The Eighties Club
The Politics and Pop Culture of the 1980s
43. The Crash of '87

Copyright 2001     Jason Manning     All Rights Reserved
"This is going to make '29 look like a kiddie party," predicted one trader on the floor of the Pacific Stock Exchange. Indeed, the stock market collapse of October 19, 1987 -- a day that would forever after be known as Black Monday -- was considerably larger in volume than the one that had occurred in October 1929 and sent the world plunging into a Great Depression lasting a decade. On Black Monday the Dow Jones industrial average plunged 508 points -- 22.6 percent of the market (almost double the 12.8 percent drop on October 28, 1929) -- and closed the day at 1738.74. What happened on Wall Street happened as well in Tokyo, Hong Kong, London, Paris, and other markets around the globe. It was the worst week in Wall Street history, and in the aftermath many people wondered anxiously if a global economic disaster would follow. A poll taken shortly after the crash revealed that two out of three Americans expected a serious economic downturn
By the end of the week, one marked by wild market fluctuations, the Dow was still down a record 295.98 points; the industrial average stood 28.3 percent below the 2722 peak of August. Volume for the week, which included the four heaviest days in exchange history, totaled an incredible 2.3 billion shares on the Big Board. But there was not much chance that an economic collapse like that which had followed the Crash of '29 would happen again. There were a number of stabilizing factors. One was the existence of federal deposit insurance. In 1929, people had made a run on the banks; after Black Monday banks seemed a far safer repository for savings than the stock market. A second stabilizer was a quick response by the Federal Reserve. The Reserve had been sharply criticized in 1929 for allowing the supply of money and credit to shrink, exacerbating the financial debacle. This time, Fed Chairman Alan Greenspan announced on Tuesday morning that the Reserve would "make as much money available as might be needed." In fact, the Reserve pumped enough money into banks that interest rates dropped. A third factor significant in easying the adverse effects of Black Monday was the government's response. After a few days of denying that the crash was anything worse than a correction, President Ronald Reagan acknowledged that federal deficits were one reason for market jitters, and indicated he would consider a modest tax increase as part of a deficit-reduction package, a turnaround from his previous intransigent refusal to contemplate a rise in taxes.
What caused the crash? By August 1987 the bull market that had existed since 1982 was the longest in 50 years. The total value of stocks in all markets had increased from $2,472 billion in 1980 to $5,995 billion in 1986. The average number of shares trades daily on the New York Stock Exchange (NYSE) tripled, from 65 million in 1982 to 180 million in 1987.  But experts worried that stock prices were too far ahead of expected corporate earnings. Prior to the crash, the average price-earnings ratio on American stocks was 23, the highest since World War II. "We were 700 points ahead on sheer greed," conceded Shearson Lehman's senior vice-president, Frank Korth. Even though the market was overspeculated, investors were reluctant to bail while stocks continued to rise. Savvy Wall Streeters knew the market was overheated, and many expected a correction of 150 to 250 points. They were concerned about rising budget and trade deficits, and wondered how long the current period of prosperity could last, But no one expected a crash.
Two weeks before the crash, investors were shaken by news that the U.S. trade deficit had not declined as expected -- in fact, the $15.7 billion deficit reported in August was 50 percent worse than anticipated. Then an increase in West Germany's interest rates provoked Treasury Secretary James A. Baker into threatening a currency war by driving the dollar down, in open defiance of February's Louvre Accords (by which the U.S., West Germany and five other nations agreed to keep their currency values within a mutually beneficial trading range.) The U.S. objected to higher foreign interest rates because they would mean lower American exports and less available capital on the international market, capital needed to cover the federal budget deficit. A declining dollar, it was feared, would result in a flight of foreign capital from the U.S. These events caused many investors to begin bailing out of the market in anticipation of rocky economic days ahead, especially in light of the chronic failure by a Republican president and a Democratic Congress to agree on how to reduce budget and trade deficits.
Computers played a crucial role in the severity of the crash. By 1987 the NYSE was completely computerized, as were most other markets. That meant trades could be executed at a volume unheard of only a decade earlier. A sell-off that would have taken days only a few years earlier could now occur in a matter of hours. As stock prices plummeted on October 19, mutual fund managers had to dump stocks for cash to pay off investors redeeming fund shares, while margin calls forced investors who had bought stock on credit to sell out. But, as usually happened after a rout, a rally of sorts took place. New buyers snapped up blue chip bargains. Over 200 corporations bought up their own stock, in part to prevent corporate raiders from acquiring it; IBM, for example, purchased $1 billion worth of its own stock. A week after the crash, the Dow showed a modest increase of 42.77 points. And while the Dow was 729 points below its August high of 2722, and U.S. stocks had lost $850 billion in value since then, optimists pointed out that even at the October 19 low of 1738 the industrial average was still only 4 percent below what it had been one year earlier. Few banks and brokerage houses had to close their doors; it was estimated that only 300 of the 12,000 brokerage firms would be forced out of business. These were smaller houses, crippled by the failure of a few high-rolling customers to cover their margin accounts. And there were no scenes of brokers or investors hurling themselves out of high windows, though in Miami an investor who had lost a portfolio worth millions marched into a Merill Lynch office and killed the branch manager before turning the gun on himself. Some economists presented a silver lining; the loss of $850 billion in buying power reduced inflationary risks -- even though, as a Merrill Lynch economist put it, "American households lost the equivalent of six years of savings." There were voices, both on Wall Street and in the business community, insisting that the media -- and the Democrats -- had blown the stock market decline out of all proportion, that the economy was more than strong enough to sustain the shock of Black Monday, and that the "Reagan recovery" would continue.
The effect on financial markets overseas was generally a modest one, since none (with the exception of Tokyo's Nikkei, the world's largest stock market) came close to the NYSE in size. The principal concern overseas was that the crash would usher in a U.S. recession that could in turn trigger a global economic downturn. These fears proved to be unfounded. The Reagan administration sacrificed the dollar, keeping interest rates down. The lower dollar, it was hoped, would trim the trade deficit by boosting exports -- a weak dollar made American goods more competitive -- while reducing imports. And as interest rates tumbled, share prices strengthened, employment remained low at 6 percent, and the economy continued to grow. Six months after the crash, the Commerce Department reported a GNP growing at a healthy 4.8 percent rate during 1987's last quarter. The weak dollar had spurred consumer spending. Unemployment was at its lowest level since 1979. Inflation remained toothless at 3.2 percent. After Black Monday, President Reagan quipped that the stock market had predicted nine out of the last six recessions. Though he had been criticized then for his flippancy, economists conceded that there was no causal relationship between stock market declines and economic contractions.
Following the crash, corporate takeovers dominated the scene as raiders scooped up stocks, often at bargain basement prices. "If companies were attractive targets when the Dow was at 2500," said Texas takeover artist T. Boone Pickens, "they will be even more attractive with the Dow at 1800." Post-crash caution on Wall Street meant some corporations were undervalued -- their assets and future earnings were worth more than the market value of its outstanding stock (exactly the reverse of the pre-crash situation.) Raiders borrowed money to buy a controlling number of a company's shares by issuing junk bonds. The New York Times estimated the total face value of high-yield junk bonds at $180 billion by the end of 1988. Corporate takeovers were not limited to homegrown sharks; Japanese, European and Australian investors spent $15.5 billion in hostile takeovers of American companies in the first six months of 1988. Mergers & Acquisitions magazine reported $80 billion worth of takeovers in the first three months of 1988, an 80 percent increase over the first quarter of 1987. The biggest junk-bond takeover in history was the $25 billion leveraged buyout of RJR Nabisco by Kohlberg, Kravis Roberts & Company in 1988. Unlike the small investor, stung by the crash of '87 and prone to overcaution in Black Monday's aftermath, the big money boys continued to play with unabated zeal.

