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Stock Market Crash of 1987 - Stock Market Crash of 1987 - Stock Market Crash of 1987
BLACK MONDAY CAUSES and EFFECTS Stock Market Crash of 1987 - Stock Market Crash of 1987 - Stock Market Crash of 1987
On Monday, October 19, 1987, the Dow Jones Industrial Average fell 508.32 and closed at a record-breaking low of 1,738.40 points (Arbel & Kaff, pg 61). This date, now known to the world as Black Monday is documented as the worst stock market crash in history. The 22.9% loss in 1987 almost doubles the percentage lost in the Crash of 1929, which was 12.82% (Arbel & Kaff, pg 61). Many stock market analysts believe that the crash was set off by a number of events, that include the poor choices of portfolio insurance professionals and program trading. One of the results of the crash was the creation of circuit breakers, which are techniques that restrict trading times in the market when market value is very high and unstable (The Economist, pg. 78). Communication between stock market regulators and investors has increased along with the access of the market to its investors.
More than one factor affected the Stock Market Crash of 1987. Economists agree that there are many reasons for the 508 point loss on October 19,1987, but not one can name a single event that ushered in the fated Black Monday. In the summer of 1987 the yield of a 30-year U.S. bond increased to almost 10 percent. Because of this investors began to shift from investing in stocks to putting their money into bonds which yielded more money (http://www.cnnfn.com...). Portfolio Insurance
The poor choices of portfolio insurance professionals also resulted in the crash. A portfolio is a collection of stocks. Portfolio insurance, a form of investment, is the guarding of other stock investments against losses (Arbel & Kaff, pg 115) This is regarded as a highly risky way of investing in the stock market because these portfolio insurance professionals rely on their intuition instead of the reliable information. These risky investors sell their stocks at a high price when they think the market is declining and their stocks are losing value. But when they feel that the market will increase again, they buy back their stocks at a lower value and use the profit made by the purchase to make up for the monetary losses within the portfolio (http://www.cnnfn.com...). This type of massive selling caused the value of the stocks used to decrease below their true value and because of the low value the process would be repeated (Sobel, pg.441).
Many people see this as carelessness in the handling of stocks. They claim that too many people today see stocks as a means to quick profit instead of as long-term investment. They do not realize that a stock represents ownership in a part of a corporation. This corporation makes new products and develops marketing programs and decides on the employment of thousands of people who care for their families (Arbel & Kaff, pg 3). Program Trading
Program trading was also a cause of the crash of 1987. This is when the prices of a stock fall below a preset price, and a programmed computer automatically sells that stock. Within one second, a computer would finalize 60 transactions (Arbel & Kaff, pg 5). These computers were handling billions of dollars per second. The market was being controlled more by computers and set prices than by investors who made careful deals. The rises and falls of the stock market echoed the sounds of the computers programmed buying and selling stocks, rather than a dependence on sound judgements made by investors.
Because of the installation of these computers, young men and women lost their jobs (Sobel, pg 442). When technology starts to replace man, an apocalypse will occur. And it did on October 19, 1987. Although program trading was used by some companies which had many clients with large funds, in 1987, program trading was not well known by investors (Sobel. pg 442). Because of the mystery behind program trading many people have blamed it for the crash (Arbel & Kaff, pg 115). Many corporations and organizations used program trading with their clients investments. Millions of shares were carelessly bought and sold during the course two minutes. Many of the clients were not aware of these actions. (Sobel, pg 442).
Some argue that blaming of the crisis in 1987 on program trading is like condemning the deliverer of bad news. Yet it also seems that the crash disabled markets so terribly that normal trading procedures did not even work. Stock quotes were changing so quickly on Black Monday that program trading could not have occured because the market information needed to make transactions was continuously being updated. Computer screens blacked out because of the surplus of information. Billions of transactions were flowing into computers which were not designed to carry so many (Arbel & Kaff, pg 116). Most analysts blame the crash on program trading, but it is clear that the overload of program trading was a result of the poor choices of the portfolio insurers. These choices were driven by the greed for money and the desire to reap as much of it as possible, even if that means sacrificing the financial future of the country.
