Wall Street History
David Wessel of the Wall Street Journal recently had a piece
titled “If a Quake Hits Markets, At Least Shock Absorbers Have
Improved Since 1987” (WSJ, June 28, 2007) and it got me
looking back to the actual environment 20 years ago, including
what the experts were saying then. There are indeed a lot of
parallels, as well as some key differences.
But first, Mr. Wessel opines:
“Twenty years ago, it was portfolio insurance and index
arbitrage. Nine years ago, it was the hubris of Long-Term
Capital Management, the big, leveraged fund that thought it was
smarter than everyone else. Today’s financial instruments are so
opaque that almost no one can be certain how risky they are.”
Wessel then cites some findings from a recent report by the Bank
for International Settlements – the central bank for central
“It’s not hard to argue that our understanding of economic
processes may even by less today than it was in the past. On the
real side of the economy, a combination of technological
progress and globalization has revolutionized production. On the
financial side, new players, new instruments and new attitudes
have proven equally revolutionary. There seems to be a natural
tendency in markets for past successes to lead to more risk-
taking, more leverage, more funding, higher prices, more
collateral and, in turn, more risk-taking .
“The danger with such market processes is that they can,
indeed must, eventually go into reverse if the fundamentals have
“Should liquidity dry up and correlations among asset prices rise,
the concern would be that prices might also overshoot on the
downside. [Wessel: “That’s central-banker-speak for ‘crash.’”]
Such cycles have been seen many times in the past.”
“Recent history is encouraging. The 1987 stock-market crash, as
frightening as it was, didn’t tank the U.S. economy. Neither did
the horror of the Sept. 11 attacks. The economy gulped and then
rebounded. That isn’t any guarantee that the next crash or crisis,
and there will be one someday, will have similarly passing
effects on the impressively resilient U.S. economy. But it is
But what of 1987? For a perspective, I turn to the archives of the
New York Times, which any subscriber can access with relative
For starters, let me lay out some key numbers.
The Dow Jones Industrial Average closed the year 1986 at the
1895 level. It was basically a moon shot from there as the Dow
soared to 2722, up 44%, by Aug. 25, 1987.
As for the economic indicators then, by this time the nation’s
unemployment rate was 5.9%, an eight-year low and a full
percentage point below its level a year earlier. The number of
jobs had increased by 12 million since President Ronald Reagan
had taken office. While manufacturing continued to take it on
the chin, though, in July there was a 70,000-job spurt in that
But inflation was rising. The Consumer Price Index was up
just 1.1% in 1986, but by mid-August ’87 was increasing at a 5.4%
clip. The Producer Price Index, down 1.7% in ’86, was also now
up to a 5.4% pace in the second quarter.
GDP, up 2.9% in ’86, rose 4.6% in the first quarter and then fell
to a 2.6% annualized rate in the second quarter. [It would rise
3.8% in the third.]
But disposable income, after adjusting for inflation, was falling.
In the first half of 1987, for example, hourly wages rose just
From a wire service report:
“The upturn in inflation appears to be the result of international
factors, not increasing wages. Oil prices have been rising, and
markets for metals and other raw materials have recovered. The
dollar is cheaper, causing import prices to rise and giving
American producers greater leeway to raise their prices.”
But the big debate in 1987 concerned the U.S. deficits and the
value of the dollar. The Commerce Department reported that the
June deficit was $15.7 billion, an all-time monthly high.
The New York Times commented on Aug. 16, “The danger
remains that the chronic budget deficit could be the undoing of
the American economy and securities markets. Last week, in his
televised address, President Reagan renewed his request for a
constitutional amendment requiring a balanced budget. ‘We
must face reality,’ he said. ‘The only force strong enough to stop
this nation’s massive, runaway budget is the Constitution.’”
The stand-off, many of you may recall, was between a
Republican White House and a Democrat-dominated Congress.
Coincidentally, Alan Greenspan had just been sworn in as the
new Chairman of the Federal Reserve earlier in August.
By Sept. 8, 1987, the yield on the 30-year Treasury (the key rate
in those days, as opposed to the 10-year today) was at 9.50%, up
about two percent on the year, and the Fed announced it was
increasing the discount rate for the first time in three years, to 6%
from 5.50%. [The discount rate was known as the benchmark
short-term measurement then, rather than today’s federal funds
“A focal point in the bond market continues to be weakness in
the dollar, which discourages foreign buyers and heightens
inflationary expectations by raising prices for imported goods
and strengthening demand for American exports.”
