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Black Monday is the name commonly given to the global, sudden, severe, and largely unexpected
stock market crash A stock market crash is a sudden dramatic decline of stock prices across a major cross-section of a stock market, resulting in a significant loss of paper wealth. Crashes are driven by panic selling and underlying economic factors. They often f ...
on Monday, October 19, 1987. In Australia and
New Zealand New Zealand ( mi, Aotearoa ) is an island country in the southwestern Pacific Ocean. It consists of two main landmasses—the North Island () and the South Island ()—and over 700 smaller islands. It is the sixth-largest island country ...
, the day is also referred to as ''Black Tuesday'' because of the time zone difference from other English-speaking countries. All of the twenty-three major world markets experienced a sharp decline in October 1987. When measured in
United States dollar The United States dollar (symbol: $; code: USD; also abbreviated US$ or U.S. Dollar, to distinguish it from other dollar-denominated currencies; referred to as the dollar, U.S. dollar, American dollar, or colloquially buck) is the official ...
s, eight markets declined by 20 to 29%, three by 30 to 39% (
Malaysia Malaysia ( ; ) is a country in Southeast Asia. The federal constitutional monarchy consists of thirteen states and three federal territories, separated by the South China Sea into two regions: Peninsular Malaysia and Borneo's East Malays ...
,
Mexico Mexico (Spanish: México), officially the United Mexican States, is a country in the southern portion of North America. It is bordered to the north by the United States; to the south and west by the Pacific Ocean; to the southeast by Guatema ...
and New Zealand), and three by more than 40% (
Hong Kong Hong Kong ( (US) or (UK); , ), officially the Hong Kong Special Administrative Region of the People's Republic of China ( abbr. Hong Kong SAR or HKSAR), is a city and special administrative region of China on the eastern Pearl River Delta ...
, Australia and
Singapore Singapore (), officially the Republic of Singapore, is a sovereign island country and city-state in maritime Southeast Asia. It lies about one degree of latitude () north of the equator, off the southern tip of the Malay Peninsula, borderin ...
). The least affected was
Austria Austria, , bar, Östareich officially the Republic of Austria, is a country in the southern part of Central Europe, lying in the Eastern Alps. It is a federation of nine states, one of which is the capital, Vienna, the most populous c ...
(a fall of 11.4%) while the most affected was Hong Kong with a drop of 45.8%. Out of twenty-three major industrial countries, nineteen had a decline greater than 20%. Worldwide losses were estimated at US$1.71 trillion. The severity of the crash sparked fears of extended economic instability or even a reprise of the
Great Depression The Great Depression (19291939) was an economic shock that impacted most countries across the world. It was a period of economic depression that became evident after a major fall in stock prices in the United States. The economic contagion ...
. The degree to which the stock market crashes spread to the wider economy (or "real economy") was directly related to the
monetary policy Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for very short-term borrowing (borrowing by banks from each other to meet their short-term needs) or the money supply, often ...
each nation pursued in response. The
central bank A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union, and oversees their commercial banking system. In contrast to a commercial bank, a central ba ...
s of the United States, West Germany and Japan provided
market liquidity In business, economics or investment, market liquidity is a market's feature whereby an individual or firm can quickly purchase or sell an asset without causing a drastic change in the asset's price. Liquidity involves the trade-off between the ...
to prevent debt defaults among financial institutions, and the impact on the real economy was relatively limited and short-lived. However, refusal to loosen monetary policy by the
Reserve Bank of New Zealand The Reserve Bank of New Zealand (RBNZ, mi, Te Pūtea Matua) is the central bank of New Zealand. It was established in 1934 and is constituted under the Reserve Bank of New Zealand Act 1989. The governor of the Reserve Bank is responsible for N ...
had sharply negative and relatively long-term consequences for both financial markets and the real economy in New Zealand. The crash of 1987 also altered
implied volatility In financial mathematics, the implied volatility (IV) of an option contract is that value of the volatility of the underlying instrument which, when input in an option pricing model (such as Black–Scholes), will return a theoretical value equa ...
patterns that arise in pricing financial
options Option or Options may refer to: Computing *Option key, a key on Apple computer keyboards *Option type, a polymorphic data type in programming languages *Command-line option, an optional parameter to a command *OPTIONS, an HTTP request method ...
. Equity options traded in American markets did not show a
volatility smile Volatility smiles are implied volatility patterns that arise in pricing financial options. It is a parameter (implied volatility) that is needed to be modified for the Black–Scholes formula to fit market prices. In particular for a given expi ...
before the crash but began showing one afterward.


