Unfortunately, we cannot simply turn the page on the crash of 1987, because we are still living in the world revealed to us on Black Monday.
The people who confronted that crisis had not faced an apocalyptic market disaster since 1929. Today, anyone of working age in America has lived through a number of baffling market malfunctions, four extremely disruptive market crises, and one acute five-alarm meltdown: the devastating financial crisis that climaxed in September 2008 with the bankruptcy of Lehman Brothers. In the aftermath of that collapse, the nation endured the worst hard times since the Great Depression.
Two months after Lehman’s fall, with markets still shaking, the chairman of the SEC told a congressional panel that “coordination among regulators, which is so important, is enormously difficult in the current Balkanized regulatory system.” His warning was seconded by a former Treasury secretary, who said, “We have a fractured regulatory system, one in which no single regulator has a clear view, a 360-degree view, of the risks inherent in the system. We need to change that.”
We didn’t change that—indeed, neither man even mentioned that the Brady Commission had offered exactly the same diagnosis after the 1987 crash. Instead, all the major mutations that were central elements of the Black Monday crisis have become even more deeply embedded in Wall Street’s genetic code:
• Computer-driven trading has accelerated, as the human middlemen of 1987 have been replaced by the circuitry of electronic markets.
• Armies of titan investors, whose scale and speed shocked regulators in 1987, have grown exponentially larger, faster, and more powerful, ultimately measuring the race to market in nanoseconds and wielding global portfolios worth trillions of dollars.
• Fragmented and feuding regulatory agencies continue to defend their political turf, aided by rigidly ideological lawmakers on the right and the left. As they squabble, the unregulated financial derivatives of the 1980s have mutated and spread around the world, and the arcane investing strategies that hastened the march to Black Monday have become even more obscure.
The crash of ’87 proved beyond argument that pragmatism is the only ideology that can deal with a large-scale modern financial panic. The crisis should have produced a more flexible, better-coordinated regulatory framework, but it didn’t—not even after its bitter lessons were reinforced by the 2008 meltdown. Even the most obvious policy lesson from 1987—that is, do not let a linchpin firm collapse in the middle of a panic—was ignored in 2008, when regulators allowed Lehman Brothers to fail, even though the markets were already nervous and on a hair trigger. Panic spread around the globe, essential markets froze up, and only extraordinarily creative intervention prevented the kind of fuse-blowing meltdown feared by the frantic regulators of 1987.
In response to the 2008 crisis, Congress actually has made it more difficult for regulators of the future to attempt a pragmatic, ad hoc rescue of the financial system. It has passed laws that greatly restrict the use of what were derisively called “bailouts,” and it has added new agencies, with rigidly defined missions, to an already crowded and poorly coordinated lineup, burdening all of them with rules that defy reality and common sense.
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THE FRONT-LINE VETERANS of the road to Black Monday followed their own paths and drew their own lessons.
Former SEC chairman John Shad, who watched the 1987 market crash from the U.S. embassy in the Netherlands, died in 1994, at the age of seventy-one. His legacy includes a $30 million gift he made in March 1987 to help support a program in ethics at the Harvard Business School.
John Phelan, the NYSE chairman, retired in 1990. When he died in 2012, at the age of eighty-one, his leadership on Black Monday was hailed as “his shining hour.” His lieutenant during the crash, Robert J. Birnbaum, left the exchange in March 1988 and spent the rest of his career at a New York law firm.
Leo Melamed and Bill Brodsky remained pillars of the Chicago derivatives markets for decades. As of this writing, the eighty-four-year-old Melamed still occupied a handsome suite in the tower looming over the Merc trading floor. But that trading floor was largely deserted; the Merc had absorbed the Chicago Board of Trade in 2007, and both futures markets became almost entirely electronic. Brodsky left the Merc a decade after Black Monday to become chairman and chief executive of the Chicago Board Options Exchange. In 1997 he tapped his longtime friend Bob Birnbaum for the CBOE’s board of directors.