During this time, Sept. 1987, stocks were still holding their own.
After peaking at 2722 on 8/25, the Dow finished September at
And then there was Japan.
“In addition to the boom-like conditions in the Japanese housing
market,” an economist told the Times, “businesses were
benefiting from lower prices for raw imported products (because
of the yen’s appreciation) [Ed. it was around 140 yen-to-dollar at
this point.] and consumers were buoyed by wealth created by
rising stock prices. Even without a fiscal stimulus package, the
gross national product (in Japan) probably will grow by about
3.5% in the coming year and could increase as much as 5%.”
On Sept. 14, 1987, Peter Kilborn had some of the following
commentary for the Times.
“Most economists, including many in the Reagan
Administration, attribute much of the trade deficit and the lost
jobs and business it represents to the other big deficit, that in the
Federal budget. The budget deficit, in turn, in their view
persists mostly because of the President’s refusal to yield on
“This viewpoint contends that the President has undermined the
economically sound and politically calculated objective of
Treasury Secretary James A. Baker 3d and the former chairman
of the Federal Reserve, Paul A. Volcker, in steering the two-and-
a-half year decline of the dollar. Well before now, Mr. Baker
could have assumed that the trade deficit would have shrunk
enough to calm the anger in Congress over the jobs the nation
was losing to foreign competition.
“Of course, a political impasse between the President and
Congress cannot alone explain why America’s purchases abroad
are exceeding the sales of its goods. In the current situation, the
expected effects of the dollar’s drop have been offset by several
other factors over which American officials have little control.
“For one thing, foreign companies have been willing to cut their
profits to hold onto the market shares they have gained in the
United States. For another, American consumers continue to
show a preference for imported goods in the belief, justified or
not, that their quality is higher. Also, the world economy has
been growing too slowly to swallow larger quantities of
“All these circumstances have led to the persistent trade deficit
that threatens the President with retribution from Congress in the
form of a politically seductive but potentially damaging
protectionist trade law. If enacted, it would limit the President’s
authority to negotiate free-trade agreements with other nations
and impose new curbs on American imports of their goods.”
Does all this sound familiar? And back then, the trade deficit
was running at about a $15-$16 billion clip, monthly, after a
record increase of $156 billion for all of 1986. Today, the
monthly figure is in the $60 billion range.
As for the budget deficit, it was a far larger problem in those
days no matter how you slice it. It was nonetheless expected to
decline from a record $221 billion in 1986 to about $160 billion
for all of ’87. But, as a percentage of the overall economy, it was
about 5% and today it’s more like 1.5%.
One other item, the current account deficit, the broadest measure
of the nation’s international trade, widened in the second quarter
of ’87 to a then record $41 billion. For the first quarter of 2007,
twenty years later, it was $190 billion over the same period.
So in 1987, there were concerns over inflation, deficits,
protectionism, the dollar, and the Federal Reserve.
And if you were looking for a China equivalent in those days, it
wasn’t Japan, but rather South Korea.
Reuters reported on Sept. 21, 1987:
“Treasury Secretary James A. Baker 3d has urged the South
Korean Government to accelerate the revaluation of the won
against the dollar
“(The South Korean news agency) said that Mr. Baker recently
sent a letter to the South Korean Finance Minister demanding an
increase in the won’s value and more access to the country’s
market for American farm products.”
On Sept. 4, the new Fed Chairman Greenspan had raised interest
rates and speculation was that Greenspan had proceeded
unilaterally in part to show the Fed’s independence from the
administration. This also put Greenspan in direct conflict with
Treasury Secretary Baker.
Baker and the White House were miffed at the chairman for
acting before the annual meetings of the International Monetary
Fund and the World Bank, then scheduled for the last week in
Greenspan, while he made no public comments, as would be his
modus operandi during his tenure, was concerned about inflation
and not the fate of the dollar when the Fed released its statement
accompanying the rate increase.
But as the Times’ Peter Kilborn wrote on Sept. 24, 1987:
“Regardless of whether it was mentioned in Mr. Greenspan’s
statement or not, the dollar is normally affected by changes in
“Higher rates lure foreign investment in American securities, and
foreigners have to buy dollars, pushing the currency up, to buy
the securities. The dollar also has a bearing on the inflation rate
because, as the currency declines, prices of imported goods rise.
