boxofdelights

I'm afraid that your parents' explanation wasn't quite right. :(

There were no regulations on stock market contracts beyond the basic "do what you said you would"s and "don't sell humans for stock" sort. And financial innovators created Buying on Margin: pay a small percent of the price of a share, borrow the rest from your broker, and when the price of the stock goes up you can sell it, pay back your broker, and get a whopping percentage profit. (Suppose, for example, you pay $1 for a share that costs $1 and it goes up to $1.10. If you then sell (with no brokerage fees) you get a 10% profit. If, on the other hand, you paid 10 cents yourself and borrowed 90 cents from your broker. when you sell for $1.10 you get a 100% profit.)

All that, obviously, is predicated on The Stock Market Never Going Down for Long. When the stock prices did go down, brokers issued margin calls: that is, demanded repayment. Their stock-gambling debtors paid up out of their pockets, by selling off their ramen noodles and land, and by withdrawing funds from banks. Next chapter.

Banks that accept deposits don't just stick the funds in a safe. The only way they could make money if they did would be charging not-insubstantial fees to depositors to hold their funds. Instead, banks hold some of a deposit in the form of cash in their vaults, to meet requests for withdrawals, and lend out the rest to profit from the interest. When a lot of people want to withdraw their deposits at once, the bank can run out of cash. Then people panic and more rush in to withdraw, which makes matters worse. When the bank calls in the loans it's made, that makes matters worse as its debtors try to withdraw their deposited funds. When banks fail-- and in 1929 there was no central bank (thanks, Andrew Jackson!) to maintian liquidity in the system-- wealth vanishes and people spend less. That decreased demand for goods and services means lower demand for the labour that makes them. So incomes go down, so demand for goods and services goes down, so....

The money supply also declines, which (again) makes things worse-- but that goes through another channel I won't explain now.