United States


Background

From August 1982 to its peak in August 1987, the
Dow Jones Industrial Average The Dow Jones Industrial Average (DJIA), Dow Jones, or simply the Dow (), is a stock market index of 30 prominent companies listed on stock exchanges in the United States. The DJIA is one of the oldest and most commonly followed equity indexe ...
(DJIA) rose from 776 to 2,722, including a 69% year-to-date rise as of August 1987. The rise in market indices for the nineteen largest markets in the world averaged 296% during this period. The average number of shares traded on the
New York Stock Exchange The New York Stock Exchange (NYSE, nicknamed "The Big Board") is an American stock exchange in the Financial District of Lower Manhattan in New York City. It is by far the world's largest stock exchange by market capitalization of its listed co ...
rose from 32 million shares to 181 million shares. In late 1985 and early 1986, the United States economy shifted from a rapid recovery from the
early 1980s recession The early 1980s recession was a severe economic recession that affected much of the world between approximately the start of 1980 and 1983. It is widely considered to have been the most severe recession since World War II. A key event leading t ...
to a slower expansion, resulting in a brief " soft landing" period as the economy slowed and
inflation In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reducti ...
dropped. On the morning of Wednesday, October 14, 1987, the
United States House Committee on Ways and Means The Committee on Ways and Means is the chief tax-writing committee of the United States House of Representatives. The committee has jurisdiction over all taxation, tariffs, and other revenue-raising measures, as well as a number of other progra ...
introduced a tax bill that would reduce the tax benefits associated with financing mergers and
leveraged buyout A leveraged buyout (LBO) is one company's acquisition of another company using a significant amount of borrowed money ( leverage) to meet the cost of acquisition. The assets of the company being acquired are often used as collateral for the loa ...
s. Also, unexpectedly high
trade deficit The balance of trade, commercial balance, or net exports (sometimes symbolized as NX), is the difference between the monetary value of a nation's exports and imports over a certain time period. Sometimes a distinction is made between a balance ...
figures announced by the
United States Department of Commerce The United States Department of Commerce is an executive department of the U.S. federal government concerned with creating the conditions for economic growth and opportunity. Among its tasks are gathering economic and demographic data for busi ...
on October 14 had a negative impact on the value of the US dollar while pushing interest rates upward and stock prices downward. As the day continued, the DJIA dropped 95.46 points (3.81%) to 2,412.70, and it fell another 57.61 points (2.39%) the next day, down over 12% from the August 25 all-time high. On Friday, October 16, the DJIA fell 108.35 points (4.6%) to close at 2,246.74 on record volume. The drop on the 14th was the earliest significant decline among all countries that would later be affected by Black Monday. Though the markets were closed for the weekend, significant selling pressure still existed. The computer models of portfolio insurers continued to dictate very large sales. Moreover, some large
mutual fund A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICAV ...
groups had procedures that enabled customers to easily redeem their shares during the weekend at the same prices that existed at the close of market on Friday. The amount of these redemption requests was far greater than the firms' cash reserves, requiring them to make large sales of shares as soon as the market opened on the following Monday. Finally, some traders anticipated these pressures and tried to get ahead of the market by selling early and aggressively Monday, before the anticipated price drop.


The crash

Before the
New York Stock Exchange The New York Stock Exchange (NYSE, nicknamed "The Big Board") is an American stock exchange in the Financial District of Lower Manhattan in New York City. It is by far the world's largest stock exchange by market capitalization of its listed co ...
(NYSE) opened on Black Monday, October 19, 1987, there was pent-up pressure to sell stocks. When the market opened, a large imbalance immediately arose between the volume of sell orders and buy orders, placing considerable downward pressure on stock prices. Regulations at the time permitted designated
market maker A market maker or liquidity provider is a company or an individual that quotes both a buy and a sell price in a tradable asset held in inventory, hoping to make a profit on the '' bid–ask spread'', or ''turn.'' The benefit to the firm is that i ...
s (also known as "specialists") to delay or suspend trading in a stock if the order imbalance exceeded that specialist's ability to fulfill orders in an orderly manner. The order imbalance on October 19 was so large that 95 stocks on the
S&P 500 Index The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of ...
(S&P) opened late, as also did 11 of the 30 DJIA stocks. Importantly, however, the futures market opened on time across the board, with heavy selling. On Black Monday, the DJIA fell 508 points (22.6%), accompanied by crashes in the
futures exchange A futures exchange or futures market is a central financial exchange where people can trade standardized futures contracts defined by the exchange. Futures contracts are derivatives contracts to buy or sell specific quantities of a commodity or f ...
s and
options Option or Options may refer to: Computing *Option key, a key on Apple computer keyboards *Option type, a polymorphic data type in programming languages *Command-line option, an optional parameter to a command *OPTIONS, an HTTP request method ...
markets. This was the largest one-day percentage drop in the history of the DJIA. Significant selling created steep price declines throughout the day, particularly during the last 90 minutes of trading. Deluged with sell orders, many stocks on the NYSE faced
trading halt A trading halt occurs in the U.S. when a stock exchange stops trading on a specific security for a certain time period. The halt, which can happen a few times a day per security if FINRA deems it, usually lasts for one hour, but is not limited to ...
s and delays. Of the 2,257 NYSE-listed stocks, there were 195 trading delays and halts during the day.U.S. GAO op. cit. p.55 Total trading volume was so large that the computer and communications systems in place at the time were overwhelmed, leaving orders unfilled for an hour or more. Large funds transfers were delayed for hours and the
Fedwire Fedwire (formerly known as the Federal Reserve Wire Network) is a real-time gross settlement funds transfer system operated by the United States Federal Reserve Banks that allows financial institutions to electronically transfer funds between its ...
and NYSE
SuperDot SuperDot was the electronic system used by the New York Stock Exchange to route market orders and limit orders from investors or their agents to a specialist located on the floor of the exchange. SuperDot was the upgraded form of the previous ele ...
systems shut down for extended periods, further compounding traders' confusion.


