Black Monday

 

Oct. 19, 1987, in U.S. history, day of financial panic. The Dow Jones Average fell 508.32 points, a drop of 22.6%, the largest since 1914. The point decline as well as the volume, 604.33 million shares, exceeded previous records. Among the possible causes were investors' anxiety about U.S. international trade and federal deficits, U.S. criticism of West Germany's economic policies, the cascading effect of the automatic computerized selling of stocks, and the drop in stock-index futures triggered by computerized trading programs. Stocks throughout the world joined the slide. By mid-1988 the stock market had recovered, and the U.S. economy was largely unaffected by the crash.

In financial markets, Black Monday is the name given to Monday, October 19, 1987, when the Dow Jones Industrial Average (DJIA) dropped by 508 points to 1739 (22.6%),^[1] and on which similar enormous drops occurred across the world. By the end of October, stock markets in Hong Kong had fallen 45.8%, Australia 41.8%, Spain 31%, the United Kingdom 26.4%, the United States 22.68%, and Canada 22.5%. (The terms Black Monday and Black Tuesday are also applied to October 28 and 29, 1929, which occurred after Black Thursday on October 24, which started the Stock Market Crash of 1929.)

The Black Monday decline was the largest one-day percentage decline in stock market history. Other large declines have occurred after periods of market closure, such as Saturday, December 12, 1914, when the DJIA fell 24.39%, ending the four month closure due to the outbreak of the First World War, and Monday, September 17, 2001, the first day after which the market was open following the September 11, 2001 attacks.

A degree of mystery is associated with the 1987 crash, and it has been labeled as black swan event.^[2] Important assumptions concerning human rationality, the efficient market hypothesis, and economic equilibrium were brought into question by the event. Debate as to the cause of the crash still continues many years after the event, with no firm conclusions reached.

In the wake of the crash, markets around the world were put on restricted trading primarily because sorting out the orders that had come in was beyond the computer technology of the time. This also gave the Federal Reserve and other central banks time to pump liquidity into the system to prevent a further downdraft. While pessimism reigned, the market bottomed on October 20.

Timeline

In 1986, the United States economy began shifting from a rapidly growing recovery to a slower growing expansion, which resulted in a "soft landing" as the economy slowed and inflation dropped. The stock market advanced significantly, with the Dow peaking in August 1987 at 2722 points, or 44% over the 1986 closing of 1985 points.

On October 14, the DJIA dropped 95.46 points (a then record) to 2412.70, and fell another 58 points the next day, down over 12% from the August 25 all-time high. On Friday, October 16, the DJIA closed down another 108.35 points to close at 2246.74 on record volume. Treasury Secretary James Baker stated concerns about the falling prices. That weekend many investors worried over their stock investments.

The crash began in Far Eastern markets the morning of October 19. Later that morning, two U.S. warships shelled an Iranian oil platform in the Persian Gulf.^[3]

Causes

Potential causes for the decline include program trading, overvaluation, illiquidity, and market psychology.

The most popular explanation for the 1987 crash was selling by program traders.^[4] U.S. Congressman Edward J. Markey, who had been warning about the possibility of a crash, stated that "Program trading was the principal cause."^[5] In program trading, computers perform rapid stock executions based on external inputs, such as the price of related securities. Common strategies implemented by program trading involve an attempt to engage in arbitrage and portfolio insurance strategies. As computer technology became more available, the use of program trading grew dramatically within Wall Street firms. After the crash, many blamed program trading strategies for blindly selling stocks as markets fell, exacerbating the decline. Some economists theorized the speculative boom leading up to October was caused by program trading, while others argued that the crash was a return to normalcy. Either way, program trading ended up taking the majority of the blame in the public eye for the 1987 stock market crash.

New York University's Richard Sylla divides the causes into macroeconomic and internal reasons. Macroeconomic causes included international disputes about foreign exchange and interest rates, and fears about inflation.

