On that historic autumn Monday, it seemed possible that the entire American financial system would crack apart. The next day, it seemed certain that it would.
The storm had not come out of a cloudless sky. There had been years of heedless expansion, months of growing anxiety, weeks of looming trouble and fading options. Then, Monday dawned—a day so terrifying that those uneasy months and weeks seemed placid by comparison.
Global markets teetered. High-speed computer trading, driven by mathematical models, outran the pace of mere humans. Poorly understood derivatives set off depth charges everywhere, revealing hidden links that bound together the banks, insurers, giant investors, and big brokerage firms that populated Wall Street. Those connections stretched across all the regulatory borders that rival government agencies defended so fiercely. At the edge of the cliff, some questionably legal steps saved a key firm from collapse, a failure that would have tipped a crisis into a catastrophe.
For many, this chronology instantly calls to mind the financial meltdown that erupted on Monday, September 15, 2008, with the collapse of the Lehman Brothers brokerage firm. The day after “Lehman Monday,” the U.S. Treasury Department and the Federal Reserve were fighting frantically to rescue the massive insurance firm AIG, which neither agency officially regulated but which was linked to other giant firms around the world through a set of financial derivatives called “credit default swaps.” Those events triggered widespread panic that eclipsed almost anything the markets had seen since 1929.
Almost anything. Because the events just described, the events at the core of this story, did not happen in the harrowing weeks of September 2008. They happened on October 19, 1987, a day almost immediately dubbed “Black Monday.”
On that single day, the Dow Jones Industrial Average, the pulse rate of the most prominent stock market in the world, fell a heart-stopping 22.6 percent, still the largest one-day decline in Wall Street history. That was the equivalent of an urgent midafternoon news flash today screaming, “DOW FALLS NEARLY 5,000 POINTS!”
A one-day decline of 22.6 percent is almost unthinkable for us now. It was truly unthinkable for the men and women of 1987. We can look back on their experience, but when they looked back, they saw nothing that remotely resembled Black Monday—not during the Great Depression, not when America went to war, not even after a presidential assassination. Until 1987, a very bad day in the stock market meant a decline of 4 or 5 percent. A horrible day meant a drop of 10 or 11 percent, a figure exceeded only during the historic crash of 1929. Then, on Black Monday, the unthinkable suddenly became the unforgettable, a market crash so steep and so fast it seemed that the entire financial system would simply shake apart like an airplane plunging to earth.
On that day, the new toys of Wall Street, derivatives and computer-assisted trading, fed a justifiable fear that an overdue market downturn would become an uncontrollable meltdown. The avalanche of selling briefly halted a key Chicago market and came within minutes of officially shutting down the New York Stock Exchange. Hong Kong closed its markets for a week. Tokyo and London, financial centers almost on a par with New York, were battered. Aftershocks hit days, weeks, and even months later. It took two years for the market to climb back to its 1987 peak.
Black Monday was the product of profound but poorly understood changes in the shape of the marketplace over the previous decade. Wall Street (shorthand for the nation’s entire financial industry) had become a place striving to get both bigger and broader, seeking profit in as many diverse markets as possible. Meanwhile, Wall Street’s clients had undergone a staggering mutation: they were exponentially larger and more demanding, and they became far more homogenized, subscribing confidently to academic theories that led giant herds of investors to pursue the same strategies at the same time with vast amounts of money.
As a result of these two structural changes, government regulators in Washington faced a new world where, time and again, a financial crisis would suddenly become contagious. Thanks to giant diversified firms and giant diversifying investors, a failure in one regulator’s market could spread like a wind-borne plague and infect those overseen by other regulators. After years of these outbreaks, Black Monday was the contagious crisis that the system nearly didn’t survive.
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AS DRAMATIC AND unprecedented as it was, Black Monday would become the Cassandra of market crashes—a vivid warning about critical and permanent changes in the financial landscape, but a warning that has been persistently ignored for decades.
As the events of 1987 receded into the past, its lessons were lost. Myth quickly replaced memory, and Black Monday, if it was remembered at all, was recalled as the crash without consequences. By the end of the decade, a broken market appeared to have magically repaired itself and then marched into a rich, less-regulated future. The subsequent prosperity, which rarely faltered through the 1990s, seemed to be proof that nothing really important had happened on that October day.
Yet, when the mythology is stripped away, it is not at all surprising that Black Monday and the 2008 crisis sound so much alike. All the key fault lines that trembled in 2008—breakneck automation, poorly understood financial products fueled by vast amounts of borrowed money, fragmented regulation, gigantic herdlike investors—were first exposed as hazards in 1987.
It is not an overstatement to say that Black Monday was the first modern market crash, the first to spotlight these fundamentally new risks. Most previous crashes, including 1929, essentially resembled one another, from the Dutch tulip bulb mania in the late 1600s, to the collapse of London’s South Sea Company in the early eighteenth century, to the “air pocket” drop that shook the U.S. stock market in late May 1962. Black Monday was a new kind of crisis, involving new players and new financial products never before involved in a stock market crash.
Today’s most dangerous crises, the ones that threaten the very survival of the financial system, are not modern-dress reenactments of the “tulip mania” bubble in old Amsterdam. They are warp-speed flashbacks to Black Monday.
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TO CALL THE events that unfold in this book “the stock market crash of 1987” is a misnomer. The crash wasn’t limited to the stock market, and it didn’t erupt suddenly on Monday, October 19. To fully understand the causes and consequences of that devastating day, we have to begin the story nearly eight years earlier, in the first months of 1980, when Jimmy Carter was in the White House, powerful computer-driven investment strategies were a mystery to most of Wall Street, and politicians and bureaucrats had an unshakable faith in rigid regulatory borders.
As the curtain rises on this tale, there is a palpable sense that uncontrolled market panics have been relegated to history’s dustbin. There had been a deep, drawn-out bear market in the mid-1970s, but the nation had not seen a sudden cataclysmic crash since 1929, and most of the people who had experienced that crash as adults were retired or dead. The market regulatory structure that had emerged from the rubble of 1929, with the Securities and Exchange Commission as its cornerstone, had stood solid and unshaken for almost fifty years. Familiar and respected, it seemed an immutable part of the political landscape.
In 1980, each separate colony of finance, whether it dealt with farm commodities or corporate stocks or life insurance or bank deposits, expected to deal with problems on its own turf in its own way, without regard to its neighbors. Financial storms were isolated events—if a major company failed, the stock market coped; if a bank got into trouble, the Federal Deposit Insurance Corporation stepped in; if an insurer faltered, some state regulator would take action. None of these events seemed to pose a threat to the financial system as a whole; indeed, they were barely felt in the neighboring precincts of the marketplace.
That vision of reality was already a dangerous delusion by 1980. Indeed, if October 1987 was a runaway train, its victims should have seen it coming. In a roiling escalation of unfamiliar crises that began in 1980, the financial system experienced a shoot-out in the commodities market that ricocheted off several banks and brokerage firms, a high-speed cash hemorrhage at one of the nation’s largest banks, outbreaks of fraud in the bond market that triggered panicky runs on a host of other banks, a computer mishap that nearly brought the Treasury bond market to a standstill, and a worsening epidemic of closing bell nosedives that traumatized the stock market.
In short, the nation’s malfunctioning financial machinery had been jolting toward disaster since the dawn of the decade. By rights, that disaster, when it finally came, should have been called “the Crash of the Eighties.”
And the journey toward that crash began with two eccentric oilmen from Texas who had developed an unlimited appetite for silver.