After sliding downward for weeks, stock prices on the New York Stock Exchange collapsed, causing fears of a repetition of the crash of 1929.
Throughout the late summer and early autumn of 1987, the prices of stocks on the New York Stock Exchange (NYSE) fell irregularly. Some analysts thought a major “correction” was coming, believing that prices were higher than merited by the earnings and financial outlooks of companies. Other analysts were convinced that there would be a rise in prices. In retrospect, it is not difficult to isolate elements in the market structure that indicated a major collapse. At the time, however, a drop of several hundred points in the Dow Jones Industrial Average
On August 25, 1987, the Dow Jones Industrial Average closed at 2,747, a new high. Stock prices had more than tripled in the past five years, and the market had advanced 43 percent since the beginning of the year. The market then began to falter, perhaps in fear of a correction. Some analysts warned of a repetition of the 1929 crash, but the stock market as a whole in 1987 was quite different from the market in 1929, making comparisons unproductive. For one thing, the stock market by 1987 was global, with New York, Tokyo, and London inextricably tied together. New financial instruments and techniques had developed in the 1970’s and 1980’s, along with changes in the customer base.
One change came in 1973, when the Chicago Board of Trade created the Chicago Board Options Exchange.
These options were used imaginatively by speculators sitting in front of computer consoles, using software that triggered sales and purchases. Arbitrageurs, who simultaneously bought and sold stocks or options to profit from disparities in the markets, would buy options on a stock index and sell the underlying shares, or do the reverse, when profits might be realized, leading to wide activity and swings in prices. A trade triggered by one computer might be large enough to change prices enough to trigger other computers, making the process rapid, interactive, and volatile. On the day options expired—when the contracts to buy or sell had to be fulfilled or settled— trading activity could be wild and unpredictable.
Newspapers across the U.S. headlined the stock market plunge of Monday, October 19, 1987.
Another new feature of the markets was portfolio insurance. A portfolio manager could sell index futures, with the cash from the sale used to offset price declines. As stock prices moved in one direction, the value of the futures changed to offset the gain or loss. Most investors did not know what portfolio insurance was, but there was between $60 billion and $90 billion of it in force in the summer of 1987.
As a result of the trade deficit of the United States and the lure of American securities, a substantial amount of foreign money entered the U.S. stock market. Pension funds were big players, as were insurance companies and trust accounts. There had been an explosion in mutual funds as small investors pooled their money to invest in diversified portfolios. Together these institutions owned half the shares in American companies and accounted for approximately 70 percent of trading activity.
To this mix were added other major factors. One was the climax of takeover activity, as corporate raiders such as T. Boone Pickens,
On September 4, Federal Reserve Board chairman Alan Greenspan announced a boost from 5.5 to 6 percent in the discount rate, the interest rate that Federal Reserve banks charge for loans to other banks. This indicated that Greenspan meant to fight the inflation that was likely to come with the lower dollar. Greenspan also may have wanted to stifle the vigorous bull market. Bond prices collapsed at the prospect of higher interest rates. The DJIA responded by declining 37 points that day, 38 the following day, and 16 on September 9 before leveling at 2,545. The market then rallied and closed the month at 2,596.
The market was skittish in early October, as meetings between President Ronald Reagan
Even before the market opened on the following Monday, it was apparent that trading would be unsettled. Portfolio insurance and arbitrage activities, in addition to developing panic, would pull the market down. Later it was learned that major mutual and pension funds had placed large sell orders before the opening. Arbitrageurs were in action, placing their sell orders. Later it would be learned that five money managers had placed sell orders on contracts worth $4 billion before the opening. Meanwhile, Wall Street learned of sharp declines on the Tokyo and London markets.
With these factors in place, it is not surprising that stocks opened at 2,047, 200 points lower than the Friday close, on heavy volume. The DJIA then rose 100 points in half an hour, on record volume. Panic selling developed around the world. Many would-be sellers could not get through to their brokers. NYSE specialists in certain stocks suspended trading because they were unable to find support levels, at which prices buyers would balance sellers. Market makers for the National Association of Securities Dealers Automated Quotations (NASDAQ)
Largely unnoticed in all of this was a sharp rise in the bond market, which received a good deal of the money that went out of stocks. This was significant because the government bond market, by itself, was ten times larger than the stock market. Gains in bonds more than outweighed losses in stocks. That night, analysts spoke ominously of the crash and what might follow. Given more attention was the announcement that the Federal Reserve banks would aggressively purchase government bonds, thus providing financial markets with needed liquidity.
