Sometime before 8:30 a.m. on Monday, October 19, 1987, John Phelan asked a secretary to track down Leo Melamed at the Chicago Merc. Phelan, who had cut his vacation short and flown home on Saturday, could see how the day was shaping up, and it made even the worst fears of Friday night look optimistic.
Tokyo had fallen sharply overnight, as traders reacted to Friday’s epic decline in New York. The Hong Kong markets had plunged so far and so fast that officials there decided to close their doors completely, to forestall total panic and widespread defaults. London was already down 10 percent, in part because of $90 million worth of sell orders from the trading desk at Fidelity Investments in Boston. Fidelity’s $9 billion Magellan Fund was the largest stock mutual fund in the country; it was chilling to think how much it would try to sell when the Big Board opened. Traders were predicting the Dow could drop that morning by at least 9 percent, a staggering percentage figure that was twice the record-setting 108-point loss on Friday and almost within reach of the historic daily losses in October 1929.
The New York Stock Exchange’s DOT system was being swamped with orders, many of them apparently from index arbitrageurs. Specialists downstairs were struggling to find a price at which they could open trading in their blue-chip stocks, a task that suddenly had become as difficult as dealing with a deluge of closing-bell orders, Phelan connected with Melamed and briefed him on the viciously lopsided orders piling up in the DOT system. “We’re seeing ‘sell’ orders like never before,” Phelan said, adding, “It looks like a very bad market.” And then, he said, “Everyone loves a free market, but we need to slow volatility on the down side. If no action is taken, the industry stands to lose something it wants.”
It’s not clear what Phelan thought Melamed could do about the market’s wild swings. The portfolio insurers were going to sell, no matter what the local traders did in the spooz pit. And if such selling made the futures cheaper than the cash market on the NYSE, the index arbitrageurs would keep dumping stocks and buying futures. Neither Melamed nor Phelan could prevent that from happening so long as these two linked markets were open.
Then Phelan checked his calendar: a young White House aide was scheduled to visit that day, and Phelan planned to show him around; he expected to be back in his office around noon.
* * *
MANY OF THE other men who would have to cope with the day’s developments, some of them still new to their regulatory duties, were scattered from Sweden to Venezuela.
Fed chairman Alan Greenspan was at his Washington office on Monday, but was packed for a midday flight to Dallas. SEC chairman David Ruder also was in his Washington office, but he had been in it for barely ten weeks, and his more experienced aide, Rick Ketchum, had taken a 6:45 a.m. shuttle to New York. Treasury secretary Jim Baker was on a flight to Stockholm, by way of Frankfurt. White House chief of staff Howard Baker had never before dealt with a financial crisis from the Oval Office. And New York Fed president Jerry Corrigan was in Caracas.
* * *
IN A FOGGY rain, John O’Brien followed the curves of Route 18 out of the mountains north of San Bernardino. It was around 7 a.m., Pacific time, on Monday, October 19. He had spent the weekend helping his wife unpack at their new home at Lake Arrowhead.
About halfway down the mountain, he turned on the car radio for the news. The stock market had opened sharply lower, and was still falling. Feeling a jolt of concern, he pulled up to a roadside restaurant and called the office from its pay phone. He recalled later being told the market was off 200 points; there were lots of calls from worried clients. He got back in the car, speeding south and west toward Los Angeles, still an hour away.
The market had not yet opened in New York when Berkeley professor Hayne Leland boarded a 6:30 a.m. flight to Los Angeles. Before the plane took off, a flight attendant announced that the market was down 60 points—“serious, but less than catastrophic,” Leland thought. When he landed, he got in a cab and asked the driver to turn the radio to the stock report. The market was down hundreds of points by then. “Oh God,” Leland said. The taxi wove through the growing traffic to the First Interstate Tower.
Up north in Marin County, Mark Rubinstein called a taxi when the market decline hit 200 points, and headed for the airport. He got to the LOR offices in Los Angeles around 10 a.m. (1 p.m. in New York), just as the stock market was chewing up the last of a fragile hour-long rally.
Leland was already there, hovering anxiously around the firm’s harried trader, who had telephone receivers in both hands and a computer monitor in front of him showing the growing disaster. In Chicago, he and other portfolio insurers had been selling for the last hour in larger volumes than they had all morning.
Around 11 a.m. (2 p.m. in New York), the trader looked up at Hayne Leland.
“I’m getting behind,” he said. He still needed to sell even more heavily in Chicago to carry out the hedging strategy, he added, “but I think the market would go to zero if I did that.”
