The practice of purchasing stocks with borrowed money, specifically prevalent during the 1920s, is a significant concept in understanding the causes of the Great Depression. Investors would pay a small percentage of the stock’s price, the ‘margin,’ and borrow the rest from a broker. For example, an investor might pay 10% of a stock’s value in cash and borrow the remaining 90%, hoping the stock price would increase. If the stock did rise, the investor could sell, repay the loan with interest, and keep the profit.
This investment strategy magnified both potential gains and potential losses. When stock prices rose, investors made substantial profits, fueling further speculation and driving prices even higher. However, the system was inherently unstable. Should stock prices decline, brokers could demand that investors provide more cash to cover their losses, a ‘margin call.’ If investors were unable to meet this demand, the broker could sell the stock, potentially triggering a cascade of sales and driving prices down further. The widespread use of this practice significantly contributed to the inflated stock market bubble of the late 1920s and exacerbated the severity of the 1929 crash when the bubble burst.