Margin calls and liquidity

Frederic Mishkin suggested that the greatest economic danger was not events on the day of the crash itself, but the potential for "spreading collapse of securities firms" if an extended
liquidity crisis In financial economics, a liquidity crisis is an acute shortage of ''liquidity''. Liquidity may refer to market liquidity (the ease with which an asset can be converted into a liquid medium, e.g. cash), funding liquidity (the ease with which borrow ...
in the securities industry began to threaten the
solvency Solvency, in finance or business, is the degree to which the current assets of an individual or entity exceed the current liabilities of that individual or entity. Solvency can also be described as the ability of a corporation to meet its long-ter ...
and viability of
brokerage house A broker is a person or firm who arranges transactions between a buyer and a seller for a commission when the deal is executed. A broker who also acts as a seller or as a buyer becomes a principal party to the deal. Neither role should be confu ...
s and specialists. This possibility first loomed on the day after the crash. At least initially, there was a very real risk that these institutions could fail. If that happened,
spillover effect In economics a spillover is an economic event in one context that occurs because of something else in a seemingly unrelated context. For example, externalities of economic activity are non-monetary spillover effects upon non-participants. Odors ...
s could sweep over the entire financial system, with negative consequences for the
real economy The real economy concerns the production, purchase and flow of goods and services (like oil, bread and labour) within an economy. It is contrasted with the financial economy, which concerns the aspects of the economy that deal purely in transac ...
as a whole. As Robert R. Glauber stated, "From our perspective on the Brady Commission, Black Monday may have been frightening, but it was the capital-liquidity problem on Tuesday that was horrifying." The source of these liquidity problems was a general increase in
margin call ''Margin Call'' is a 2011 American drama film written and directed by J. C. Chandor in his feature directorial debut. The principal story takes place over a 24-hour period at a large Wall Street investment bank during the initial stages of th ...
s; after the market's plunge, these were about 10 times their average size and three times greater than the highest previous morning variation call. Several firms had insufficient cash in customers' accounts (that is, they were "undersegregated"). Firms drawing funds from their own capital to meet the shortfall sometimes became undercapitalized; 11 firms received margin calls from a single customer that exceeded that firm's adjusted net capital, sometimes by as much as two-to-one. Investors needed to repay end-of-day margin calls made on October 19 before the opening of the market on October 20. Clearinghouse member firms called on lending institutions to extend credit to cover these sudden and unexpected charges, but the brokerages requesting additional credit began to exceed their credit limit. Banks were also worried about increasing their involvement and exposure to a chaotic market. The size and urgency of the demands for credit placed upon banks was unprecedented. In general,
counterparty risk A credit risk is risk of default on a debt that may arise from a borrower failing to make required payments. In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased ...
increased as the creditworthiness of counterparties and the value of collateral posted became highly uncertain. The Black Monday decline was, and currently remains, the biggest drop on the
List of largest daily changes in the Dow Jones Industrial Average This is a list of the largest daily changes in the Dow Jones Industrial Average from 1896. Compare to the list of largest daily changes in the S&P 500 Index. Largest percentage changes The first four tables show only the largest one-day change ...
. (Saturday, December 12, 1914, is sometimes erroneously cited as the largest one-day percentage decline of the DJIA. In reality, the ostensible decline of 24.39% was created retroactively by a redefinition of the DJIA in 1916.)