Shocked, Leland instantly replied, “No! Don’t do that!”
* * *
ALERTED BY HIS staff to the morning’s sell-off, Jerry Corrigan immediately booked a seat on an earlier flight home from Caracas, and spent the time before he left for the airport making calls to New York and Washington from an office in the presidential palace, where he had been scheduled to have breakfast.
* * *
IN CHICAGO, THE S&P 500 futures pit had opened on time, and the tension was fierce. The subdued crowd in the normally seething pit was smaller than usual. Melamed waited for the opening bell and saw the opening price. At first, he couldn’t believe it. The spooz had dropped 7 percent on the first trade, a staggering decline.
“There were blank stares. No one could believe it was happening. Some people began to leave the pit,” a senior Merc trader later recalled. Portfolio insurers sold more than three thousand spooz contracts in the first thirty minutes, and the futures price seemed to be falling more steeply than the S&P index itself.
This was an illusion. When Chicago opened at 8:30 a.m. (9:30 a.m. in New York), many of the S&P 500 stocks had not yet actually started trading on the floor of the NYSE because there were no buyers. In that interval, the S&P 500 index was being calculated with stale prices from Friday, making the stocks seem far more expensive than the futures contracts—far more expensive, in fact, than they actually were.
Nevertheless, index arbitrageurs began their familiar dance, with a slight but devastating variation. As usual, they sold stocks heavily in New York, and in the first ninety minutes, the Dow dropped 208 points, more than 9 percent, the loss predicted for the entire day. However, instead of immediately buying the S&P 500 futures, a number of index arbitrageurs held back, waiting for even lower prices in Chicago. And by not buying, of course, they helped guarantee that prices in Chicago would continue to fall.
By 11 a.m. in New York, most of the stocks on the Big Board were open for trading, and there was a brief rally. After forty minutes, though, it was snuffed out. With the S&P 500 futures still dropping in Chicago, the Dow now sank under wave after wave of sell orders from all kinds of professional investors—mutual fund managers, index arbitrageurs, and Wall Street’s own proprietary trading desks.
* * *
BY THEN, SEC chairman David Ruder had returned to his office from the Mayflower Hotel after giving a half-hour speech at a conference there sponsored by the American Stock Exchange.
Needless to say, it had been an uneasy audience; people were slipping out to the pay phones in the hall to check on the market. The SEC chairman had been surrounded by a scrum of journalists the minute he stepped from the podium. They pressed him to know if any steps had been taken to close the plunging market—perhaps because, two weeks earlier, Ruder had given a speech saying that a brief trading halt might be wise during a disorderly market collapse. With professorial caution, he told them that no discussions had been held but “anything is possible … There is some point, and I don’t know what that point is, that I would be interested in talking to the NYSE about a temporary, very temporary halt in trading.”
Trading halts in individual stocks were the cornerstone of John Phelan’s last-gasp plan to preserve the exchange. He had mentioned the plan in a call with Ruder that morning, and described it months earlier in a magazine article. At that point, however, Phelan himself had not suggested closing the exchange as a whole. A more experienced regulator than Ruder likely would have been more cautious about even mentioning the issue in public at such a stressful moment. After fifteen minutes of questions, Ruder hurried out to his waiting car.
Upon returning to his office, he almost immediately got a call from Rick Ketchum. Ketchum had raced downtown to the NYSE following his early panel in Midtown Manhattan and had met with Phelan moments after the Big Board chairman wrapped up a meeting with the CEOs of the biggest Wall Street firms.
Ketchum said Phelan had told him that the executives “didn’t seem to have any inkling of how bad the situation really was.”
* * *
THE COMPUTER MONITORS on the credenza behind Gordon Binns’s desk on the twenty-fifth floor of the General Motors Building in Manhattan were as bleak as anything he had ever seen—it was already a market crash on a par with 1929.
Binns may have thought back to his childhood in Richmond, to a powerful story his mother had told him about finding a little slip of paper in their basement, on which their worried housekeeper had carefully itemized every penny of her tiny $12 budget. His mother, already pinched by the gathering Depression, had sat on the basement steps and wept at her housekeeper’s far more desperate plight. She resolved that the family would do everything they could to avoid letting the woman go in the hard times ahead. Binns, a public-spirited man, had been raised to think of others. He never talked about the decisions he made that dark Monday afternoon, but the facts are intriguing.