Black Monday
9:30 AM -- With the Tokyo and Hong Kong markets already declining because investors were made jittery by Friday's record loss (108 points) on Wall Street, the NYSE Big Board opens. Within 30 minutes, 50 million shares are sold.
10:30 AM -- With 140 million shares traded, the Dow is down 101 points, to 2145.
11:45 AM -- A brief turnaround gives traders a flicker of hope as the Dow regains 95 points in a half-hour.
1 PM -- As rumors spread about a NYSE shutdown, the Dow plunges 100 points in the next hour.
2:15 PM -- With the Dow down 300 points, an investor outside the NYSE screams, "Down with Reagan! Down with MBAs! Down with yuppies!"
4 PM -- The NYSE closes. Chairman John Phelan says it was the closest thing to a "financial meltdown" that he had ever seen.





REFERENCES

The Economist, 31 October 1987

Newsweek, 2 November 1987

Time, 2 November 1987, 9 November 1987, 4 April 1988

U.S. News & World Report, 2 November 1987, 9 November 1987, 16 November 1987

"After the Crash: The Real Reason Why the Economy Is Still Going Strong"
David L. Birch, Inc, Vol. 10, No. 12 (December 1988)

"The International Crash of October 1987"
Richard Roll, Financial Analysts Journal, Sept/Oct. 1988

"Why The Crash Left Few Traces"
William Sheeline, Fortune, Vol. 118, No. 9 (Oct. 24, 1988)

Crash: Ten Days In October...Will It Strike Again?
Avner Arbel & Albert E. Kaff (New York: Longman Financial Services Publishing, 1989)