The effects of the Crash of 1987 were not as devastating as expected. No depression, big or small resulted from it, and, in retrospect, is actually seen as a “marvelous buying opportunity”. In the following decade, interest rates declined, and investors displayed a renwed trust in the market. (The Economist, pg 13). Investors returned to the market as it made a comeback and began to rise. (http://www.detnew.com...). But this renewed trust was also bolstered by some precautionary procedures that were implemented after the crash. Circuit Breakers and Limits
Circuit breakers were put into place in 1988 in order to keep any future market drops from transforming into panics. They were controversial at the time of their installation and have remained so. Many critics of the circuit breakers believe that instead of making share prices less volatile, they increased them instead (The Economist, pg. 78). There are three stages in the establishment of the circuit breaker device. The first two stages are sometimes referred to as collars (http://www.detnews.com...). The first step is described as the least obstructive. The plan in this step limits computer program trading from sending orders to the New York Stock Exchange if the Dow has risen or fallen more than 50-points from the earlier day’s close (http://www.detnews.com...). Upon the placement of the circuit breakers, a 50-point change was tantamount to a 2% modification in the Dow. But with the Dow presently approaching 8000, a 50-point change is miniscule. Because of this fact, the first step is used more frequently (The Economist, pg. 78). In the second stage of the circuit breaker plan, program trading is postponed for 5 minutes if the Dow loses 96 points and the Standard & Poor’s 500 stock-index drops by more than 12 points (The Economist, pg. 78). This stage restricts traders using computer programs to make large orders. These investors abuse the price differences between particular exchanges. Some blame their pejorative manipulation of the market to be the cause of the crash (The Economist, pg. 78). The third circuit breaker phase was designed to sever trading in all U.S. major exchanges for an hour if the Dow fell 250 points in a day. The tradings would then continue after the hour had expired, but if the Dow continued to fall 150 points after tradings continued, the market would then close for two more hours. These regulations have been modified so that a 350-point fall would spur a thirty minute stop in trading and another 200-point fall would evoke a one hour suspension of the market (The Economist, pg. 78).
The circuit breakers were installed primarily to prevent extreme changes in the stock market. Their usefulness is often in doubt because in order to prevent extreme shifts in the market the causes of values change must be revealed. There are several suggestions as to what can cause these changes. A primary cause is the fundamental changes in the economy, including the availability of money or the changes in interest rates. Here restrictions on trading are detrimental because they can decrease the effectiveness of the pricing in the stock market (The Economist, pg. 78). The advocates of circuit breakers insist that periods of suspension of the market will allow time for the investors to consider what their next move will be and how to overcome this large price move (The Economist, pg. 78). Yet, that investors will sit and contemplate the reasoning behind the drop in points is unlikely. Most are apt to become nervous and anxious as they consider what the market will do when it resumes.
Lawrence Harris, an economist at the University of Southern California, has sought to determine if circuit breaker restrictions have made a difference in the market. His results have found that the average daily volatility of share prices has decreased since the introduction of circuit breakers. But Harris believes that this does not verify the beneficial aspects of circuit breakers. Harris attributes the lower daily votality of share prices to the skepticism of investors and the high inflation rate in the U.S. When the differences of inflation are revised, Harris found that the votality before and after the placement of the circuit breakers are very closely related. In fact, votality has increased and is now greater than before their installation (The Economist, pg. 78). The stock market has not experienced any extreme changes in prices which may suggest that circuit breakers have made a difference, but that fact could also mean that the circuit breakers have yet to be fully tested. Harris acknowledges that these restrictions have had a small effect in the Dow, but he concludes that circuit breakers have not had an obvious effect that can be easily distinguished (The Economist, pg. 78).
