top of page
  • Writer's pictureLawrence Cummins

The Stock Market Crash of 1987

Updated: Aug 26, 2023


The Causes of the Stock Market Crash of 1987

Heightened hostilities in the Persian Gulf, fear of higher interest rates, a five-year bull market without a significant correction, and the introduction of computerized trading have all been named as potential causes of the crash. There were also deeper economic factors that may have been to blame.


Under the Plaza Accord of 1985, the Federal Reserve agreed with the central banks of the G-5 nations–France, Germany, the United Kingdom, and Japan–to depreciate the U.S. dollar in international currency markets in order to control mounting U.S. trade deficits. By early 1987, that goal had been achieved: the gap between U.S. exports and imports had flattened out, which helped U.S. exporters and contributed to the U.S. stock market boom of the mid-1980s.


The steep decline in U.S. stock prices over a few days in October of 1987 which also impacted other major world stock markets. It is speculated that the roots of the crash lay in a series of monetary and foreign trade agreements– the Plaza Accord and the Louvre Accord–that depreciated the U.S. dollar in order to adjust trade deficits and then attempted to stabilize the dollar at its new lower value. Computer program-driven trading models on Wall Street contributed to both the rise in stock prices to overvalued levels prior to the crash and the steepness of the decline.


The Central Bank

Alan Greenspan assumed the role of Federal Reserve Chairman in August 1987, just a few months before the crash. The dollar had been declining for several years due to an international agreement in 1985 to devalue the dollar in order to help American exporters. Fearing that the dollar had fallen too far, Greenspan took measures to raise interest rates to defend the dollar. This action spooked the markets, which had gone through a painful period of high rates in the early 80s.


Greenspan and the Federal Reserve attacked the panic aggressively, issuing public statements confirming their commitment to stabilizing the markets, and adjusting interest rates downwards. In fact, over the years, Greenspan developed a reputation for aggressively combatting recessions and market convulsions so much so that traders began to feel that the Federal Reserve would bail them out whenever the going got rough.


Black Monday 1987

Black Monday is used most often to refer to the second-largest one-day percentage drop in stock market history. It occurred on Oct. 19, 1987, when the Dow Jones Industrial Average dropped 22.61%, falling 508 points to 1738.74. The S&P 500 fell 20.4%, dropping 57.64 points to 225.06. It took two years for the Dow to regain this loss.


The stock market had been in a bull market for five years. It rose 43% in 1987 alone, reaching a peak of 2,746.65 on Aug. 25, 1987. It continued to stay in a slightly lower trading range until Oct. 2. Then it began falling dramatically. It lost 15% in the two weeks leading up to Black Monday.


What Caused the '87 Crash

A Securities and Exchange Commission study concluded that it was traders' fears over the impact of anti-takeover legislation that was moving through the House Ways and Means Committee. The bill was first introduced on Tuesday, Oct. 13 and passed on Oct. 15. In just those three days, stock prices fell more than 10%, the largest three-day drop in 50 years. The stocks that fell the most were the companies that would have been hurt most by the legislation.


New Proposed Laws

To eliminate the tax deduction for loans used to finance corporate takeovers. The 1980s was the era of Michael Milken and Ivan Boesky, both of whom admitted engaging in illegal insider trading on upcoming mergers and acquisitions. This bill, among others, was Congress' way to regulate the markets. Black Monday was Wall Street's reaction. Ironically, the tax deduction provision was stripped from the bill before it became law.


Computerized Trading

There were other contributing factors, as well. Computerized stock trading programs made the sell-off worse. They had set points that automatically called in sell orders when the market dropped by a certain percentage. Dealers on the New York Stock Exchange were overwhelmed when all these programs acted at once. They could not find enough buyers for some stocks. As a result, the stock exchange halted trading.



After this crash, the Federal Reserve and stock exchanges intervened by installing mechanisms called "circuit breakers," designed to slow down future plunges and stop trading when stocks fall too far, too fast.


What can we learn from

While high stock valuations can contribute to a fall they are not necessarily the catalyst, valuations in the US, UK and Europe are higher now than they were in 1987, yet stock markets continue to hit record highs.


The Markets of 1987 where a very different place than it is today. Computers were an auxiliary tool in the late 1980s, while today they dominate every aspect of the business. “Complex” financial instruments have only become more so financial engineering the in late ’80 looks quaint to the hyper “quants” of today’s markets And financial markets across the globe are interconnected in a way that would have seemed inconceivable 35 years ago.


At the same time, all panics are essentially made of the same stuff. No matter how much the markets changes, there will always be a tug of war between overconfident traders armed with new hedging mechanisms and the regulators tasked with keeping them in check. Increasingly, humans will struggle with how to deploy computers to make markets more efficient without having those computers hijack the process. And central banks will walk a tightrope between protecting the public from economic calamity and distorting natural market mechanisms.


International Financial Markets

We now take it for granted that financial markets are global. Multinational banks dominate the landscape and investors can buy stocks and bonds across borders with relative ease. But this was not always the case. It was in the 1980s that stock markets around the world became deeply interconnected, with American companies increasingly searching for capital the 1987 crash spread internationally in “a matter of hours,” and was quickly a global phenomenon. Global regulations and standard practices increasingly allowed “trading stocks away from their home exchanges,


This internationalization of the capital markets, of course, has only accelerated. One need only look to Europe and to the fear with which bankers and policy makers eye the possibility of financial contagion spreading from European to American banks and this issue remains a problem today.

Sources:

S&P Dow Jones Indices. "Sizzlers and Fizzlers." Accessed March 20, 2020.

Federal Reserve History. "Stock Market Crash of 1929." Accessed March 20, 2020.

U.S. Securities and Exchange Commission. "The October Market Break: A Stimulant to the United States-Japanese Cooperative Securities Regulation." Accessed March 20, 2020.

Federal Reserve History. "Stock Market Crash of 1987." Accessed March 20, 2020.

MacroTrends. "Dow Jones - DJIA - 100 Year Historical Chart." Accessed March 20, 2020.

Yahoo! Finance. "Dow Jones Industrial Average (^DJI)." Accessed March 20, 2020.

46 views0 comments

Commentaires


bottom of page