Sobering Anniversary : Stock Crash Gloom Held Silver Lining

After the stock market took its worst one-day tumble in history last Oct. 19, economic seers had a dark vision of the future.

Many agreed: The wipeout of so much wealth spelled hard times for Americans in 1988. Freewheeling investors would be transformed into thrift-conscious consumers. Typical members of the public would panic and hang onto their money.

A few months of this behavior and the colossal machinery of the U.S. economy would screech to a halt, analysts feared.

You might call it the greatest economic calamity that never happened.

‘No Economic Scars’

“The remarkable aspect of this is that we had this extraordinary decline in stock prices--and virtually no economic scars,” observed Henry Kaufman, a New York economist and Wall Street veteran, in a recent interview.

The economy sputtered for a few weeks after Oct. 19, statistics now suggest. But then, defying the widespread predictions, it got back on its feet, brushed off the crash’s debris and resumed marching forward.

The crash’s one-year anniversary approaches at a time of humming factories, booming exports and low unemployment. In a quirky twist to the story, some experts now say the debacle indirectly helped many businesses and consumers because it prompted the Federal Reserve Board to lower interest rates.

“In an odd way, the crash probably postponed the next recession--because it stopped interest rates from going up at the time,” said Neal M. Soss, chief economist at First Boston Corp., a New York investment firm.

The loss of $500 billion in stock value in a single day hurt investors, of course, notably the small percentage of U.S. households with major holdings, certain workers near retirement and the 15,000 employees of the New York-based financial services industry who lost their jobs.

And it awakened those who had forgotten during the market’s five-year climb that they were participating in a euphoric gamble all along.

“There was a sense that things are different this time,” recalls Steven G. Einhorn, a partner and investment strategist at Goldman, Sachs & Co. in New York. “The most important effect of the Oct. 19 crumble was to reintroduce the concept of risk to investors.”

It is a concept that many are distinctly uncomfortable with in the post-crash era. Even today, investors remain spooked by the Dow Jones industrial average’s stomach-turning 508-point collapse, and trading continues at sluggish levels. That translates to less profit for investment firms and continued job worries for their employees.

The market’s shadow has spread to college campuses, where students no longer appear quite so eager to join the get-rich-quick world of investment banking.

At Harvard Business School, the percentage of graduates taking jobs in the field shrank to about 11% this year from 30.3% in 1987--in part because of the new uncertainties, said Elizabeth Hardin, Harvard’s director of MBA program administration.

A year later, the market’s wild plunge may still exert a subtle effect on social attitudes that reach far beyond Wall Street.

‘New Pragmatism’

For example, the shockingly abrupt disappearance of so much wealth may have reinforced a “new pragmatism” on the part of the public, in which people have a keener appreciation of quality, said Tom Miller, a vice president of the Roper Organization, a polling firm. “It did sober people up,” he said.

Nonetheless, for typical working Americans--those who live far from Wall Street, work outside the financial world and do not directly own stock--Black Monday has become a fading memory. “As far as I can tell, it’s history--an interesting non-event from the point of view of consumers,” declared F. Thomas Juster, an economics professor at the University of Michigan.

It was not expected to turn out that way. Bombarded with scary predictions of a recession, many Americans feared a financial calamity and sought to protect whatever they had.

The jitters were manifest in different ways. Consumers initially watched their cash closely, shying away from big purchases, as they struggled to figure out what the crisis meant to their own lives.

“We saw an influx of new money like you wouldn’t believe,” recalls Nancy Hardcastle, a vice president and branch manager with Southwest Savings & Loan Assn. in Los Angeles.

‘Jumbo’ Accounts Soar

At her branch on Wilshire Boulevard, the number of new “jumbo” accounts (holding $98,000 or more) soared from just one in September, 1987, the month before the crash, to 38 in October--including 27 after Black Monday, Hardcastle recalled. One customer liquidated his stock holdings and opened nine $100,000 accounts.

Nationally, savings and loans gained $9 billion in new deposits in October and November, a temporary departure from the broader, negative trend, said Martin A. Regalia, director of research and economics at the National Council of Savings Institutions in Washington.

“They were looking for a place to park their money while they figured out whether the world was coming to an end,” he explained.

The crash did not affect just people’s savings practices. Immediately afterward, ominous signs appeared that the economy was stalling. In November, the government’s index of leading economic indicators--a grab bag of 11 measures, including such gauges as stock values, unemployment claims and new equipment orders--took its biggest tumble since mid-1984.