On his fund’s behalf, Wells Fargo Investment Advisors had been sending enormous sell orders to the Big Board’s DOT system all morning, every hour on the hour. Instead of selling futures contracts in the disorderly spooz pits, the firm had started selling the actual stocks out of GM’s vast $33 billion portfolio, in thirteen separate transactions of 2 million shares each, for a total of almost $1.1 billion.
Specialists on the NYSE trading floor would never forget that relentless bombardment. One regulator recalled how a specialist had described it to him: “Boom, another sell order, then boom, another sell order, like it would never stop.”
At 2 p.m., for some reason, it stopped.
The portfolio insurance specialists at Wells Fargo never conceded any concern; top executives at that firm would argue for decades that portfolio insurance was an innocent scapegoat in this crisis. It is unlikely that the hedging sales required for GM’s portfolio had been completed by 2 p.m., with no need for further selling. Indeed, by one account, Wells Fargo had another 27 million shares to sell for GM before the closing bell.
Nevertheless, at 2 p.m. in New York—the same hour that LOR’s chief trader in Los Angeles was worrying that the markets would “go to zero”—this specific barrage of sell orders hitting the NYSE just … stopped.
* * *
A LITTLE AFTER 1 o’clock, a newswire sent out a story reporting David Ruder’s comments about a “very temporary” trading halt. In the next hour, the Dow fell 112 points. The SEC quickly denied discussing any closure of the exchange, but the uncertainty was enough. Index arbitrageurs stopped buying in Chicago, afraid they would not be able to execute the other side of their trades if the Big Board closed. As a consequence, the gap between the cash index and the futures price now widened to unprecedented—indeed, unthinkable—levels. Panic was flickering in the eyes of traders in New York and Chicago. The alarmed gossip hurtling between the two trading floors was becoming as dangerous as the investment strategies tying them together. No trading halt could unplug this lightning-fast rumor mill. Both markets dropped further and further, under selling from all quarters. By 2:30 p.m., the Dow’s loss, about 13 percent, had eclipsed the worst day of the 1929 crash. The market was falling into history now, and no one knew where the new bottom would be.
* * *
ROLAND MACHOLD HAD $6 billion worth of South Africa–related stocks that he was obligated to sell before the middle of 1988, under New Jersey’s anti-apartheid divestment law. His staff had regularly been selling between $100 million and $200 million worth of stock a day. “Our noses were to the South African grindstone,” he later recalled. But Machold had grown increasingly wary of the market and had put the cash from these sales into safer investments.
Sometime after 2 p.m. on Monday, October 19, one of his colleagues came into his office and told him what was happening at the NYSE. He hurried to the room that served as the fund’s trading desk. In one corner was a small Knight Ridder newswire printer, perched on a flimsy tripod, spewing out four-inch-wide strips of newsprint with barely an eye blink between updates.
The market was down almost 300 points.
Machold looked at the individual stock prices spooling out of the machine. He instantly asked, “How much cash do we have?”
His team found about $200 million that could be quickly deployed, and they started trying to get through to brokers to buy some of the dirt-cheap blue chips going begging. Working against the clock, they put the whole $200 million to work, plucking up bargains as fast as they could.
They were the bargain hunters the professors in Berkeley had been counting on, but with no way of knowing that the avalanche of sell orders was coming, they had limited time and limited cash, compared to the giant institutions lining up to sell at any price. “Nothing would slow that market,” Machold said.
As the clock’s hand moved toward 4 o’clock, the market dropped like a bouncing boulder, smashing through the 300-point loss line, plunging past the 400-point loss line. A strange hilarity seized Machold and his staff. They began to perversely applaud each new negative milestone, even though it meant their own stock portfolio’s value was shrinking.
When the index was down 492 points, it bounced back up a bit—and the little squad in the trading room groaned. Then, in a final rush, the Dow broke the 500 level and finished down a staggering 508 points. “We all cheered,” Machold said. “What else could we do?”
* * *
WHEN JOHN PHELAN saw his Washington visitor out the door and returned to his desk in the early afternoon, the Dow was already down a historic 200 points. Then, as he watched, the market simply “melted away.” At the close, the Dow stood at 1,738.74 points; it had fallen 22.6 percent since the opening bell. That was twice as bad as the worst day of the fearsome 1929 crash, and the point loss was almost five times worse than Friday’s epic decline. In its speed and scale—an unprecedented 604 million shares had been traded, twice as many as on Friday—it was the most apocalyptic one-day crash the market had ever seen. Monday, October 19, 1987, would thereafter be known as Black Monday.
Phelan, outwardly calm but grim, summoned his staff at the closing bell: “I want to know what went wrong, not right. Bad news first.”
