Ghost of Black Monday Helps to Manage Crisis : Wall St. Chronology: Regulators stay calm, use lessons learned in 1987 to avert panic. So far, it’s worked.
Last Friday afternoon, when the damage from Wall Street’s second worst point fall had become fully apparent, Federal Reserve Chairman Alan Greenspan and Treasury Secretary Nicholas F. Brady began planning how to avoid the Crash of 1989.
The two men are experienced hands at stock crashes. Greenspan had endured criticism for conflicting actions that some thought contributed to the 1987 crash; but many believe that his pledge on the day after Black Monday to pump money into the nation’s financial system helped stop the bloodletting on Wall Street then. Brady’s recommendations in 1988 as chairman of a White House commission studying the 1987 crash led to reforms designed to lessen the impact of a rerun.
By Sunday evening, after a weekend of meetings and phone calls with key government officials and Wall Street executives, the two men were set to act. The Fed would pump money into the financial system Monday morning--and not wait until Tuesday before acting, as in 1987--but remain as low key as possible. No need to get people excited, or frightened. Cooperation among regulators, rather than confrontation, would be the key.
No one would publicly raise the possibility of closing down the markets. The prospect of a shutdown had been mentioned during the height of the 1987 panic by then-Securities and Exchange Commission Chairman David S. Ruder--and some contend that that comment aggravated the fall, in which the Dow Jones industrial average slid 508 points.
The coordinated efforts of these government officials--and their ability to avoid the errors of two years ago--were cited on Monday as a key reason that the stock market avoided a repetition of the 1987 debacle.
Other players--from powerful Wall Street executives to key traders--also had roles in defusing the situation. Officials simply refused to panic--at least for now.
Wall Street’s jitters are not over, by any means, and stocks may be due for some tough sledding later this week. But, so far, it’s worked. Here is an account of how the market rout turned into a rebound:
The week started off on a high note. On Monday, the Dow Jones industrial average set a record high of 2791.41, yet another tribute to the powerful bull market that in nearly two years had more than made up what it lost in the crash of 1987. Already in 1989, the market had gained nearly 30% as measured by the Standard & Poor’s 500-stock index--making it one of the best years ever.
But not all was well.
The market for high-risk, high-yield junk bonds was withering amid some widely publicized defaults. Investors were wary of further defaults and nervous that future junk-financed corporate takeovers might never materialize as potential bond buyers ran for cover. More bad news: On Wednesday, the junk bond market tumbled again amid word that the Ramada Inns hotel chain had failed to sell a $400-million issue of junk bonds.
In addition, investors picked up signals that the Federal Reserve Board would not ease credit conditions and thus lower interest rates.
As trading opened Friday morning, investors were hit with another piece of bad news. The rise in the producer price index, measuring inflation on the wholesale level, exceeded expectations and caused new inflation fears. How could the Fed ease when inflation was rising?
Still, the Dow was down only about 20 points.
Then, at about 2:40 p.m. EDT, the wires coughed up news that bank financing had fallen through for the $6.75-billion management-led buyout of UAL Corp., parent company of United Airlines.
The news hit Wall Street hard. Arbitragers, professional speculators who seek to profit from short-term run-ups in stocks involved in takeovers, had become the primary shareholders of UAL. They thought it was a sure bet. The deal had a deep-pockets investor in British Airways; all of the financing was to be conservative bank financing rather than risky junk bonds.
“People felt UAL was the epitome of a safe deal,” reasoned one New York arbitrager with a large position in the carrier. “If that deal cannot be financed, the message was that every other deal is in trouble.”
The rout was on.
Arbitragers were joined by others who managed big pools of money for pension funds, insurance companies and mutual funds in abandoning stocks that had been the subject of takeover speculation. In short order, other stocks nose-dived. By 3:05 p.m., the Dow was down 90 points.
At that point, something happened that some traders blame for exacerbating the fall. The Chicago Mercantile Exchange, following procedures adopted a year ago, automatically halted trading in the key December futures contract on the Standard & Poor’s 500-stock index for a half hour. The contract had tumbled past a predetermined level.
With institutional investors no longer able to trade futures, panic set in. They sold stocks even more furiously. When trading in the futures was halted yet again at about 3:40, the rout intensified. By the close at 4 p.m., the Dow had tumbled a startling 190 points--a tumble exceeded in points only by the 508-point collapse on Black Monday, Oct. 19, 1987.
Paul. J. Tierney, a managing partner at Coniston Partners, a firm that manages a $1.1-billion investment portfolio, joined the selling spree. “We probably liquidated 5% of our total positions . . . ones which were susceptible because of the weaknesses in the junk bond market.”
So fast was the fall that some investors complained of not getting through on phones to place their orders.
“It happened so quickly in the last half hour,” said Samson Wang, president of Beacon Capital Management, a money management firm in Boston. “I wanted to buy some things--like Disney and Quaker Oats--but I couldn’t. There were not too many people answering telephone calls on the other end. It was rather chaotic, to say the least.”
Friday’s jolt in the stock market also affected other kinds of investments over the weekend, putting downward pressure on the dollar, for example. Many currency traders sought to unload dollars on Sunday when markets opened in New Zealand and Australia.