Retail Sales Lag

The economy limped to the end of the year, injured by drops in auto sales and housing starts. Despite a respectable Christmas season, retailers entered the new year with large amounts of unsold merchandise, a condition that threatened to slow down factories and bring the economy to a grinding halt.

Yet the oft-forecast recession never arrived. Why? In part, the reason seems to be that Americans reacted to the episode much more carefully and rationally than economists had counted on.

“The questions in people’s minds were: What does this mean? Am I going to lose my job? Is my paycheck getting smaller?” said Sandra Shaber, an economist with the Futures Group, a consulting firm in Washington.

The answers were critical. They could determine whether or not the market’s ills would spread to the whole economy. And as the weeks passed, most Americans concluded that their personal situations were secure. Contrary to forecasts, the public did not bring on a recession by refusing to part with its money.

Confidence Returns

“Consumers watched and waited to see if something more dire was going to happen--and it didn’t,” recalled Jason Benderly, an economist with Goldman, Sachs. “Then their confidence went back up.”

Even as worries mounted in the first days after the collapse, public confidence fell only about half as much as it did during the oil crisis of the early 1970s, said Richard T. Curtin, director of consumer surveys at the University of Michigan.

“The oil embargo had clear implications for each person, as well as for the economy as a whole,” he explained. “People had to each pay for gas and wait in the lines.”

Another pessimistic assumption about the crash--that the loss in wealth would cause a big decline in spending by investors--also seems to have proved wrong.

To be sure, stock values were lacerated: Between Oct. 13 and Oct. 19 alone, they lost an astonishing $1 trillion in value. Aging workers who had plowed retirement savings into the stock market saw their nest eggs shrink as much as 40% to 50%.

Yet such problems were far removed from the day-to-day realities affecting most households, even those with wealthy investors.

Questionable Assumption

To assume that average investors scaled down their spending plans after the crash is to assume that they scaled them up during the heady run-up of 1987--and that is questionable. Even after the crash, the Dow Jones industrial average was no lower than its level 18 months earlier--and remained 124% higher than its level at the start of the five-year rally.

Steven R. Malin, an economist at the Conference Board research organization in New York, argued that the spending drop failed to materialize in part because stock market wealth has an aura of unreality even to most investors.

“They’re thrilled when the market’s going up, and they feel terrible when it’s going down,” he said. “But they drive the same car, wear the same clothing and take the same vacation.” By contrast, he added, “Take money out of someone’s paycheck, and they’ll go through the roof.”

Consumer behavior was not the only thing that limited damage from the crash. Another key factor was the bricks-and-mortar economy of industrial America, a far different creature from the mercurial financial markets.

New Keys to Growth

The stock collapse took place at a time when this “real” economy was embarked on a fundamental shift in which manufacturing and business investment were replacing consumer spending as the keys to growth.

“Real business was continuing,” observed A. C. Moore, research director of Argus Research in New York. “Out in the Midwest, exports were picking up. People that I know in Texas regarded this as my problem, not their problem.”

Much of the good economic news last year arose from overseas demand for U.S. products, which had become priced much more competitively because of the weaker dollar. In addition, industry was reaping the rewards of tough cost-cutting moves taken earlier in the 1980s. Once manufacturing executives concluded that the U.S. financial system was not falling apart after Oct. 19, they got back to business.

“We didn’t pay a heck of a lot of attention to it (the crash), it’s that simple,” said T. L. Russell, general manager of corporate planning and analysis at Chevron Corp., which this year is spending more than $3 billion on oil exploration and other investments. “There are other things we worry about much more--like the price of oil.”

Ironically, Wall Street’s trauma turned into an unexpected boost for the rest of the country in at least one respect.

As the crisis developed, federal monetary officials shifted their concern from stemming inflation to preventing financial paralysis among major brokerage houses and their banks. As a result, the Federal Reserve Board provided billions of dollars to the banking system--in marked contrast to federal actions after the 1929 stock market crash.

Rates Slide Quickly

Interest rates plunged immediately. The short-term federal funds rate slid from its level above 7.5% before Oct. 19 to under 6% by early November. Long-term rates tumbled as well: The bellwether 30-year Treasury bond fell to 8.8% from 10.2% within weeks of the crash.