In the Treasury’s view, Germany and Japan should at least have
been asked to buttress the Fed’s action by lowering their interest
“Mr. Greenspan seems to have confused people further about his
view of inflation. On Monday, about two weeks after he cited
signs of inflation as a reason for raising rates, Mr. Greenspan
said in a speech that he saw few such signs.
“ ‘To hear that two weeks after they acted is a little puzzling,’
said one economist at the Brookings Institution.”
That wouldn’t be the first time Greenspan’s actions and his
words weren’t necessarily in sync.
So we press ahead to the week of Oct. 12, 1987. The Friday
before, 10/9, the Dow closed at 2482; having declined about 115
points since the start of the month. By the close of action on
Tuesday, Oct. 13, though, the Dow was back up a bit to 2508.
Then stocks fell 10.4% over the next three days to close the week
at 2246. It was the wickedest three-day move in terms of Dow
points, ever. One problem was an increase in the prime rate by
Chemical Bank of New York to 9 from 9 .
“The stock market has (also) been battered by dismay over the
nation’s persistent trade deficit and its implications for the dollar
and interest rates .
“At the same time, the dollar closed lower on remarks by
Treasury Secretary Baker that many in the market interpreted as
meaning that the United States is prepared to see a lower dollar.
“Anxiety over interest rates continued yesterday despite
comments by the White House and Mr. Baker stating that rates
are higher than justified by current or expected inflation.”
And there was an increasing amount of program trading, or what
was labeled then “portfolio insurance activity.”
Monday, Oct. 19, 1987
“Last week’s spectacular drop in the stock market has left
investors searching for ways to hedge their bets and financial
leaders hoping for new international policies to solve the
problems that led to the plunge.
“ ‘I don’t think there is reason to be alarmed, but one has to be
concerned,’ David Rockefeller, the retired chairman of the Chase
Manhattan bank said yesterday.
“H. Ross Perot, the Dallas entrepreneur and founder of
Electronic Data Systems, suggested that Wall Street’s tumble
could be constructive if it seized the attention of business
executives and policymakers. ‘This is like a tremor out there on
the West Coast,’ he said. ‘Maybe it will help us realize that
there’s a big one out there waiting to happen.’
[Perot was referring to the problems caused by excessive deficits,
a theme he stayed on over the next decade.]
“Several business leaders said Congress and the Administration
should take the stock market activity last week as a warning to
address the deficits in the Federal budget and the balance of
trade, as well as the poor coordination of Western economies .
“Recent indications by Treasury Secretary James A. Baker 3d
that the United States would tolerate a lower dollar against the
West German mark confirmed the market’s apprehension that a
breakdown of international cooperation could fuel inflation, raise
interest rates and further depress the stock market. And the drop
in buying by foreign investors is worrying the credit markets .
“Referring to the trade deficit and the budget deficit, Peter G.
Peterson, Commerce Secretary under President Nixon and now
chairman of the Blackstone Group, an investment bank, said:
‘We’re going to find that, in this era of the twin towers, the need
for economic adjustment is going to be given a new kind of
urgent meaning. There is going to be pain and sacrifice of some
sort, and part of that sacrifice is going to be changing our
previous unsustainable patterns of consuming more than we
[Pete Peterson never changed his tune, either.]
But do you think you have it bad today, re interest rates? Back in
“Already, many people are rethinking their day-to-day
investment decisions. Homebuyers are warily watching double-
digit mortgages, while people who financed their homes with
adjustable-rate mortgages are contemplating how to reduce their
spending in order to meet higher monthly payments.”
Well, as we learned, Black Monday, Oct. 19, 1987, was history
making as the Dow Jones plunged 508 points to close at 1738.
New York Times, Oct. 20, as reported by R. W. Apple Jr.
“The shouts of panic on Wall Street and in exchanges around the
world today echoed only faintly in the corridors of the Reagan
“Few people in official Washington seemed to have any
prescription to offer demoralized investors.
“Fewer still ventured any predictions as to whether the plunge in
stock prices was a forerunner of a major recession, as the Crash
of 1929 signaled the onset of the Depression.
“Many of the key players were absent. Treasury Secretary James
A. Baker 3d was in Frankfurt, attempting to resolve differences
over currency levels that have helped to unsettle the markets.
After today’s stock plunge, he canceled the rest of his trip and
hurried back to Washington, where he is expected to confer with
President Reagan Tuesday.