The Economist's writers believe whether circuit breakers made a difference or not is not the point. The magazine's analysts understand that after the crash of 1987, federal regulators were pressured to prevent any sort of crash again. But no one knows the best way to prevent a crash from occurring. In order to design “preventive measures” that would “protect” the market from dangerous declines, the regulators imposed the circuit breakers that would act as weak restraints and would probably do no harm (The Economist, pg 78).
The Economist's writers seem to believe that the circuit breakers have little to do with the stock market but demonstrate more about the use of regulation. Because of the very weak restraints provided by these circuit breakers, it does seem that their purpose is to cover the backs of the stock market regulators. If they did nothing to try to prevent another crash, the public would not regard them very highly. If nothing was done after the crash, the public would distrust the market and its high volatility. Because of this distrust, investors would be reluctant to put their money in the market and might instead invest it in the bank where interest rates would climb and the market would decline. Increased Access
After the crash, communication between regulators and markets improved. The chairmen of the Federal Reserve Board, the Securities and Exchanges Commission, the Commodity Futures Commission and the Treasury Department have met constantly in order to avert another crash. Regulators and major markets have also increased their communication with each other through a “squawk box,” which is a line that is kept open at all times to connect members of working groups to the floors of the exchanges. This “squawk box” is supposed to keep the developments in all markets accessible to everyone.
Manuals have been made which list procedures that should be taken if the market should decline. Some procedures are dependent upon the degree of the decline. Home phone numbers of all important people that are needed in case of a market decline are also posted in the manual. One of the most frustrating aspects of Black Monday for the fund investors was the inablility to call in in order to check their stock prices, or even trade, for that matter. In many large corporations a phone system that was designed to control up to 2,500 calls a day was deluged with more than two times that amount in the days after Black Monday. Shareholders and investors were put on hold for more than an hour. Many hung up. Because of the overflowing number of calls, many companies have additional trained crash teams to handle the calls in case of another crash. Touch-tone order systems were also added to help stock investors check their prices. In many cases, even computer access to stock quotes can create a jam. E* Trade, an online investing company in Palo Alto, California, was overflowing with so many clients that the computer could not pull up their accounts for 2 1/2 hours. Because of incidents like this, many companies have tripled their phone system capacity. (Brindley, pg 59).
Unlike the untested circuit breakers, these regulations seem to do more to avoid another crash and maximize the access of investors to check prices and trade. Because of these new developments, the market can run more smoothly, with an emergency plan in place in case of a major decline. The presence of these plans and developments assure the investors that their money will be safe and a crash will be avoided at all costs. Although some may claim that these rules can be seen only as limits that are just there to cover the backs of the federal regulators (like the circuit breakers), the time, effort and money put into the installation of them seems to argue otherwise.
On October 19,1987, when the Dow Jones Industrial average took a 508.32 dive, the country was unsure of its financial security and future. Chaos ran through citizens’ minds, as the media announced the 22.9 percent loss the stock market had sustained. People acted desperately, some even killed themselves. But although the stock market crash of 1987 was the biggest loss this country has ever recorded, no recession or depression occured. The media, as it is supposed to do, reported the incident to the country. But many journalists may have magnified the problem by exaggerating the event. Many economists and stock market analysts have studied and poured over data from the crash trying valiantly to discover what caused the crash and how to prevent it from happening again. Yet, every stock market analyst and every economist knows that the causes of a crash are is unknown. They do know that one factor alone does not cause a crash. There are so many variables contributing to a collapse in the market that it is impossible to cover all of the bases. There will always be something left unprepared or unthought. The circuit breakers that have yet to be used placed after Black Monday are more of a security blanket, instead of a real preventive provision that could stop a crash from happening. The circuit breakers will only buy time, and that is all. It seems evident that a crash cannot be hindered by a few hours. Another crash is inevitable. All the federal regulators can do is prepare for a crash, not prevent one.
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