“We were marching down one road, and all of a sudden we marched down a different one,” recalls Robert T. Parry, president of the Federal Reserve Bank in San Francisco. “I think it’s safe to say the decline in interest rates not only avoided a serious slowdown--but in some people’s view it may have extended the life of the expansion.”

By springtime, Parry said, the economy’s vitality was apparent, and the Fed returned its focus to inflation. Yet while the overall U.S. economy survived Black Monday without lasting damage, the high-flying securities industry did not emerge unscathed.

About 18,000 employees initially lost their jobs as companies scrambled to cut costs, with about 3,000 eventually finding work elsewhere in the industry. Further cutbacks are still possible as firms struggle to make money in today’s climate of slow trading.

Trading Volume Drops

Average daily trading volume on the New York Stock Exchange dropped to 174.2 million shares in the first half of 1988 from 189.2 million shares in the first half of 1987, according to the Securities Industry Assn. in New York. Trading has fallen even more sharply in over-the-counter shares, a truer reflection of individual investors’ behavior.

Similarly, sales of stock mutual funds have plummeted. July’s $2.2 billion in sales was less than half the level of a year earlier. The market, meanwhile, has remained hard to predict since the crash, discouraging some investors from jumping back in.

“Much of what industrial America experienced early in the 1980s came hitting home to the securities industry in 1988,” said Jeffrey M. Schaefer, research director at the Securities Industry Assn.

The market’s ills have hit home as well to fledgling companies that often relied on stock offerings to raise needed capital. The value of such initial offerings shriveled to less than $3 billion in the first half of this year from more than $14 billion in the first half of 1987, Schaefer estimates.

Yet even in the financial capital of New York City, it is hard to find broad signs of pain caused by the crash. Retail sales have held up. And despite some evidence of a softening real estate market, the unemployment rate was lower during the first half of this year than in the same period of 1987.

Alarming Forecasts

“A lot of the forecasts said the abyss was at hand--but it never worked out that way,” said Samuel M. Ehrenhalt, a regional commissioner in New York for the Bureau of Labor Statistics.

It may be too soon to write off the episode entirely, however. The crash was such a stunning, unique event that some experts warn that its implications are not yet fully understood.

“One thinks: Was it a strange aberration, or will we still have to pay the bill?” asked Gavin R. Dobson, a vice president of Kemper International Fund in Chicago. “The suspicion is that we still have to pay the bill. We do think about it--a lot.”

Some predict, for example, that the market’s enduring malaise could prompt thousands of new layoffs before the end of the year, with greater damage to the New York economy. “I think that some of the impact in the city and region is still to come,” said Matthew P. Drennan, an economics professor at New York University.

Collapse Seems Unlikely

Despite such worries, a massive collapse of stocks appears unlikely, analysts said. Stocks today are trading much closer to their historical values. The U.S. dollar appears more stable than it did in October, 1987, and institutional investors have reduced the amount of assets subject to the computerized sell orders that prompt dizzying up and down movements in price.

“What happened Oct. 19 is generally regarded as a one-shot phenomenon,” said Robert H. Chandross, chief North American economist for Lloyds Bank in New York. “It’s not likely to repeat itself anytime soon.”

At the same time, some experts say the stock plunge highlighted instability that is built into today’s globally linked financial markets--and that there is no guarantee that the U.S. economy could so easily weather a future crisis, or that the Federal Reserve Board response would be as successful next time.

“Was Oct. 19 the end of volatility?” economist Kaufman asked. “No--it was a reaffirmation that substantial volatility is inherent in the system.”

Vulnerable to Swings

According to Kaufman and others, stocks are more vulnerable to dangerous, helter-skelter swings than in the past because of a variety of modern realities. These include the many investment instruments now available, which heighten pressure on portfolio managers to achieve quick gains; the concentration of stocks in the hands of relatively few institutional investors, and the worldwide forces pushing and pulling the markets.

Albert M. Wojnilower, a managing director at First Boston, likens America’s experience with the Oct. 19 collapse to a pedestrian who managed to run across a crowded freeway: If you survive once, it’s tempting to think you can do it once more.

“This suggests that in the future, when people have had a chance to forget Oct. 19, something like this will happen again--and who knows whether we will get across the freeway or not?” he asked.

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AFTER THE CRASH Consumer confidence dipped only briefly. . . Source: Conference Board survey . . . and GNP continued to grow Source: Business Conditions Digest