Federal Reserve response

" e response of monetary policy to the crash," according to economist
Michael Mussa Michael Louis Mussa (April 15, 1944 – January 15, 2012) was an American economist and academic. He was chief economist at the International Monetary Fund from 1991 to 2001 and was a member of the Council of Economic Advisers from 1986 to 1988. H ...
, "was massive, immediate and appropriate." One day after the crash, the
Federal Reserve The Federal Reserve System (often shortened to the Federal Reserve, or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after ...
began to act as the
lender of last resort A lender of last resort (LOLR) is the institution in a financial system that acts as the provider of liquidity to a financial institution which finds itself unable to obtain sufficient liquidity in the interbank lending market when other facil ...
to counter the crisis. Its
crisis management Crisis management is the process by which an organization deals with a disruptive and unexpected event that threatens to harm the organization or its stakeholders. The study of crisis management originated with large-scale industrial and envir ...
approach included issuing a terse, decisive public pronouncement; supplying liquidity through
open market operation In macroeconomics, an open market operation (OMO) is an activity by a central bank to give (or take) liquidity in its currency to (or from) a bank or a group of banks. The central bank can either buy or sell government bonds (or other financial as ...
s; persuading banks to lend to securities firms; and in a few specific cases, direct action tailored to a few firms' needs. On the morning of October 20, Fed Chairman
Alan Greenspan Alan Greenspan (born March 6, 1926) is an American economist who served as the 13th chairman of the Federal Reserve from 1987 to 2006. He works as a private adviser and provides consulting for firms through his company, Greenspan Associates LLC. ...
made a brief statement: "The Federal Reserve, consistent with its responsibilities as the Nation's central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system". Fed sources suggested that the brevity was deliberate, in order to avoid misinterpretations. This "extraordinary" announcement probably had a calming effect on markets that were facing an equally unprecedented demand for liquidity and the immediate potential for a liquidity crisis. The market rallied after that announcement, gaining around 200 points, but the rally was short-lived. By noon the gains had been erased and the slide had resumed. The Fed then acted to provide
market liquidity In business, economics or investment, market liquidity is a market's feature whereby an individual or firm can quickly purchase or sell an asset without causing a drastic change in the asset's price. Liquidity involves the trade-off between the ...
and prevent the crisis from expanding into other markets. It immediately began injecting its reserves into the financial system via purchases on the open market. On 20 October it injected $17 billion into the banking system through the open market – an amount that was more than 25% of bank reserve balances and 7% of the
monetary base In economics, the monetary base (also base money, money base, high-powered money, reserve money, outside money, central bank money or, in the UK, narrow money) in a country is the total amount of money created by the central bank. This includ ...
of the entire nation. This rapidly pushed the federal funds rate down by 0.5%. The Fed continued its expansive open market purchases of securities for weeks. The Fed also repeatedly began these interventions an hour before the regularly scheduled time, notifying dealers of the schedule change on the evening beforehand. This was all done in a very high-profile and public manner, similar to Greenspan's initial announcement, to restore market confidence that liquidity was forthcoming. Although the Fed's holdings expanded appreciably over time, the speed of expansion was not excessive. Moreover, the Fed later disposed of these holdings so that its long-term policy goals would not be adversely affected. The Fed successfully met the unprecedented demands for credit by pairing a strategy of
moral suasion Moral suasion is an appeal to morality, in order to influence or change behavior. A famous example is the attempt by William Lloyd Garrison and his American Anti-Slavery Society to end slavery in the United States by using moral suasion. In econ ...
that motivated nervous banks to lend to securities firms alongside its moves to reassure those banks by actively supplying them with liquidity. As economist
Ben Bernanke Ben Shalom Bernanke ( ; born December 13, 1953) is an American economist who served as the 14th chairman of the Federal Reserve from 2006 to 2014. After leaving the Fed, he was appointed a distinguished fellow at the Brookings Institution. Duri ...
(who was later to become Chairman of the Federal Reserve) wrote: The Fed's two-part strategy was thoroughly successful, since lending to securities firms by large banks in Chicago and especially in New York increased substantially, often nearly doubling.


United Kingdom

On Friday, October 16, all the markets in London were unexpectedly closed due to the Great Storm of 1987. After they re-opened, the speed of the crash accelerated, partially attributed by some to the storm closure. By 9:30AM, the
FTSE 100 Index The Financial Times Stock Exchange 100 Index, also called the FTSE 100 Index, FTSE 100, FTSE, or, informally, the "Footsie" , is a share index of the 100  companies listed on the London Stock Exchange with (in principle) the highest market ...
had fallen over 136 points. It was down 23% in two days, roughly the same percentage that the
NYSE The New York Stock Exchange (NYSE, nicknamed "The Big Board") is an American stock exchange in the Financial District of Lower Manhattan in New York City. It is by far the world's largest stock exchange by market capitalization of its listed co ...
dropped on the day of the crash. Stocks then continued to fall, albeit at a less precipitous rate, until reaching a trough in mid-November at 36% below its pre-crash peak. Stocks did not begin to recover until 1989.