Then he headed down the hall to the stately boardroom, where he and his top aides sat in front of a small wooden table crowded with microphones and faced the biggest assemblage of reporters, television cameras, and photographers Phelan had ever seen.
After a poised and reassuring press conference, he called David Ruder with a far more alarming update. He had seen “no hint of any buying interest” at the close, he said, but the “combined judgment” at the exchange was to open for business on Tuesday morning.
The trading floor had been bombarded by selling. Specialists were carrying approximately $1.3 billion in inventory—stocks for which they had been the only buyers, stocks they would have to pay for with borrowed money. The DOT system had been overwhelmed, printers had faltered, systems had malfunctioned, and orders for more than 1 million shares had not been executed.
The wreckage stretched far beyond the Big Board—indeed, the only rallies in sight had been in gold and Treasury securities, as panicked investors sought safety. In Chicago, the S&P 500 futures contract had fallen a historic 28.6 percent. The American Stock Exchange was down 12.6 percent, a loss on a par with 1929. The Nasdaq market had been frozen much of the day, and was down 11 percent—a number no one believed because some dealers had just stopped trading. The options market was a disaster, able to handle barely a third as much trading as on Friday, as prices gyrated wildly. The dollar had tumbled in foreign currency markets. Stock markets from London to Tokyo were battered. Even the futures prices for farm commodities such as wheat and pork bellies, sensitive to the fears of worried pit traders, had plummeted.
* * *
JERRY CORRIGAN, WHO had gone directly to his New York office from the airport, listened patiently during a long conference call that Alan Greenspan conducted from his hotel room in Dallas. The Fed culture called for consensus. At some point, one Fed governor suggested, “Maybe we’re overreacting. Why not wait a few days and see what happens?”
Greenspan, normally diplomatic, snapped back: “We don’t need to wait to see what happens. We know what’s going to happen.”
Fear, simple irrational fear fed by this historic and almost incomprehensible crash, was going to infect every senior banker in the country. Credit was going to dry up like a summer puddle, just when the markets needed it most. Unable to borrow, the markets would be unable to function. The daily transactions that lubricated the economy—selling commercial paper, extending credit through overnight loans, hedging a big purchase made in some foreign country—would all stop.
For Greenspan, it was clear that the Fed had to inject not only cash but confidence into the financial system, and it had to do so before the markets opened on Tuesday.
* * *
AT ABOUT 2 a.m. on Tuesday, October 20, John Phelan woke up. He got out of bed and walked to the window of the Manhattan apartment where he spent weeknights. The market had fallen almost 33 percent in three trading days. Phelan wondered: What would that mean to those people out there? How would it hit the rest of the country? What if the whole system came unhinged on Tuesday?
The NYSE was the tip of the spear, in Marine Corps parlance. It would take the brunt of the day, and it had to get through it.
* * *
“WILL YOU OPEN in the morning?”
Alan Greenspan’s question, delivered in a calm midnight phone call from Dallas, echoed in Leo Melamed’s mind in the predawn hours of Tuesday, October 20, when he heard the stunning figure from the head of the Merc’s clearinghouse: $2.53 billion. That was how much the losing futures traders owed their luckier trading partners after Monday’s debacle.
Like all futures markets, the Merc was a “pay-as-you-go” operation. The previous day’s trades had to be settled (double-checked, tallied, and paid for) before the market could open for a new day of trading. On a typical morning, that meant somewhere around $120 million changed hands. Melamed was aghast at the scale of the settlement challenge.
The Merc’s foreign currency traders, attuned to Europe’s trading day, were supposed to start testing the day’s bids and offers at 7:20 a.m., Chicago time, on Tuesday morning. The Merc had to be open and ready for business by then.
The NYSE had been battered on Monday, and the entire world knew it. While the general public didn’t follow news about the Merc, it would still be calamitous if it failed to open on Tuesday. Professional investors would instantly realize that the losers on Monday had been unable to fully pay their debts to the winners, who then might not be able to meet their own obligations. Doubts would tumble through the market like dominoes—dominoes made of dynamite.
While some traditionalists might cheer to see the innovative troublemakers in Chicago brought low, it would be a body blow to the financial system. That system was held together by invisible strands of trust—the confidence that debts would be paid, trades would be settled, institutions would function, money would circulate. Shred that web of trust, and the system would not hold together. The Merc simply had to open on time on Tuesday; the world had to see that it and its trading firms could be trusted.