“In Mr. Baker’s absence, President Reagan said early today that
‘steady she goes’ was the best course for the economy, without
mentioning the turmoil on Wall Street. Later, the White House
issued a statement asserting that consultations with investment
leaders ‘confirm our view that the underlying economy remains
sound.’ The statement added: ‘We are in the longest peacetime
expansion in history.’”
R.W. Apple Jr. compared the above to October 1929, when
President Herbert Hoover issued a similar statement. “The
fundamental business of the country, that is production and
distribution of commodities, is on a sound and prosperous basis.”
Also on Black Monday, President Reagan was preoccupied with
an attack on an Iranian oil rig in the Persian Gulf. No doubt this
accounted for a bit of the loss in the Dow as well.
But the response on the part of the administration was pretty
much “What the market does is its business, not ours.” One
senior official commented in some exasperation early in the
evening after the 500-point crash.
“What do you expect us to do? Announce that all the Cabinet
members will be buying IBM and General Motors tomorrow?”
R. W. Apple Jr. wrote, “There was no comment on the market’s
spasm from Alan Greenspan and none from Mr. Baker .
“With the nation listening and few in Washington saying much,
the voices that were raised came through clearly. David S.
Ruder, the chairman of the Securities and Exchange
Commission, discussed in a general way the possibility of briefly
halting trading to restore order. Rumors had swept Wall Street,
and the commission had to issue a ‘clarification’ making it plain
that there was no present intention of ordering any such
Amidst the aftermath came the blame game.
“In a television interview on Sunday, before he left for Europe,
Mr. Baker said that Democratic plans for increased taxes on
business had contributed heavily to last week’s less severe sell-
off on Wall Street. Today, House Speaker James Wright
described that assertion as ‘balderdash’ and blamed Mr. Reagan
for record trade deficits and domestic budget deficits that he
suggested had been the real reasons for the loss in confidence.”
Of course the big concern in the aftermath of the Crash was the
health of the U.S. economy. As he boarded a helicopter on Black
Monday, President Reagan said “I don’t think anyone should
panic because all the economic indicators are solid.”
Towards that end, Robert Kavesh, a professor of finance at New
York University’s School of Business, was quoted in a separate
New York Times piece on Oct. 20.
“In 1929, you didn’t have insurance of bank deposits, you didn’t
have the Securities and Exchange Commission, you had much
less knowledge of how the economy worked,” he said.
Today the Government is much more willing to intervene to keep
the economy growing. Noted economist John Kenneth Galbraith
said “All governments, liberal and conservative, have assumed
that responsibility, which wasn’t the case in 1929.” Galbraith,
though, noted huge Federal budget deficits made it difficult for
Washington to increase Government spending, if necessary.
But Galbraith also cautioned that at least one factor was worse in
‘87 than in 1929: the large presence of foreign investors. “If
they should suddenly withdraw,” wrote a Times reporter in
summing up Galbraith, “it would not only depress the markets
further but hurt the dollar as well.”
As it turned out, Reagan was right. The U.S. economy’s
underpinnings were fine and by Oct. 22 the markets had calmed
down. Tuesday morning, Oct. 20, was quite scary, though, as
another wave of selling prompted the Federal Reserve to flood
the system with money as a way of reassuring markets, and it
worked. The Dow Jones would finish the year at 1939. A year
later, 12/31/88, it was up to 2168.
Studies would later blame program trading, primarily, though we
also learned that Treasury Secretary Baker’s meddling in the
dollar and his jawboning of Japan and Germany certainly didn’t
But when you compare 1987 to today, you do see many
similarities; at least in terms of the debate. Deficits and trade
were, and remain, two major items, but as the deficits have
grown, what impact did this have, at least in terms of equity
prices? Virtually zero. It’s why I try not to harp on them in my
own writings, though no doubt, one day, perhaps sooner than
we’d like to think, the deficits will indeed matter.
As for the Federal Reserve, whoever is chairman largely keeps
their mouth shut when it comes to making pronouncements that
could move the market, and as noted above, future Treasury
secretaries learned to keep theirs shut as well, particularly on the
topic of the dollar. You might say lesson learned.
Sources: Aside from R. W. Apple Jr. and Peter Kilborn of the
New York Times, other Times reporters used for the above
included Alison Leigh Cowan, Phillip H. Wiggins, Michael
Quint, Kenneth N. Gilpin, Leonard Silk and Steve Dodson.
Wall Street History will return next week.