Skip to comments.A College Freshman History Text on the Stock Market Crash of 1987.
Posted on 08/22/2006 10:51:02 AM PDT by mcvey
A seeming epidemic of greed and self-absorbed materialism had spread through the country. Wall Street witnessed a rash of arrests and convictions . . . .
And more government officials, including Attorney General Edwin Meese, became entangled in the web of corruption. Commentators talked of a compulsive materialism energizing the . . . professionals dubbed Yuppies. Caught up in the race for money, goods, and status, these baby boomers in the fast lane captured the tone and mood of affluent life in the 1980s.
Then on October 19, 1987, the bill collector suddenly arrived at the nations doorstep.
The Dow Jones industrial average plummeted . . . an astounding 22.6 percent.
What caused such a goring of the bull market?
But most [analysts] agreed that the . . . problem was the nations spiraling indebtedness and chronically high trade deficits. Americans were consuming more than they were producing, importing the difference, and paying for with borrowed money . . . Foreign investors had lost confidence in Reaganomics and were no longer willing to finance Americas spending binge.
For the first time, [Reagan] indicated that he was willing to include increased taxes in such a package. Yet the eventual compromise plan was so modest that it did little to restore investor confidence. As one Republican senator lamented: There is a total lack of courage among those of us in the Congress to do what we all know has to be done.
George Brown Tindall and David Shi, American A Narrative History (New York: W. W. Norton & Company, 2004) Brief Sixth Ed., pp. 1188-1189.
The mergers and acquisitions wave of the 1980s was fueled in larger part by changing finance technology - the signficantly increased use of leverage in the form of corporate debt of one kind or another (including high yield or 'junk' bonds), pay-in-kind (PIK) preferred stocks and the like. Clever businessmen and their counsel in the very early 1980s understood that as stocks had declined in the 1970s, and given accounting rules, companies often held assets (often real estate) whose value the public reports understated - a value that could be unlocked and realized if one took over the company. Since directors often did not want to sell their companies, at least in the case of publicly held companies, tender offers were devised. Those deals were a lot of fun in 1981. Later, management and venture capitalists decided to get in on the good thing, and you had the wave of leveraged buyouts as well as the increased use of tender offers.
Bankers, lawyers and finance types - and investors - operate in a herd mentality - they want to do the same deals everyone else is doing that make money. So, as a few very smart guys made a very large amount of money doing takeovers, everyone wanted to get in on the good times. Banks wanted fees (and equity kickers to the extend permitted) and to book loans, investment bankers geared up to find deal and marry investors with takeover artists (who always like OPM - other peoples money) to do even bigger and better deals.
Most of early deals were very strong economically, as there was little competition and the smart guys could choose only the most profitable deals. As the 1980's moved along, with more and more people trying to do deals, the quality of the deals declined (although their size increased) and the degree of leverage and riskiness of the financing increased. Dramatically.
And, of course, the Tax Reform Act of 1986 - overall a good thing - played a role by eliminating some of the best takeover techniques, making deals harder and harder to do.
So was it greed? sure, but not in some malevolent Machiavellian sense. Were there guys (and gals) who went to far and broke the law? sure. insider trading, and the like happened, and was usually prosecuted.
The market crash affected the deal market buy tightening the financing availability and raising interest rates and the amount of equity needed (reduced the leverage those financing deals were willing to tolerage).
Hope that's useful.
That's very interesting. I was a corporate associate at a large corporate and securities law firm in New York City at the time, and a huge leveraged buyout deal that our firm was working on collapsed a short time before the crash (within a week, as I recall). People in the firm used to joke that our firm caused the crash, but I was not involved in that deal and never understood the connection between the two.
We researched to find quotes for a whole bunch of options - well-known stocks - for that week because a major player went under and we needed to calculate his net balance for each of those days. We couldn't - there weren't any quotes at all for many options.
PS. At least a solid majority, if not 2/3, of the people doing all of this financing and lbo-ing and m&a activity were good liberal Democrats - in the law firms, the investment banks and the investors. And the managerial and executive groups.
I wish I had time, but this is almost complete without basis in fact.
Combine automated sell programs with the use of stock as collateral in backing loans . . .
Boesky and Milken didn't get a mention I see. Meese, who was completely exonerated, however, did.
He wrote a 6 volume set of paperback textbooks published by the American Textbook Committee called "A Basic History of the United States". It was no-frills but it was much appreciated by conservative professors in the late 70s.
IMO every book he wrote is excellent - and I read them all in college. Many I still have. "Fateful Turn", "Flight From Reality", "World In the Grip of An Idea".
However, it won't be permanent and people who bought their homes prior to the start of the boom and who have no plans to sell or refinance will not be affected too badly.