After leaving the Fed, Paul Volcker worked for a time at the Wall Street investment firm Wolfensohn and Company but devoted most of his time to other forms of public service—notably as the head of a multinational panel that mediated Holocaust-era claims on Swiss banks. In 2009 he returned to Washington as a special adviser to help President Barack Obama deal with the wreckage left by the 2008 crisis.
His former troubleshooter, Jerry Corrigan, worked tirelessly in the years after Black Monday to strengthen the global network of financial clearinghouses. In 1994 he joined Goldman Sachs, where he continued to press for greater transparency for potentially dangerous derivatives. He retired from the firm in 2016.
When David Ruder stepped down from the SEC chairmanship in 1989, he returned to the law faculty at Northwestern, where he continued to teach securities law, and serve on multiple regulatory task forces and market advisory committees, for more than twenty-five years.
As for the CFTC leaders: Phil Johnson continued to write and advise clients on derivatives law, eventually settling outside Jacksonville, Florida. Susan Phillips served from 1991 to 1998 as a member of the Federal Reserve Board and then returned to academia. Jim Stone returned to Boston and had a long career as an insurance executive. In 2016 he published a book titled Five Easy Theses: Commonsense Solutions to America’s Greatest Economic Challenges. The dust jacket carries a complimentary quote from Paul Volcker.
After forty years at General Motors, pension manager Gordon Binns retired in July 1994; by then, his staff was overseeing $55 billion in investments. He returned to his native Richmond, where he served for four years as the chief investment adviser to Virginia’s public pension fund. He died in 2002 at the age of seventy-two, leaving behind a trove of vintage travel guides that entirely filled the three-bedroom apartment he rented to house them. Roland Machold remained at the helm of the New Jersey Division of Investment until 1998; during his tenure, New Jersey’s pension fund was routinely ranked as one of the top-performing state pension plans in the country.
In the aftermath of Black Monday, Hayne Leland, Mark Rubinstein, and John O’Brien tried to launch another new financial product: the “SuperTrust,” a complicated forerunner to the now-popular exchange-traded funds. They enlisted a selling syndicate that included all the top Wall Street firms, but they met daunting and costly regulatory delays—perhaps because their idea was novel and complex, or perhaps because they were the people responsible for the “much-maligned” portfolio insurance. As the years passed and the legal obstacles piled up, other competitive products were developed and Wall Street’s interest in the SuperTrust concept waned.
The little consulting firm waned with it, but the three LOR partners remained friends and allies for decades. John O’Brien became an adjunct professor at Berkeley, where Hayne Leland and Mark Rubinstein continued to teach, lead path-breaking research, and win awards. Leland retired in 2008, and Rubinstein followed his friend into retirement four years later.
Steve Wunsch, LOR’s ally in the fight for sunshine trading, put his idea to work in 1990 by launching the Arizona Stock Exchange, a computer-driven “single-price” auction market that could match up big buyers and big sellers electronically, but it failed to attract enough institutional trading volume to survive.
Perhaps none of the first-line responders to the 1987 crash had more influence over the way financial markets have evolved than Alan Greenspan, who remained chairman of the Federal Reserve until January 2006 and was repeatedly credited with masterful management of the nation’s economy. In 1998 he was described by Time magazine as belonging, along with Treasury secretary Robert Rubin and his deputy, Lawrence Summers, to “the most powerful economic triangle in Washington,” in a cover story that dubbed the trio “The Committee to Save the World.”
But during his tenure, the Fed also favored a more laissez-faire approach to financial regulation and failed to assert its power to curb predatory subprime lending, sowing the seeds for the reckless practices that helped trigger the 2008 crash. His confidence that Wall Street could be trusted to act prudently was an enormous mistake, he later acknowledged. He decided, on reflection, that the forecasting models on which he had long relied simply did not give enough weight to raw human nature—to “fear and euphoria,” risk aversion, herd behavior, and a host of other market-moving emotions.