These were not Chicago pit gypsies whose credit was on the line. The Merc was owed roughly $1 billion by Morgan Stanley; in turn, it was obligated to pay $670 million to Goldman Sachs and $917 million to Kidder Peabody.
There already was sand in the machine, the kind of computer trouble that Jerry Corrigan had confronted nearly two years before at the Bank of New York—the kind of blindsiding mechanical malfunction that can erupt in any high-speed crisis. Because of a software flaw, the reports sent out by the Merc clearing system after the close on Monday had failed to reflect a margin call collected earlier in the day, making it appear that the Merc was calling for an additional $2.5 billion, not a total of $2.5 billion. That had thoroughly spooked a number of already nervous banks, and credit had tightened sharply.
Nerves in the banking industry were further rattled when the Fedwire, the critical electronic highway that moved cash from bank to bank, broke down entirely on Monday between 11 a.m. and 1:30 p.m., New York time, overwhelmed by the unprecedented volume of traffic it had to handle. Thus, Chicago banks had to pay clearinghouses before New York banks could deliver the cash to cover those payments. That took a lot of faith, and faith was in short supply.
The markets in Chicago had already dodged a potentially ruinous crisis late Monday night, thanks in part to the Merc’s exhausted president, Bill Brodsky. A major trading firm had incurred big losses on the Merc, but had made a big profit on the Chicago Board Options Exchange. Unfortunately, it had to pay the Merc before it collected its money from the CBOE. If the two exchanges didn’t agree to net out the firm’s position, a default was inevitable. Before that happened, Brodsky worked out an ad hoc payment deal with a longtime friend who ran the options market’s central clearinghouse. It was done virtually on a handshake. “There was no writing, no lawyers,” Brodsky said. “It was the middle of the night.” The deal had forestalled a devastating chain of defaults that could have crippled both markets.
Now the Merc was facing another default threat.
By 7 a.m., Chicago time, Morgan Stanley still had not fully settled its account. Bill Brodsky had checked repeatedly that morning with Wilma Smelcer, the chief financial officer at Continental Illinois, where the Merc had its clearinghouse account. As the minutes ticked away, Leo Melamed stood at a wall phone in a conference room upstairs from the trading floor, waiting for the latest update from the bank.
You’re still short some $400 million, Smelcer reported.
“You mean we’re down to $400 million from $2.5 billion? That’s pretty damned good,” Melamed said.
“Yes, Leo, but not good enough.”
Melamed grew increasingly upset, insisting that Continental could advance the $400 million to the Merc as a short-term loan; they knew the loan would be repaid within hours, if not minutes.
“Leo, my hands are tied.” The loan was too large for her to authorize. She sounded close to tears, Melamed thought.
Then Smelcer spotted the bank’s new CEO, Tom Theobald, outside her office and hurried to consult him. As Melamed and his Merc colleagues again waited on hold, he noticed the clock. He recalled later that it had ticked toward 7:17 a.m. before Smelcer got back on the line and said, in a triumphant tone, “Leo, we’re okay. Tom said to go ahead. You’ve got your money.”
Three minutes later, the Merc opened for business.
* * *
THERE WOULD BE plenty of money for loans like that, Alan Greenspan assured the nation’s bankers less than a half hour later.
At 8:41 a.m., New York time, the Fed released a succinct message whose wording Greenspan and Corrigan had labored over on Monday evening: “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.”
Of course, it would do no good for the Fed to put money into bankers’ hands if they hoarded it like frightened gnomes. They needed to lend it out—immediately—to the financial institutions that held the market together. Corrigan was growing increasingly worried that they would not.
He was right to worry. During those frightened hours, the president of Merrill Lynch was outraged when one of that firm’s bankers “called me and said, ‘You need X number of dollars to cover your positions and we need it here in ten minutes—or else.’ I’ll never forget that. I said, ‘Hey, you son of a bitch, calm down. Relax. This is Merrill Lynch. You’ll get your money.’”
In his cavernous wood-paneled office in New York, Corrigan worked the phones, cajoling the chairmen of all the major banks, one by one. He assured them that the Fed understood their plight, and was standing by to help. Of course, he couldn’t order them to make the loans that Wall Street needed, but he wanted them to consider “the big picture, the well-being of the financial system”—in short, the mounting danger of total financial gridlock—in the crucial hours and days ahead.
* * *
THE FEDERAL RESERVE Bank of Chicago was making similar calls to local bank CEOs, but Continental’s Tom Theobald didn’t need encouragement to lend. He was lending like crazy to try to save his subsidiary, First Options, which was facing an old-fashioned run. Traders, hearing rumors that the giant clearing firm was in trouble, were pulling out surreal amounts of cash.