I bought my current house in the summer of 2001, it is now worth about three times what I paid for it. I put close to 20% down and I have not taken any equity out (though I did refinance last year for a lower rate). I fully expect the house to lose a fair percentage of it's value over the next year, but I don't plan to move anytime soon, I don't need to refinance and I don't need an equity loan. So the reality is that all I will lose is some paper profits that I never had any real plans to cash in on. If for some reason I decided to move (and that would be a "geographic" move, not "upsizing"), I would get less in a year than I would now, but I would also be paying less for the house I was buying -- the real negative would be the higher interest rate, but when you look at the history of mortgage rates, the "higher" rates of today would still have been a "bargain" just a decade ago.
It would no have been either!
Boesky was out in the early 1980s. Milken (and his firm, Drexel Burnham Lambert) stayed extremely active until some time in 1989, I believe.
Why would the LA market affect those whose market is NOT declining ?
Boesky pled guilty in the fall of 1986 and Milken was under investigation by the summer of 1987. And they were both big Democrats (one of Milken's biggest "fans" was Jesse Jackson).
You have a good sense of humor for a pencil head. LOL.
Boesky was indicted in 1984 or 1985, I believe. I personally worked on nearly half a dozen Drexel deals in 1988 alone, and although Drexel had to put language in its disclosure documents reporting that the SEC was looking at it this did not stop the company from doing its deals. The 1987 market crash had no effect on its activities, as far as I know.
I don't care for Kelly. Maybe because I attended UCSB when he was teaching there.
M&C are all right. But I'm suggesting if you have to have ONE, ours is the most comprehensive. And, of course, M&C are not updated now, so you'd be missing half the 20th century.
After the crash, the stock exchanges established new procedures to limit computerized trading and stabilize the market when the market has made a big move in either direction. Since 1987, the market has been much more stable and hasn't had any huge one-day moves....the biggest one-day moves have been in the 3-5% range.
I wouldn't use that textbook. It's sounds stunningly biased to me.
Because if you live in say, Wisconsin, and work for the Kohler company, then your job may be impacted because they're selling fewer toilets etc. If you live in Georgia and work for a lumber company, then your job will be impacted. Places like Home Depot will cut personnel and close stores across the country to keep their stock prices up.
The housing bubble doesn't happen in a vacuum. People in one part of the country don't get to sit back and watch the crash as if it's happening on TV. Housing is such a large part of the economy that mostly everyone will feel it, if not in the price of their homes then at their jobs.
The price of homes and real estate goes up and down. Always has and always will. That's not what concerns me. What concerns me is the impact of a real estate crash on the rest of the economy.
For what it's worth I'll give you my own take and why I was short the market when it occurred.
There had been a seven year bull market, a very good market in fact and if you overlay a chart of the period to the 1929 crash to 1987 there are some disquieting similarities. There is absolutely no question in my mind that the physiological state of mind was jittery.
Why it happened on that day and not another day/week/month or whatever instead is a mystery to me but it was obvious from pre market fair value numbers that something was up and it was going to be big.
Once the spit hit the fan it was unquestionably exacerbated by program trading and the inability of the markets to execute trades. I tried to close my short positions and, fortunately, my broker, a big name house, couldn't get the trade entered. I say fortunately because there was still more downside coming.
So the best I can do is the first was a psychological panic and then technology run amok with program trading that went off the deep end. Subsequently the exchanges instituted "circuit breakers" that, when the market moved a certain amount program trading was suspended. I think this fact indicates that the exchanges realized that a large part of the program was program trading. I hadn't thought about it in a while but I can't recall the last time the circuit brakers went into effect.
Obviously lots of personal opinion and very little fact, but it's the best I can put my finger on after spending every day since trying to figure it out.
I don't think I could have just one.... :-) not even in Europe anymore where I'd use both the Palmer, et. al. The Making of the Modern World and Barzun's From Dawn to Decadence.... CHeers!
That's about it. All the institutional computers were kicking in with the same set of parameters at lightning speed. It was caos.
As I remember it, the NASDAQ didn't get hit nearly as bad, but NASDAQ was a whole lot more computer savvy than New York.
The New York exchange resisted moving to computers for the longest time. Old fogeyism at its finest. After the bloodbath, they had a whole new attitude.
The market was looking bad in Sept 87. I didn't want to sell my stocks and get lots of capital gains taxes on stocks I had owned for 40 years. I sold many call options and did fairly well, but was surprised at the steepness of the October 19 drop in prices. One company was selling at half its value, and if I had been more of a gambler I could have made lots of money buying it since its price recovered in a few days. What one needs to succeed in the stock market is an oversupply of luck.