Japan

In Japan, the October 1987 crash is sometimes referred to as "Blue Tuesday", in part because of the time zone difference, and in part because its effects after the initial crash were relatively mild. In both places, according to economist Ulrike Schaede, the initial market break was severe: the Tokyo market declined 14.9% in one day, and Japan's losses of US$421 billion ranked next to New York's $500 billion, out of a worldwide total loss of $1.7 trillion. However, systemic differences between the US and Japanese financial systems led to significantly different outcomes during and after the crash on Tuesday, October 20. In Japan the ensuing panic was no more than mild at worst. The
Nikkei 225 The Nikkei 225, or , more commonly called the ''Nikkei'' or the ''Nikkei index'' (), is a stock market index for the Tokyo Stock Exchange (TSE). It has been calculated daily by the ''Nihon Keizai Shimbun'' (''The Nikkei'') newspaper since 1950. ...
Index returned to its pre-crash levels after only five months. Other global markets performed less well in the aftermath of the crash, with New York, London and Frankfurt all needing more than a year to achieve the same level of recovery. Several of Japan's distinctive institutional characteristics already in place at the time, according to
economist An economist is a professional and practitioner in the social science discipline of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy. Within this field there are ...
David D. Hale, helped it dampen volatility. These included
trading curb A trading curb (typically known as a circuit breaker in Wall Street parlance) is a financial regulatory instrument that is in place to prevent stock market crashes from occurring, and is implemented by the relevant stock exchange organization. Si ...
s such as a sharp limit on price movements of a share of more than 10–15%; restrictions and institutional barriers to
short-selling In finance, being short in an asset means investing in such a way that the investor will profit if the value of the asset falls. This is the opposite of a more conventional " long" position, where the investor will profit if the value of the ...
by domestic and international traders; frequent adjustments of
margin requirement In finance, margin is the collateral that a holder of a financial instrument has to deposit with a counterparty (most often their broker or an exchange) to cover some or all of the credit risk the holder poses for the counterparty. This risk ...
s in response to changes in volatility; strict guidelines on
mutual fund A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe include the SICAV ...
redemptions; and actions of the
Ministry of Finance A ministry of finance is a part of the government in most countries that is responsible for matters related to the finance. Lists of current ministries of finance Named "Ministry" * Ministry of Finance (Afghanistan) * Ministry of Finance and Eco ...
to control the total shares of stock and exert
moral suasion Moral suasion is an appeal to morality, in order to influence or change behavior. A famous example is the attempt by William Lloyd Garrison and his American Anti-Slavery Society to end slavery in the United States by using moral suasion. In econ ...
on the securities industry. An example of the latter occurred when the ministry invited representatives of the four largest securities firms to tea in the early afternoon of the day of the crash. After tea at the ministry, these firms began to make large purchases of stock in
Nippon Telegraph and Telephone , commonly known as NTT, is a Japanese telecommunications company headquartered in Tokyo, Japan. Ranked 55th in ''Fortune'' Global 500, NTT is the fourth largest telecommunications company in the world in terms of revenue, as well as the third l ...
.


Hong Kong

The worst decline among world markets was in Hong Kong, with a drop of 45.8%. In its biggest-ever single fall, the Hang Seng Index of the Hong Kong Stock Exchange dropped 420.81 points on Black Monday, eliminating HK$65 billion' (10%) of the value of its shares. Noting the continued fall of New York markets on their next trading day, and fearing steep drops or even total collapse of their own exchanges, in Hong Kong the Stock Exchange Committee and the committee of the Futures Exchange announced the following morning that both markets would be closed. Their closure lasted for four working days. Their decision was motivated in part by the very real possibility that market collapse could have extremely serious consequences for the entire financial system of Hong Kong, perhaps resulting in rioting in the streets, with the added threat of intervention by the army of the People's Republic of China. According to Neil Gunningham, a further motivation for the closures was brought on by a significant conflict of interest: many of these committee members were themselves futures brokers, and their firms were in danger of substantial defaults from their clients. Although the stock exchange was in distress, structural flaws in the futures exchange, which was then world's most heavily traded outside the U.S., were at the heart of the greater financial crisis. The structure of the Hong Kong Futures Exchange differed greatly from many other exchanges around the world. In many countries, large institutional investors dominate the market. Their principal motivation for futures transactions is hedging. In Hong Kong, the market itself, as well as many of its traders and brokers, was inexperienced. It was composed heavily of small, local investors who were relatively uninformed and unsophisticated, had only a short-term commitment to the market, and whose goals were primarily speculative rather than hedging. Among all parties involved, there was little or no expectation of the possibility of a crash or a steep decline, or understanding of the consequences of such a fall. In fact, speculative investing that depended on the bull market to continue was prevalent among individual investors, often including the brokers themselves. The key shortcomings of the futures exchange, however, were mismanagement and a failure of regulatory diligence and design. These failures were particularly grave in the area of credit controls. In Hong Kong, the approach to credit control involved a system of margins and margin calls plus a Guarantee Corporation backed by a guarantee fund. Although on paper the Hong Kong exchange's margin requirements were in line with those of other major markets, in practice brokers regularly extended credit with little regard for risk. In a lax, freewheeling and fiercely competitive environment, margin requirements were routinely cut in half and sometimes ignored altogether. Hong Kong also had no suitability requirements that would force brokers to screen their customers for ability to repay any debts. The absence of oversight creates an imbalance of risk due to
moral hazard In economics, a moral hazard is a situation where an economic actor has an incentive to increase its exposure to risk because it does not bear the full costs of that risk. For example, when a corporation is insured, it may take on higher ri ...
: it becomes profitable for traders with low cash reserves to speculate in futures, reaping benefits if they speculate correctly, but simply defaulting if their hunches are wrong. If there is a wave of dishonored contracts, brokers become liable for their clients' losses, potentially facing bankruptcy themselves. Finally, the Guarantee Corporation was severely underfunded, with capital on hand of only HK $15 million (US $2 million). That amount was obviously inadequate for dealing with any large number of clients' defaults in a market trading around 14,000 contracts a day, with an underlying value of HK$4.3 billion. The Black Monday crash initially left about 36,400 contracts worth HK$6.7 billion S $1 billionoutstanding. As late as April 1988, HK$800 million of this still had not been settled. According to Neil Gunningham, the accumulative effect of these shortcomings was nearly fatal to the Hong Kong futures market: "Whereas futures exchanges elsewhere n the worldemerged from the crash with only minor casualties, the crisis in Hong Kong has resulted, at least in the short term, in the virtual demolition of the Futures Exchange." Finally, in the interest of preserving political stability and public order, the Hong Kong government was forced to rescue the Guarantee Fund by providing a bail-out package of HK$4 billion dollars.


