investment portfolio amplifies the swings of the stock market. Some investment securities have leverage built into them (e.g., stocks of highly levered firms, options, and stock index futures).A series of presumably undramatic events may establish a setting for a wide price decline.A segment of the market can experience bad news and a price decline that infects the broader market. In 1929, it seems to have been public utilities. In 2000, high technology firms were candidates.Interpreting events and assigning blame is unreliable if there has not been an adequate passage of time and opportunity for reflection and analysis — and is difficult even with decades of hindsight.It is difficult to predict a major market turn with any degree of reliability. It is impressive that in September 1929, Roger Babson predicted the collapse of the stock market, but he had been predicting a collapse for many years. Also, even Babson recommended diversification and was against complete liquidation of stock investments (Financial Chronicle, September 7, 1929, p. 1505).Even a market that is not excessively high can collapse. Both market psychology and the underlying economics are relevant.