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2020-10-19 e
Happy Anniversary - Black Monday, 19 October 1987

Black Monday, 1987: The Birth Of Stock Market Moral Hazard

The following exchange took place between President Reagan and reporters after the market close on Black Monday, October 19, 1987. Leaving to visit the First Lady in the hospital, President Reagan spoke just after the market lost over 20 percent of its value on the day.

Q: What about the market? Tomorrow will it go down again?

President Reagan: I don’t know. You tell me.

Q: Is the market your fault?

President Reagan: Is it my fault? For what, taking cookies to my wife?

Q: Reaganomics?

President Reagan: I just told you. Good Lord, we reduced the deficit over last year by $70 billion. And all the other things I’ve told you about the economy are as solid as I told you. So, no, I have no more knowledge of why it took place than you have.

Thirty-three years ago today, now infamously known as Black Monday, my grandfather, M. Peter McPherson, was Deputy Secretary of the U.S. Treasury and acting Secretary that day, while Treasury Secretary James Baker was in the air traveling to Europe. McPherson was the most senior Treasury official left in Washington to handle the crisis.

The stock market had already peaked in August after an almost 100 percent rally in the prior two years. By late August, the DJIA had gained 44 percent in a matter of seven months, raising concerns of an asset bubble, and had become very volatile as interest rates had been rising rapidly since bottoming in September of the prior year.

Similar to 1929, where the stock market peaked in early September, the markets had already begun to unravel, foreshadowing the record losses that would develop that Monday in October.

As the markets around the world began to crash, my grandfather convened with the U.S. Treasury’s Undersecretary of Domestic Finance and the Department Chief of Staff to discuss the government’s appropriate response. The Dow Jones eventually closed 508 points down, or a 22.61 percent, almost double the historic Crash of 1929, where the Dow fell 12.8 percent in one day.

Government Kicks Into Action

According to my grandfather, the situation demanded that his team put together a plan to calm the markets. The economy was doing fine, and there were no signs of recession. Real GDP growth came in at 3.5 percent in 1987.

Jitters about the U.S. trade deficit, rising interest rates, and the path of the U.S. dollar during the Plaza Accord are oft-cited as the fundamental reasons that triggered the crash, but nobody knows for sure. Trees don’t grow to the sky, and neither do markets. Stocks markets do what stocks markets do, keep their own schedule, and march to their own drummer.

The team’s conclusion at Treasury that day was the market was under severe strain for technical reasons and complicated by the new computerized program trading related to portfolio insurance. Nevertheless, the steep losses were causing significant dislocations in the financial markets.

Many large firms were under heavy liquidity pressure and were dangerously close to not making their margin calls and on the brink of failure.

My grandfather and his team placed a call to the then-new Federal Reserve Chairman, Alan Greenspan, only a month into the job, to encourage the issuance of a Fed statement that it would do whatever it takes to provide the liquidity to keep markets functioning.

It wasn’t the time to think about the policy’s broader economic implications, such as the potential moral hazard, as the plane was on fire and going down and desperately needed a rescue plan.

It was also clear Greenspan had been thinking along similar lines. (read more)

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