New Zealand

The crash of the New Zealand stock market was notably long and deep, continuing its decline for an extended period after other global markets had recovered. Unlike other nations, moreover, for New Zealand the effects of the October 1987 crash spilled over into its real economy, contributing to a prolonged recession. The effects of the worldwide economic boom of the mid-1980s had been amplified in New Zealand by the relaxation of
foreign exchange controls Foreign exchange controls are various forms of controls imposed by a government on the purchase/sale of foreign currencies by residents, on the purchase/sale of local currency by nonresidents, or the transfers of any currency across national bor ...
and a wave of banking deregulation. Deregulation in particular suddenly gave financial institutions considerably more freedom to lend, though they had little experience in doing so. The finance industry was in a state of increasing optimism that approached euphoria. This created an atmosphere conducive to greater
financial risk Financial risk is any of various types of risk associated with financing, including financial transactions that include company loans in risk of default. Often it is understood to include only downside risk, meaning the potential for financia ...
taking including increased
speculation In finance, speculation is the purchase of an asset (a commodity, goods, or real estate) with the hope that it will become more valuable shortly. (It can also refer to short sales in which the speculator hopes for a decline in value.) Many ...
in the stock market and real estate. Foreign investors participated, attracted by New Zealand's relatively high interest rates. From late 1984 until Black Monday, commercial property prices and commercial construction rose sharply, while share prices in the stock market tripled. New Zealand's stock market fell nearly 15% on the first day of the crash. In the first three-and-a-half months following the crash, the value of New Zealand's market shares was cut in half. By the time it reached its
trough Trough may refer to: In science * Trough (geology), a long depression less steep than a trench * Trough (meteorology), an elongated region of low atmospheric pressure * Trough (physics), the lowest point on a wave * Trough level (medicine), the l ...
in February 1988, the market had lost 60% of its value. The financial crisis triggered a wave of
deleveraging At the micro-economic level, deleveraging refers to the reduction of the leverage ratio, or the percentage of debt in the balance sheet of a single economic entity, such as a household or a firm. It is the opposite of leveraging, which is the pr ...
with significant macro-economic consequences. Investment companies and property developers began a
fire sale A fire sale is the sale of goods at extremely discounted prices. The term originated in reference to the sale of goods at a heavy discount due to fire damage. It may or may not be defined as a closeout, the final sale of goods to zero inventory ...
of their properties, partially to help offset their share price losses, and partially because the crash had exposed overbuilding. Moreover, these firms had been using property as collateral for their increased borrowing. When property values collapsed, the health of balance sheets of lending institutions was damaged. The Reserve Bank of New Zealand declined to loosen monetary policy in response to the crisis – which would have helped firms settle their obligations and remain in operation. As the harmful effects spread over the next few years, major corporations and financial institutions went out of business, and the banking systems of New Zealand and Australia were impaired. Access to credit was reduced. In fact, because of legislation requiring the
Reserve Bank of New Zealand The Reserve Bank of New Zealand (RBNZ, mi, Te Pūtea Matua) is the central bank of New Zealand. It was established in 1934 and is constituted under the Reserve Bank of New Zealand Act 1989. The governor of the Reserve Bank is responsible for N ...
to achieve an inflation rate no higher than 2 percent by 1993, interest rates were volatile, with multiple increases. The combination of these contributed significantly to a long recession running from 1987 until 1993.


Possible causes

Discussions of the causes of the Black Monday crash frequently focus on two theoretical models, which differ in whether they focus on variables that are exogenous or endogenous. The first framework searches for exogenous factors, such as significant news events, that affect investor perceptions and behavior. These events are taken as "triggers" of market behavior. The second, "cascade theory" or "market meltdown", attempts to identify endogenous internal market dynamics and interactions of systemic variables or trading strategies such that an order imbalance leads to a price change, this price change in turn leads to further order imbalance, which leads to further price changes, and so on in a spiralling cascade. It is possible that both could occur, if a trigger sets off a cascade.