It wasn’t hard to imagine what would happen if the firm that handled nearly half the trading accounts on the Chicago Board Options Exchange, the nation’s largest options market, suddenly was shut down. Its clients stood little chance of finding a new clearing firm in this storm; they would have no choice but to stop trading. Liquidity would drain away, and the central clearinghouse, which served every options exchange in the country, would take a body blow that might trigger panic elsewhere.
Continental Illinois had already defused a crisis at the Chicago Merc. Now it was imperative that it rescue its First Options subsidiary, if it possibly could.
* * *
SHORTLY BEFORE THE NYSE opened at 9:30 a.m. on Tuesday, Phelan asked member firms not to use the DOT system for program trades, to keep it free for small investors’ orders. However well intentioned, this fateful step essentially unplugged the index arbitrage machine. Phelan may have hoped to stanch the arbitrage sell orders in New York, but the step would also curb the arbitrage buy orders in Chicago, where they were desperately needed to offset the selling being done by portfolio insurers.
Despite this sea of worry, Tuesday opened with a rally. The Dow climbed a record-setting 11.5 percent (or 200 points) above Monday’s close, though still far from its closing price on Friday. Nimble specialists were able to shed some of the shares they had been holding overnight, but within a half hour, the selling pressure returned in greater force than anyone had ever seen. All the gains in the morning rally were wiped out, and the market kept falling. By 12:30 p.m., the Dow was hovering just above 1,700 points, 38 points below Black Monday’s nadir.
The shortage of index arbitrage buyers in Chicago and the inevitable whispers about a crisis at the Merc clearinghouse put the S&P 500 index futures into free fall. Between 9 and 11:15 a.m. (that is, between 10 a.m. and 12:15 p.m. in New York), the spooz price fell almost 27 percent, reaching a level that implied that the Dow’s value was actually 1,400 points.
The spooz traders began to step out of the pit—some because of sheer panic or an instinct for self-preservation, some because their clearing firms had insisted on cutting their losses. The liquidity that Melamed had boasted about for years was drying up before his eyes.
The yawning gap between the futures price in Chicago and the apparent cash price in New York became “a billboard” to professional investors, warning that stock prices were likely to drop even further. Blue-chip buyers held back, waiting for bigger bargains, so the demand to buy NYSE stocks was vastly unequal to the pressure to sell them.
By midday on Tuesday, both John Phelan and Leo Melamed must have feared they were watching the destruction of the world they had known all their lives.
* * *
AT 11 A.M. IN New York, with the Dow off about 100 points, Phelan had left his office and gone down to the trading floor. The floor was crowded but eerily quiet, like the eye of a hurricane. For lack of bids, trading had been halted in IBM, Kodak, and ten other stocks that accounted for 54 percent of the value of the Dow Jones index. In the unnatural stillness, Phelan mustered the four senior floor officials and led them behind a canvas flap screening some construction work at the edge of the trading floor.
“Get them open,” he told them. “Let’s get these stocks up and trading and get on with it. We’ve got to trade out of this.” He added, “We’re not going to close this place down, but we’ll continue to shut down stocks.”
More than eighty or ninety stocks were already shut down or soon would be, Phelan was told. In the next few minutes, specialists would manage to open all but fifteen of them, but as the selling pressure increased, those and sixty others would stop trading.
Phelan returned to his office. He took a few calls, possibly one from Leo Melamed, and then strode out to the reception area and told his secretary to place calls to “Baker, Ruder, Corrigan.” It was 12:05 p.m.
* * *
ACCORDING TO NOTES David Ruder made during his brief noontime conversation with Phelan, the NYSE chairman said that there were “no bids” and he was “really worried about liquidity.” The next phrase reads: “thinking—about closing for a short time.” Phelan also reportedly said, surprisingly, that “the Chicago Mercantile Exchange was interested in stopping trading.” It is unclear how or when he had gotten that impression.
Phelan told Ruder that “he had been in contact with the White House, and would call the White House again to seek support for a trading halt.” Message slips and phone logs from the Oval Office show that Howard Baker spoke with Phelan at 12:15 p.m., and again at 12:22 p.m.
Decades later, Phelan insisted he had assembled his staff in his office sometime between noon and 12:30 p.m. and told them that “come hell or high water, we were going to stay open.” His backup plan was to keep shutting down individual stocks, without actually closing the exchange. There were more than 1,500 stocks listed on the Big Board. “They could not all be under intense pressure at once,” he thought.
