The Crash of 1987: 25 Years After Black Monday, Not Much Has Changed

It’s the 25th year anniversary of Black Monday, a day which ushered in a precipitous collapse in world markets. The Dow Jones dropped by 508 points to 1738.74 or 22.61 percent of its total value, but the collapse was experienced worldwide. The financial epidemic began in Asia and contagion quickly spread. By the end of October, stock markets in Hong Kong had dropped 45.5 percent, Australia 41.8 percent, Spain 31 percent, the United Kingdom 26.45 percent. New Zealand got hit so hard, 60 percent from its peak, it took years for the island country to recover.

It should have been a lesson learned. The financial industry, despite recent populist scorn, is fundamental to the operation of our worldwide economy. It’s the lube for everyday wheel churning we generally take for granted: going to the store to buy food food, having a credit card, owning a home, or getting that new “extra special” iPhone. Finance is the air our economy breathes.

At its essence, it’s about the efficient distribution of capital. So that those who need cash or credit can use it to do useful or necessary things. That’s why governments are printing money like crazy, endlessly, and recklessly — in the hope that eventually, the necessary funds will trickle down to those who need it most. In theory anyway. Nevermind that there is a mountain of middlemen taking their cut along the way, these things are necessary. These are desperate times, after all.

But it started a quarter century ago, just a few months after the world became intimately acquainted with a guy named Alan Greenspan, the newly minted chairman of the Federal Reserve. Depending on who you ask, it’s a position of power considered to be one of the greatest in all the lands, free from the jurisdiction of those pesky politicians. While our presidential type representatives squabble over things like tax cuts and Obamacare, and binders full of women, Ben Bernanke is making moves, doing things when no one else can.

We know Greenspan well, partly because of his brilliantly ambiguous quotes, but also because of the monetary precedents he put into place. They call it the Greenspan Put. A put is a financial instrument known as an option — essentially a contract that allows you to sell an asset at a certain price. So if you own a put, even if the stock is tanking, you still have the option to sell it at whatever price predetermined by your put contract. It’s insurance, a safety net, a way to cut your losses.

The Greenspan Put was an understanding. The understanding that if anything went wrong with the market and it tanked, the Fed would come in and start printing money, as a means of propping things up. It was a safety net and it was supposed to reduce the swings in the market. Things would never get too bad, because before they did, Alan Greenspan would swoop in and save the day. In 1987, it worked. Through the Federal Reserve, Greenspan started buying things off the market, pushing interest rates below 7 percent (they didn’t have targets back then, they still had so much room to work with). The rush of dollars hit the market like your first line of blow. It was exhilarating and it made us all feel great. We were back baby.

There are two problems to this sort of bandage, however. First is the high. While Greenspan set a floor, there was no ceiling and thus, no protection from bubbles. So bubbles got bigger. Which meant that when they burst, they required that much more monetary invention, that many more dollars printed to stabilize the situation.

Two. This is medicine in our most modern sense, where we treat symptoms while often ignoring the underlying cause. Medicine has side effects and one of those side effects is the loss of proper price discovery. This is something fundamental to how markets work. We expect markets to price things efficiently based on the idea of supply and demand. But when the Fed intervenes and floods the market with funds, we lose a sense of what that true demand is. Prices start to lose some of their relevancy. We lose a sense of reality. As we fall deeper into our addiction, we fall further from the truth. This is Greenspan’s legacy.

But let’s talk about the underlying cause back in 1987. It’s a familiar theme. Like many things finance, there’s a lot of debate and numerous reasons, like the issues with global currency rates and the impact of Asia, but the widely accepted cause was the computers. “Program trading was the principal cause,” said U.S. Congressman Edward J. Markey, who had been warning about the possibility of a crash well before it happened, referring to the advent of computers that rapidly performed stock executions based on predetermined algorithms.

So what have we learned? Very little, it seems. Behold, the rise of high-frequency computerized trading in the last five years.

The majority of all trades made everyday are now executed by robots looking to exploit micro-movements in stock price in a perpetual game of musical chairs. “25 years later we’re still talking about the impact of technology on the markets and what kinds of solutions could be created to try to soften the movements,” Ken Leibler, then president of the American Stock Exchange in 1987, told Business Week.

“With high-frequency trading, there are tremendous amounts of trading done, but now it’s done in thousandths of a second,” he said. “The problem is similar today to what it was back then.” Only many orders of magnitude greater.