Black Monday

Nothing much happened on 19 October 1987. No bank failed, no war began, no company of consequence went bankrupt. The Dow Jones Industrial Average fell 22.6% anyway — still, decades later, the worst single day in its history, nearly twice the worst day of 1929.

The setup was a genuine boom: American shares had risen 44% in the seven months to late August, on takeover money, tax cuts and a widespread sense that equities had been too cheap for too long. The trigger was mundane — a widening trade deficit, rising rates, a poor Friday.

The mechanism was the interesting part, and it was a machine built to prevent exactly this. Portfolio insurance was a strategy sold to institutions as synthetic downside protection: as the market falls, sell index futures, so losses in the portfolio are offset. Backtested on one fund, it worked. Applied to sixty billion dollars of equities simultaneously, it meant that a decline generated automatic selling, which generated more decline. The futures market gapped below the cash market, arbitrageurs sold stock against it, and the two markets chased each other down through a day when many stocks simply could not be traded.

The Federal Reserve’s response, one sentence from Alan Greenspan affirming its readiness to supply liquidity, stopped it in a day. That is why the book files 1987 as an anomaly with a lesson rather than a catastrophe: an asset-price collapse with almost no credit behind it, met by an immediate lender of last resort, left the real economy essentially untouched. The lesson institutions actually drew — that the Fed would always be there — has been called the Greenspan put ever since.

What it cost

The Brady task force measured the loss: almost $1.0 trillion off the value of all outstanding US stocks in the four trading days to 19 October. Almost none of it travelled. US unemployment averaged 6.2% in 1987, 5.5% in 1988 and 5.3% in 1989, and the NBER dates the next recession from July 1990, thirty-three months later. The toll that did land, landed on the securities industry.

• −$1.0 trillion off the value of all outstanding US stocks between the close on 13 October and the close on 19 October 1987; households held about $3.2 trillion of stock before the fall, directly and through mutual and pension funds Report of the Presidential Task Force on Market Mechanisms, January 1988, chapter one
• 6.2% → 5.3% US unemployment, annual averages for 1987 and 1989; the number of people out of work fell from 7.4 million to 6.5 million while the market was still recovering Economic Report of the President 2013, Table B-35, Civilian population and labor force, on Bureau of Labor Statistics data
• 343,170 → 325,230 employment in the US security brokers and dealers industry, May 1987 to May 1990, a fall of 5.2%; bonuses were down about a fifth in 1989, the industry lost $162 million before taxes in 1990, and employment went on falling until February 1992 Brett Illyse Graff, Employment trends in the security brokers and dealers industry, Monthly Labor Review, Bureau of Labor Statistics, September 1995, pp.21 and 23, and Table 1

On Monday 26 October 1987, a week after the crash, a long-standing Merrill Lynch customer named Arthur Kane walked into the firm’s branch at The Falls, in suburban Miami, and shot the branch manager, Jose Argilagos, and another vice president, Lloyd Kolokoff, before killing himself. Argilagos, who had joined Merrill Lynch in 1961, was killed; Kolokoff was flown to hospital critically wounded. Metro-Dade police said that day that they believed the shooting was related to losses suffered in the recent downturn.

What followed

The Presidential Task Force on Market Mechanisms reported in January 1988 and recommended one coordinating regulator, unified clearing, margins made consistent across marketplaces, and circuit breaker mechanisms — price limits and coordinated trading halts — to protect the market system. The circuit breakers are what stuck: the New York Stock Exchange now halts trading when the S&P 500 falls 7%, 13% and 20%. No administration fell over Black Monday.

Report of the Presidential Task Force on Market Mechanisms, January 1988, conclusion; Bernhardt and Eckblad, Stock Market Crash of 1987, Federal Reserve History

Phases on show: euphoriadistresspanic