Market triggers

The crisis affected markets around the world; however, no international news event or change in market fundamentals has been shown to have had a strong effect on investor behavior. Several exogenous events have been cited as potential triggers for the initial fall in stock prices: a general feeling that stocks were overvalued and were certain to undergo a correction, the decline of the dollar, persistent trade and budget deficits, a proposed tax change that would make corporate takeovers more costly, rising interest rates, and uncertainties regarding the
Louvre Accord The Louvre Accord (formally, the Statement of the G6 Finance Ministers and Central Bank Governors) was an agreement, signed on February 22, 1987, in Paris, that aimed to stabilize international currency markets and halt the continued decline of t ...
. Sources have questioned whether these news events led to the crash. Nobel-prize winning economist
Robert J. Shiller Robert James Shiller (born March 29, 1946) is an American economist, academic, and author. As of 2019, he serves as a Sterling Professor of Economics at Yale University and is a fellow at the Yale School of Management's International Center for ...
surveyed 889 investors (605 individual investors and 284 institutional investors) immediately after the crash regarding several aspects of their experience at the time. Only three institutional investors and no individual investors reported a belief that the news regarding proposed tax legislation was a trigger for the crash. According to Shiller, the most common responses were related to a general mindset of investors at the time: a "gut feeling" of an impending crash, perhaps brought on by "too much indebtedness".


Market meltdown


De-linked markets and index arbitrage

Under normal circumstances the stock market and those of its main derivatives–futures and options–are functionally a single market, given that the price of any particular
stock In finance, stock (also capital stock) consists of all the shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which ownership of a company ...
is closely connected to the prices of its counterpart in both the futures and options market. Prices in the derivative markets are typically tightly connected to those of the underlying stock, though they differ somewhat (as for example, prices of futures are typically higher than that of their particular cash stock). During the crisis this link was broken. When the futures market opened while the stock market was closed, it created a pricing imbalance: the listed price of those stocks which opened late had no chance to change from their closing price of the day before. The quoted prices were thus "stale" and did not reflect current economic conditions; they were generally listed higher than they should have been (and dramatically higher than their respective futures, which are typically higher than stocks). The decoupling of these markets meant that futures prices had temporarily lost their validity as a vehicle for
price discovery In economics and finance, the price discovery process (also called price discovery mechanism) is the process of determining the price of an asset in the marketplace through the interactions of buyers and sellers. Overview Price discovery is dif ...
; they no longer could be relied upon to inform traders of the direction or degree of stock market expectations. This had harmful effects: it added to the atmosphere of uncertainty and confusion at a time when investor confidence was sorely needed; it discouraged investors from "leaning against the wind" and buying stocks since the discount in the futures market logically implied that investors could wait and purchase stocks at an even lower price; and it encouraged portfolio insurance investors to sell in the stock market, putting further downward pressure on stock prices. The gap between the futures and stocks was quickly noted by
index arbitrage Index arbitrage is a subset of statistical arbitrage focusing on index components. An index (such as S&P 500) is made up of several components (in the case of the S&P 500, 500 large US stocks picked by S&P to represent the US market), and the val ...
traders who tried to profit through sell at market orders. Index arbitrage, a form of
program trading Program trading is a type of trading in securities, usually consisting of baskets of fifteen stocks or more that are executed by a computer program simultaneously based on predetermined conditions. Program trading is often used by hedge funds an ...
, added to the confusion and the downward pressure on prices: Although arbitrage between index futures and stocks placed downward pressure on prices, it does not explain why the surge in sell orders that brought steep price declines began in the first place. Moreover, the markets "performed most chaotically" during those times when the links that index arbitrage program trading creates between these markets was ''broken''.


Portfolio insurance hedges

Portfolio insurance Portfolio insurance is a hedging strategy developed to limit the losses an investor might face from a declining index of stocks without having to sell the stocks themselves. The technique was pioneered by Hayne Leland and Mark Rubinstein in 1976. ...
is a hedging technique which attempts to manage risk and limit losses by buying and selling
financial instrument Financial instruments are monetary contracts between parties. They can be created, traded, modified and settled. They can be cash (currency), evidence of an ownership interest in an entity or a contractual right to receive or deliver in the form ...
s (for example, stocks or futures) in reaction to changes in market price rather than changes in market fundamentals. Specifically, they buy when the market is rising, and sell when the market is falling, without regard for any fundamental information about ''why'' the market is rising or falling. Thus it is an example of an "informationless trade" that has the potential to create a market-destabilizing feedback loop. This strategy became a source of downward pressure when portfolio insurers whose computer models noted that stocks opened lower and continued their steep price decline. The models recommended even further sales. The potential for computer-generated feedback loops that these hedges created has been discussed as a factor compounding the severity of the crash, but not as an initial trigger. Economist
Hayne Leland Hayne Leland is an economist and professor emeritus at the University of California, Berkeley. Prior to becoming emeritus, he was the Arno Rayner Professor of Finance at the Haas School of Business. Before joining Berkeley, Leland was an assistan ...
argues against this interpretation, suggesting that the impact of portfolio hedging on stock prices was probably relatively small. Similarly, the report of the
Chicago Mercantile Exchange The Chicago Mercantile Exchange (CME) (often called "the Chicago Merc", or "the Merc") is a global derivatives marketplace based in Chicago and located at 20 S. Wacker Drive. The CME was founded in 1898 as the Chicago Butter and Egg Board, an a ...
found the influence of "other investors—mutual funds, broker-dealers, and individual shareholders—was thus three to five times greater than that of the portfolio insurers" during the crash. Numerous econometric studies have analyzed the evidence to determine whether portfolio insurance exacerbated the crash, but the results have been unclear. Markets around the world that did not have portfolio insurance trading experienced as much turmoil and loss as the U.S. market. More to the point, the cross-market analysis of
Richard Roll Richard Roll (born October 31, 1939) is an American economist and professor of finance at UCLA, best known for his work on portfolio theory and asset pricing, both theoretical and empirical. He earned his bachelor's degree in aerospace engineerin ...
, for example, found that markets with a greater prevalence of computerized trading (including portfolio insurance) actually experienced relatively less severe losses (in percentage terms) than those without.