According to Ruder, however, Phelan told him that he “thought he needed 10 minutes to get more support, but he expected to issue a press release in 10 minutes announcing that they were halting.” On the strength of that comment, the SEC quickly alerted the other exchanges and the CFTC that the NYSE might close.
Phelan later said he had been misunderstood. “When I mentioned a backup plan to the SEC and the White House, they seemed to interpret this as if I were about to shut the market down. This, of course, was not true.” He said everyone in his office heard the call on a speakerphone and knew that “I was determined to keep the market open.”
In Washington and Chicago, people who talked with Phelan by phone in these ghastly minutes clearly got the impression that the Big Board was most likely going to be forced to close, at least for a short time. Their certainty was such that they acted on that impression without seeking further clarification or confirmation. That, more than anything, is a measure of how terrible the situation was that confronted John Phelan at that noontime hour on Tuesday.
* * *
IN CHICAGO, THE Chicago Board Options Exchange, dependent on current NYSE stock prices that were not available, had halted trading. The American Stock Exchange’s options market and other regional futures markets were closing. Now, Leo Melamed’s regulators told him the NYSE was “considering closing.” He was rattled. “If the NYSE closed, uncontrollable panic would follow. In such a case, if the Merc was left open, the world would dump on us.”
According to Melamed, he called Phelan at around 11 a.m. (noon in New York), using a speakerphone in Bill Brodsky’s office. He asked Phelan if it was true that the NYSE was going to close.
“Phelan’s voice sounded like death warmed over,” Melamed later reported. Phelan’s reply, according to Melamed, was: “It’s getting close to that … There are no buyers … We are going into a meeting to decide. We may very well close.” The Merc executives in Brodsky’s office looked at one another. “There was virtual certainty that the NYSE was about to close,” Melamed would recall.
The Merc officials decided they had to close the S&P 500 pit first, before news about an NYSE shutdown leaked out. Had Melamed somehow conveyed that desperate intention to Phelan? Was that the germ of the comment Phelan made to Ruder? It’s possible, but not documented.
Sometime after his first call to Ruder—it’s not certain how long after—Phelan called back and told the SEC chairman the NYSE “was not going to close; the market had turned up and it would try to stay open.” Corrective calls were quickly made to everyone that Ruder’s office had called just minutes earlier.
This obviously raises the question of why Phelan made this call at all, if his prior call had been to announce that the exchange wouldn’t close.
In Chicago, at 11:15 a.m. (12:15 p.m. New York time), Leo Melamed and several other Merc executives left the phones and went down to the floor to announce that the spooz pit was closing immediately, pending a clear answer about what the NYSE would do.
The Chicago Board of Trade, characteristically, would have nothing to do with a Merc-led trading halt. Its MMI pit, thinly populated and wildly volatile, continued to trade. And thank God for that, thought Blair Hull, a well-known trader on the Chicago Board Options Exchange and the only member of his small trading firm who also had a seat on the Chicago Board of Trade.
Hull needed to meet a margin call. With the CBOE closed, he hurried to the Board of Trade’s trading floor, stepped into the MMI pit, and began buying to cover a short position that was costing him a lot of money. Sellers swarmed him, and he quickly bought what he needed.
And on the strength of his buying, the MMI futures contract suddenly rallied, spurting up beyond any sensible level, as it regularly did. On trading desks everywhere, where computer monitors flashed red for downticks and green for upticks, there was a sudden, unexpected spark of green.
* * *
THE GREEN FLASH showed up on the trading desk at Salomon Brothers in Manhattan. By then, the desk was a hive of activity. Sometime around noon on that frightening Tuesday, Stanley Shopkorn, the legendary head of the firm’s equity trading desk, finished a phone call and bustled out of his glass-walled office. He told his legion of traders to start making bids to buy, and they went to work.
Shopkorn had just spoken with Robert Mnuchin, his counterpart at Goldman Sachs, and they had decided they would both step in as big buyers of the major stocks that had been halted on the NYSE. They wanted to make a profit, obviously, but they also had to consider “the good of the system.”
An enormous number of stocks had been halted—more than 160 at one point. The normal routine at the NYSE was that trading halts were promptly reported to the newswires. Today, for some reason, they weren’t. So, when certain stock prices appeared to have stabilized, it wasn’t immediately clear that they simply were not trading. Indeed, in what was later called a mistake, an NYSE staffer publicly denied reports of specific Dow stocks having been halted.