That night, the stock markets of other countries plunged. Tokyo’s Nikkei index fell 15 percent, and the slump in London continued, with a 22 percent loss in two sessions. The same held true in secondary markets. Singapore’s was down 21 percent, Australia’s fell 25 percent, and those in Hong Kong and New Zealand simply shut down. If proof was needed that the world’s markets were connected, it was provided early that week.
The NYSE opened up 211 points the following day, Tuesday, October 20, and for a while it seemed that the hoped-for “bounceback” had taken place. The DJIA then fell almost 100 points in the first half hour, rallied, and then fell again. By 12:30
The market rose 187 points on Wednesday, fell 78 points on Thursday, and rose by 1 point on Friday to close the week at 1,950. There was a 157-point loss the following Monday, but trading volume indicated that it was not caused by a panic. Rallies enabled the DJIA to end the month at 1,994. The index had lost more than 600 points in October.
During that month, scare headlines and dour predictions prompted thoughts that the events that began on what became known as Black Monday would follow the pattern of 1929. The New York Times charted the 1987 market against that of 1929. The market’s recovery and continued strength soon caused such fears to dissipate, and by mid-November it appeared that all would indeed be well.
The shake-up in the stock market apparently had not caused more widespread problems. Payrolls swelled in October in the best performance since September, 1983. During the first ten months of 1987, factory employment expanded by 26,700 jobs per month, compared with average monthly losses of 30,000 in 1985 and 13,500 in 1986. Department store sales increased on a year-to-year basis by 1.4 percent, while consumer spending rose by 0.5 percent. Christmas sales in 1987 reached a new record. The Commerce Department later reported that the U.S. gross national product had advanced by an annualized rate of 4.1 percent during the third quarter of 1987.
Foreign central banks began reducing their key interest rates, led by the German Federal Bank (Deutsche Bundesbank), which reduced short-term rates from 3.5 percent to 3.25 percent. There was talk of a new international monetary conference. Lower interest rates may have invigorated spending in other countries, increasing U.S. exports and lessening pressure on the trade deficit.
By the year’s end, several fact-finding commissions were at work investigating the crash. One, sponsored by the federal government, was headed by former U.S. senator from New Jersey and future secretary of the treasury Nicholas F. Brady. The NYSE conducted its own investigation, chaired by former U.S. attorney general Nicholas de Belleville Katzenbach.
After completing its investigation, the Brady Commission
Bargain hunters bought many of the stocks that had fallen in price, aiding recovery of the market. Overall, losses were largely erased within two years of the crash. A smaller crash occurred in 1989, but share prices recovered and the DJIA soon flirted with the 3,000 level. Within the subsequent decade, it more than tripled to a level well above 11,000.
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Barro, Robert J., et al. Black Monday and the Future of Financial Markets. Homewood, Ill.: Dow Jones Irwin, 1989. Offers a scholarly, technical account of the crash along with an analysis of how future shocks can be prevented. -
Bose, Mihir. The Crash: Fundamental Flaws Which Caused the 1987-1988 World Stock Market Slump and What They Mean for Future Financial Stability. London: Bloomsbury, 1988. Valuable for insights regarding the interrelations of world financial markets. -
Hughes, Jonathan, and Louis P. Cain. American Economic History. 6th ed. Boston: Addison-Wesley, 2002. Comprehensive volume on the economic history of the United States includes discussion of the 1987 stock market crisis. -
Kindleberger, Charles P., and Robert Aliber. Manias, Panics, and Crashes: A History of Financial Crises. 5th ed. New York: John Wiley & Sons, 2005. General survey of financial speculation and monetary crises from the eighteenth century to the early twenty-first century. Includes discussion of the 1987 stock market crash. -
Sobel, Robert. Panic on Wall Street: A History of America’s Financial Disasters. Rev. ed. Washington, D.C.: Beard Books, 1999. Reissue of an earlier work includes a new chapter on the panic of 1987 that stresses the differences between that event and the stock market crash of 1929. -
U.S. Congress. House. Committee on Banking, Finance, and Urban Affairs. Impact of the Stock Market Drop and Related Developments on Interest Rates, Banking, Monetary Policy, and Economic Stability. 100th Congress, 2d session, 1988. Discussion and analysis of the Brady Report. By the time of the hearings it had become evident that the crash would have no long-lasting effects, but the legislators did think in terms of reform. -
Wood, Christopher. Boom and Bust: The Rise and Fall of the World’s Financial Markets. New York: Atheneum, 1989. Presents a journalistic account of the crash, including information on its causes and its aftermath.
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