Noise trading

Contemporaneous causality and feedback behavior between markets increased dramatically during this period. In an environment of increased volatility, confusion and uncertainty, investors not only in the US but also across the world were inferring information from changes in stock prices and communication with other investors in a self-reinforcing contagion of fear. This pattern of basing trading decisions largely on market psychology is often referred to as one form of "noise trading", which occurs when ill-informed investors " radeon noise as if it were news". A significant amount of trading takes place based on information which is unquantifiable and potentially irrelevant, such as unsubstantiated rumors or a "gut feeling",. Investors vary between seemingly rational and irrational behaviors as they "struggle to find their way between the give and take, between risk and return, one moment engaging in cool calculation and the next yielding to emotional impulses". If noise is misinterpreted as meaningful news, then the reactions of risk-averse traders and arbitrageurs will bias the market, preventing it from establishing prices that accurately reflect the fundamental state of the underlying stocks. For example, on October 19 rumors that the New York Stock Exchange would close created additional confusion and drove prices further downward, while rumors the next day that two
Chicago Mercantile Exchange The Chicago Mercantile Exchange (CME) (often called "the Chicago Merc", or "the Merc") is a global derivatives marketplace based in Chicago and located at 20 S. Wacker Drive. The CME was founded in 1898 as the Chicago Butter and Egg Board, an a ...
clearinghouses were insolvent deterred some investors from trading in that marketplace. A
feedback loop Feedback occurs when outputs of a system are routed back as inputs as part of a chain of cause-and-effect that forms a circuit or loop. The system can then be said to ''feed back'' into itself. The notion of cause-and-effect has to be handled ...
of noise-induced-volatility has been cited by some analysts as the major reason for the severe depth of the crash. It does not, however, explain what initially triggered the market break. Moreover, Lawrence A. Cunningham has suggested that while noise theory is "supported by substantial empirical evidence and a well-developed intellectual foundation", it makes only a partial contribution toward explaining events such as the crash of October 1987. Informed traders, not swayed by psychological or emotional factors, have room to make trades they know to be less risky.


Resulting regulation

After Black Monday, regulators overhauled trade-clearing protocols to bring uniformity to all prominent market products. They also developed new rules, known as "
trading curb A trading curb (typically known as a circuit breaker in Wall Street parlance) is a financial regulatory instrument that is in place to prevent stock market crashes from occurring, and is implemented by the relevant stock exchange organization. Si ...
s" or colloquially as circuit breakers, allowing exchanges to temporarily halt trading in instances of exceptionally large price declines in some indexes; for instance, the DJIA. These trading curbs were first used multiple times during the
2020 stock market crash On 20 February 2020, stock markets across the world suddenly crashed after growing instability due to the COVID-19 pandemic. It ended on 7 April 2020. Beginning on 13 May 2019, the yield curve on U.S. Treasury securities inverted, and re ...
.


See also

* 2010 Flash Crash *
List of largest daily changes in the Dow Jones Industrial Average This is a list of the largest daily changes in the Dow Jones Industrial Average from 1896. Compare to the list of largest daily changes in the S&P 500 Index. Largest percentage changes The first four tables show only the largest one-day change ...
*
Wall Street Crash of 1929 The Wall Street Crash of 1929, also known as the Great Crash, was a major American stock market crash that occurred in the autumn of 1929. It started in September and ended late in October, when share prices on the New York Stock Exchange coll ...
(Black Tuesday) *
Black Monday (TV series) ''Black Monday'' is an American historical dark comedy television series created by Jordan Cahan and David Caspe that premiered on January 20, 2019, on Showtime. The series stars Don Cheadle, Andrew Rannells, Regina Hall, Casey Wilson, and Pa ...
* Black Monday (2020)


Footnotes


References


Sources

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Further reading

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External links


CNBC Remembering the Crash of 1987

Black Monday photographs
{{Authority control 1987 in New York City 1987 disasters 1987 in economics Economic crises in the United States Financial crises Stock market crashes 1987 in international relations Monday October 1987 events in the United States