I know a lot of people who learned their lesson six years ago. They have made some serious money in real estate in the past few years, but they have been slowly cashing out since last summer. They are sitting on a bunch of cash right now and they are ready to go in and pick up some real bargains when things start bottoming out.
In retrospect, 2000 wasn't that bad (as I said earlier, nothing in the past quarter century has seemed as bad as the Carter years) and I don't think the real estate downturn will be as bad as people think.
Wasn't ol Ivan busted for his junk bond stuff?
Let's hope it's not as bad. For a lot of people, all they have is their home.
Yes, but if they have no intention of selling their home in the near future, what difference does it make what it's worth today. My parents have lived in the same house since 1979, it's paid for and they would love to see it lose ALL of the market value it's had in the past five years because it would cut their property taxes by two thirds.
Just a sense of security for many people.
Thought you may be inerested in this ping
I think most people inherently understand that a home and land has real value and that even if it loses its value, it's still a place to live.
""the text is great except for this section, ....." when you get there or to a part that you find troublesome. "
and then you can use the text as an illustration of historical bias (which students should also learn)
Many people don't understand that it has fluctuating value. And yes, it's still a place to live, but a lot of people are banking on their homes to pay for college educations, retirement, etc. etc.
In hindsight, it is clear that the so-called stock market crash of 1987 was a correction of a minor bubble.
To put this correction into the category of crash trivializes true crashes (e.g., the crashes following the boom market of the 1920s and the boom market of the 1990s).
Further, it obscures the underlying reason for crashes, which was almost always involves an outbreak of over-optimism following one or more positive events.
Most recently, during the boom market of the 1990s, these positive events included breakthroughs in transportation and communication technologies and in the political arrangements effecting world trade, as well as the spread of free markets and democracy in the world. As we now realize, these breakthroughs - while very important - did not immediately usher-in Nirvana. We are now having to deal with, among other things, reactionary forces, and some dislocations caused by the integration of the U.S. economy with the global economy. But, even with regard to the stock market crash of 2001, we can see that the stock market has rebounded approximately to its premature height prior to the crash.
Finally, commentators who use any problem in free market-oriented, democratic countries to justify their basically cynical world view are just revealing their prejudices.
Ivan Boesky was charged with insider trading. He was accused of having established a network of attorneys and investment bankers who would leak him information about upcoming transactions, in violation of their fiduciary duty of confidentiality. He was just a crook and had nothing to do with junk bonds.
Michael Milken virtually single-handedly established a credit market for companies with riskier credit profiles than typically available in the capital markets. He demonstrated that while any single transaction may be risky, a diversified portfolio was pretty safe. He was arrested for securities manipulation.
Well, there's also the complete reworking of credit deductibility that also caused the S&L crisis.
A big problem with society today, and I think the education system is primarily to blame for this, is that most people don't understand basic economics.
All competent financial advisors have long frowned on using your primary residence as part of your net worth because you still need a place to live. Lately, people have been using their home equity as a "virtual checkbook" without the basic understanding that someday that money would need to be paid back. It's fine to treat rental property that way, because you can always sell it. But if your home is rising in value 25% or more a year, chances are that anyplace you would want to move to is doing the same thing. The notion of selling and "downsizing" is erroneous because almost nobody actually does that (many people do retire to a "smaller" home, but it is often more luxurious than their previous home and just as, if not more, expensive).
"A Patriot's History of the United States,"
The DJIA was making large moves in the days leading up to that. When it went off the cliff there was no mechanism to stop it. Now there is. They simply stop trading.
Yes and the same type of people are now creating a "poor economy" out of 4.8 % unemployment.
It is all in the spin.
Marty Schwartz' book Pit Bull, as well as my own little effort, have some, er, choice comments about various phases of mkt action that day.
You know, we have used Tindall and Shi off and on for years. I think its the best of its type and keeps me below the radar.
But I can point to numerous places where I do know things and it is wrong and always on the left side of being wrong.
I think some things are so emotional for writers that they let myth get in the way.
The odd thing is that what may have been a very technical correction, aided by technology not quite under control, may have actually helped the market.
In any instance, there seems to have been no backing off of foreign investment and no, as you put it, "malevolent" greed.
Which burns my fanny.
Meese was exonerated and the text is written so that students will believe he is rotting in Sing Sing or some similar place.
Trust me, most of them are worse.
You should read the hatchet job done in Eric Foner's textbook--which I have been able to stave off using.
Here's a little story: we all get to agree on a textbook for history. But our far far leftist wanted something to her taste, so she created an American Studies course so that she could use Zinn's People's History.
I may be building a course around historical bias. Which will royally p*ss off my colleagues.