The internal reasons included innovations with index futures and portfolio insurance. I've seen accounts that maybe roughly half the trading on that day was a small number of institutions with portfolio insurance. Big guys were dumping their stock. Also, the futures market in Chicago was even lower than the stock market, and people tried to arbitrage that. The proper strategy was to buy futures in Chicago and sell in the New York cash market. It made it hard -- the portfolio insurance people were also trying to sell their stock at the same time.^[6]

Economist Richard Roll believes the international nature of the stock market decline contradicts the argument that program trading was to blame. Program trading strategies were used primarily in the United States, Roll writes. Markets where program trading was not prevalent, such as Australia and Hong Kong, would not have declined as well, if program trading was the cause. These markets might have been reacting to excessive program trading in the United States, but Roll indicates otherwise. The crash began on October 19 in Hong Kong, spread west to Europe, and hit the United States only after Hong Kong and other markets had already declined by a significant margin.

Another common theory states that the crash was a result of a dispute in monetary policy between the G-7 industrialized nations, in which the United States, wanting to prop up the dollar and restrict inflation, tightened policy faster than the Europeans. The crash, in this view, was caused when the dollar-backed Hong Kong stock exchange collapsed, and this caused a crisis in confidence.^{[citation needed]}Jude Wanniski stated that the crash happened because of the breakup of the Louvre Accord, a monetary pact between the US, Japan, and West Germany to keep currencies stable. Just prior to the crash, Alan Greenspan had said that the dollar would be devalued.^{[citation needed]}

Another theory is that the Great Storm of 1987 in England, which happened on the Friday before the crash, helped contribute to it. In 1987 there was no Internet trading, and brokers had to physically get to work in the City of London in order to do their deals. On Friday, October 16, many routes into London were closed and consequently many traders were unable to reach their offices in order to close their positions at the end of the week. This presumably caused panic selling the following Monday.

See also

• Great Storm of 1987
• Program trading

Further reading

• "Brady Report" Presidential Task Force on Market Mechanisms (1988): Report of the Presidential Task Force on Market Mechanisms. Nicholas F. Brady (Chairman), U.S. Government Printing Office.
• Carlson, Mark (2007) "A Brief History of the 1987 Stock Market Crash with a Discussion of the Federal Reserve Response," Divisions of Research & Statistics and Monetary Affairs Federal Reserve Board, Washington, D.C.
• Securities and Exchange Commission (1988): The October 1987 Market Break. Washington: The Securites and Exchange Commission.
• Shiller, R. (1989): “Investor Behavior in the October 1987 Stock Market Crash: Survey Evidence,” in Market Volatility. Boston: Massachusetts Institute of Technology.
• Robert Sobel Panic on Wall Street: A Classic History of America's Financial Disasters-With a New Exploration of the Crash of 1987 (E P Dutton; Reprint edition, May 1988) ISBN 0-525-48404-3.

References

1. ^ Browning, E.S.. "Exorcising Ghosts of Octobers Past", The Wall Street Journal, Dow Jones & Company, Monday, 15-10-2007, pp. C1-C2. Retrieved on 2007-10-15. 
2. ^ Taleb, Nassim Nicholas (2007). The Black Swan: The Impact of the highly improbable. Random House, 400. ISBN 1400063515. 
3. ^ Motley Fool's Black Monday 10th Anniversary 1987 Timeline (10-19-1997). Retrieved on 2007-10-15.
4. ^ The Concise Encyclopedia of Economics, "Program Trading," by Dean Furbush accessed May 22, 2007
5. ^ Albert, Bozzo (10-12-2007). Players replay the crash. Remembering the Crash of 87. CNBC. Retrieved on 2007-10-13.
6. ^ Annelena, Lobb (10-15-2007). Looking Back at Black Monday:A Discussion With Richard Sylla. The Wall Street Journal Online. Dow Jones & Company. Retrieved on 2007-10-15.

External links

• Motley Fool's Black Monday 10th Anniversary 1987 Timeline
• CNBC Remembering the Crash of 1987
• Black Monday 1987
• CBC Reports on Black Monday

Stock market crashes

1819 panic • 1869 black Friday • 1873 panic • 1884 panic • 1893 panic • 1896 panic • 1901 panic • 1907 panic • 1929 Wall Street crash • 1973–1974 stock market crash • 1982 Souk Al-Manakh stock market crash • 1987 black Monday • 1989 Friday the 13th mini-crash • 1997 Asian financial crisis • 1997 mini-crash • 1998 Russian financial crisis • 2002 stock market downturn • 2007 Chinese correction List of stock market crashes

Black days of the week
Black Sunday | Black Monday | Black Tuesday | Black Wednesday | Black Thursday | Black Friday | Black Saturday

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