As the clock crept toward 12:30 p.m., with the Dow trading 38 points below its disastrous close on Black Monday, Phelan and several senior staffers simply stared at the big computer monitor on the credenza behind his desk. “The market had to rally,” he thought.
They saw the MMI futures flash green. They saw the number of Dow stocks that were open for trading begin to bubble up a bit. A number of big corporations had announced they were buying back their own shares—David Ruder had waived certain SEC rules to speed that process up—so perhaps that was finally kicking in.
To Phelan’s sixth sense, the market felt stronger. Without the grim “billboard” effect of the futures prices in Chicago, and with many stock prices at a standstill, the market was perfectly poised to respond to the buy orders that had begun to trickle in, no matter where those orders came from. As it recovered, more people rushed to snap up bargains before this demented market came to its senses.
That was most likely the moment John Phelan picked up the phone to tell David Ruder that the NYSE was not going to close. “We’re still hanging in,” he said.
The NYSE stayed open, and a short time later the spooz pit reopened, after having been closed for forty-nine minutes. As the Amex and the Nasdaq markets continued to lose ground, the Dow climbed a record 200 points by 3:30 p.m., and then lost half that gain in the half hour before the closing bell. It ended the day at 1,841 points, up 102 points, or almost 6 percent.
Once upon a time, a few weeks earlier, a 102-point gain would have been historic, a cause for celebration. Today, it merely meant survival, for at least one more day.
* * *
DID THE NYSE deliberately mislead the market about how many stocks were actually open for trading during those grim hours on Tuesday? Did that allow it to hold out until titan buyers such as Salomon Brothers and Goldman Sachs stepped in? Or was there a bigger conspiracy, one in which all the stock index futures markets deliberately stopped trading except for the Chicago Board of Trade so that traders there could ram up the thinly traded Major Market Index futures contract until it was more expensive than its underlying Dow stocks, thereby sparking arbitrage-linked buying interest on the NYSE?
The Chicago Board of Trade and the CFTC investigated the allegations of MMI manipulation and concluded that the vague reports were unfounded. Beyond that, there are myriad commonsense reasons to doubt a larger conspiracy. It would have required lightning-fast coordination among natural enemies, including the rebelliously uncooperative Board of Trade, which would have been the spear tip market willing to keep trading while every other futures market closed. The Board of Trade might team up with the Merc to beat New York, but it seems unlikely it would link arms with the Merc, at substantial risk to itself, to save the NYSE. Blair Hull’s trades were pure self-preservation, as he consistently said both at the time and decades later, when there was no need to preserve a cover-up. The MMI pit was notoriously illiquid, as its wild swings throughout Monday and Tuesday demonstrated, so no manipulation was needed to produce a sharp spike on the strength of a few purchases. Moreover, with the DOT system closed to program trading, many index arbitrage traders were on the sidelines that day, so it was far from certain that an MMI uptick would actually have produced any arbitrage buying in New York. There is even some dispute about whether, at the time, the Street, obsessively focused on the S&P 500 futures, would even have noticed the volatile MMI’s uptick, or cared; if it hadn’t, that alone would have doomed the plot to failure.
So, what caused the market’s “miraculous” turnaround between noon and 1 p.m. on Tuesday, October 20? The power of the money that Salomon Brothers and Goldman Sachs started pumping into NYSE stocks (estimated by several sources at several hundred million dollars) would have been psychologically enhanced by the legendary status of both firms and their chief equity traders. If they were buying big, it would certainly have given heart to the NYSE specialists and to other shaky trading desks, as would have the proliferating announcements of corporate stock buybacks that day. And certainly, the MMI’s spike after Blair Hull’s buy orders would have helped stave off despair. If there was any “conspiracy,” it was an opportunistic one centered on the concealment of how widespread the trading halts were on the Big Board.
The fact remains: While the market had fallen on Monday, it had almost fallen apart on Tuesday. All that had saved it was a makeshift web of trust, pluck, and improvisation—and perhaps a few bits of inspired subterfuge here and there.
Only misinformed hindsight sees that midday turning point as the “end” of the 1987 crash. For Phelan and Melamed, for Ruder and Corrigan and Greenspan, for the stunned portfolio insurers in California, it was simply a fragile rally that let the market stumble toward the blessed closing bell on Tuesday without shattering the world’s confidence in America’s financial system.
The bell on the balcony of the Big Board would ring again at 9:30 a.m. on Wednesday, and none of them knew how that day would end.