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WHERE DOES THIS leave us today, thirty years after Black Monday? Exactly where we were then: in a storm-tossed lifeboat in which all the passengers are shackled together with the obnoxious crew members who carelessly steered our ship into the storm. Imagine, if you can, that the angry passengers vote to toss the crew members overboard to punish them for their folly. That’s the current plan for dealing with a future crisis in the American financial system.
The excuse for this insanity is that keeping the reckless crew in the lifeboat would be an undeserved “bailout.” This is a recipe for national and personal ruin—unless the shackles are first struck off. And no one has devised a remotely realistic plan for doing that, since it would involve a degree of federal intervention in private enterprise that seems politically unlikely—or a degree of market self-discipline that would be historically unprecedented.
When a market merely falls, it “recovers” by rising again to its previous price levels. And that certainly happened after 1987—though not nearly as quickly or as painlessly as Black Monday’s mythology claims.
But when a market falls apart, because of dangerous levels of stress and unseen and unprecedented shocks, it should “recover” by rebuilding itself so that it can withstand those shocks and stresses in the future. And that certainly did not happen after 1987.
It still hasn’t happened—and unless we finally learn the right lessons from Black Monday, it never will happen.
The crash of ’87 revealed the iron link between market regulation and market structure. Policing a labyrinth at night is vastly harder than supervising an open field in the daylight. Allowing a market to become a dark and opaque maze ensures that it cannot be adequately supervised by anyone, even the giant investors who trade there.
Yet that is precisely what happened on a global scale after 1987. Left to shape its own future, Wall Street created profit-driven electronic markets catering to its richest and most powerful customers; today’s corporate-owned exchanges barely even pay lip service to the notion that they serve anyone but their own shareholders. A host of “dark pools” (private “members-only” computer networks) now handle a substantial amount of the world’s institutional trading activity. Individual investors have become not only irrelevant but virtually invisible in the regulatory conversation. In recent years, even the individual investors’ surrogates, mutual funds and pension funds, are being drowned out by the demands of an immense army of high-speed traders and algorithm-wielding speculators, all trying to squeeze drops of profit from an increasingly volatile, robot-driven market.
At every step, the justification for this radical transformation has been that it has reduced trading costs—as if saving a fraction of a penny on a trade makes up for the immeasurable social damage done by structural instability on a global scale.
Those pennies, of course, came out of the pockets of the specialists at the New York Stock Exchange and the traders in the spooz pits in Chicago. Their personal battles to survive the catastrophe of 1987 were victories in a losing war. Today, the New York Stock Exchange has disappeared into a giant global conglomerate, taking with it the last memory of a deep and liquid central marketplace. Other stock exchanges, in the United States and abroad, have followed suit. Small wonder that today’s fragmented public market is usually the last place any sensible entrepreneur would turn to raise capital for a new venture—which was once the fundamental reason for the market’s existence.
The policy makers in Washington and the titan players on Wall Street thought the lesson of Black Monday was that the market’s machinery was too slow, too small, too parochial, too hamstrung by antique rules and traditions. They set out to fix that, to repeal the technical and legal limitations on the markets.
But that is not the lesson of 1987. The actual lesson is that human beings do not cope well in a crisis when speed, complexity, secrecy, and fear all batter our emotions at the same time. We panic—or, most of us do. We are not the cool, rational investors postulated in academic theories, and we never will be.
There simply is no way to repeal the limits imposed on the market by human nature and all the messy emotional baggage that being human entails.
The road from Black Monday could have led to a different outcome, to broader, deeper, and more coherent markets operated for the public good, with technology applied in ways that foster stability, liquidity, and transparency. Instead, it led us here—to a global market that is a fragile machine with a million moving parts but few levers to govern its size or its speed.
Imagine a delicate but powerful sports car hurtling through a labyrinth in the dark. What could possibly go wrong?