Bears and bulls were both busy.
P.Q. Wall, a Denver market watcher who lately has become a leading guru of gloom and doom, proclaimed the end was at hand. Monday’s record high “may not be exceeded in 20 years,” he proclaimed.
Meanwhile, not to be outdone by the bears, Wall Street brokerage houses--whose vitality and long-term future depend on bullish thinking--were busy trying to figure out how to persuade other investors to think positive.
Peter DaPuzzo, manager of retail trading in New York for Shearson Lehman Hutton Inc., met over the weekend with key executives to form a strategy for the resumption of market trading Monday morning. One of the key lessons from the 1987 crash, he said, was “those who panicked in ’87 lost more money than they should have.”
The Shearson group “came up with a positive scenario for Monday.” Research analysts were asked to come up with a list of stocks to recommend. Shearson connected key people in New York with their counterparts in Tokyo and London so that they could be in constant contact when those overseas markets opened.
Some Wall Street houses, such as Morgan Stanley & Co., resolved to refrain from the practice of program trading on their own investment accounts, once the severity of Friday’s plunge became apparent. The technique, which involves coordinated investments in the stock markets and futures markets, is believed to make stock prices much more volatile.
Also busy were Brady and Greenspan.
As early as Friday afternoon, Brady had phoned Robert Glauber and David W. Mullins Jr., often referred to as the Harvard “Gold Dust twins” who serve, respectively, as undersecretary of the Treasury for finance and assistant Treasury secretary for domestic finance. Both Glauber and Mullins served as Brady’s key lieutenants on the commission he led that investigated the crash.
Brady told them both to get as much information as possible and begin analyzing the situation. Mullins had open lines to the Fed and the New York Stock Exchange and began gathering information. “Mullins was in his element,” an Administration official said.
Indeed, one official pointed out that, because of their involvement in the Brady Commission report after the Black Monday market crash, Glauber and Mullins “know a heckuva lot about” big slides.
Brady also made calls to Wall Street officials and traders, some of whom he had known during his days as chief executive of the Dillon Read & Co. investment firm.
When the three Treasury officials began analyzing the afternoon’s activity, “it became pretty clear that the factors were different from 1987,” one aide said. Interest rates were lower, stocks were more modestly priced relative to corporate earnings, the dollar was stronger. “It seemed to be a technical correction,” the aide said.
Another key difference compared to 1987 was that pension funds had switched strategies for managing their risks. In 1987, portfolio insurance was used by big pension funds to hedge their risks in the stock market. That had been replaced by a technique called asset allocation, which was a way for pension funds to diversify their investments.
The difference, while technical, was a big and important one. The underpinning of portfolio insurance was to sell when stocks tumbled, and it was accused of contributing to the 1987 debacle. But the underpinning of asset allocation was to buy when stocks became cheaper. So, this time around, institutional investors might be poised to buy on Monday, rather than sell.
On Saturday morning, Brady called Greenspan and invited him to a meeting at the Treasury on Sunday. Senior Fed officials themselves were conferring then and apparently decided to pump money into the financial system, if necessary, to avert a crisis.
Not everything went according to plan. A senior Fed official spoke to both the New York Times and the Washington Post on Saturday, saying that the Fed was prepared to inject funds into the banking system to ease fears. When the story ran on Sunday morning, Greenspan was said to be angry. He and other officials had hoped to play down any sign of intense activity on the theory that they shouldn’t do anything to create the impression that fear had taken hold in Washington.
Brady and Greenspan met in Brady’s corner Treasury office from 4 p.m. to 6 p.m. Sunday afternoon. The purpose of the meeting was, first, to make sure the Fed, Securities and Exchange Commission and Treasury Department had exchanged all appropriate information, and, second, to make certain that all sides were coordinated for Monday’s market opening.
One source said that “there definitely was concern” on the part of everyone involved. But everyone agreed that “the technical analysis didn’t support a conclusion of worry.” On the other hand, there were eerie parallels to 1987. “You can’t look at something like that and dismiss it.”
Sunday evening, Brady went home but left orders that he be called during the night if anything major happened. Greenspan left the meeting at Treasury and went to dinner with top officers of the American Bankers Assn., which was in town for its annual convention.
Everyone knew Sunday night would be crucial. That was when trading would begin on the Tokyo Stock Exchange, giving the first clues as to what would happen Monday morning when Wall Street opened.
If the Japanese market plunged, Japanese investors were expected to sell U.S. securities to raise cash, said Jack Barbanel, managing director of First Global Asset Management in Princeton, N. J.
The initial response from Asia was encouraging, with few Japanese investors expecting a further plunge in U.S. stock values this week. The Nikkei Dow fell only 1.8%.
“No one felt that the U.S. market had been that overbought,” said Stephen H. Axilrod, vice chairman of Nikko Securities Co. International in New York, using a Wall Street term for stock prices that are excessively high. Axilrod was in contact with Japanese colleagues on Friday and Sunday.
“The fact that the (Tokyo market) held up as well as it did was a psychological boost for U.S. markets,” Barbanel said.
On Monday, many of those who earn their livings on Wall Street came to work prepared for anything.
Peter B. Roche, a spokesman for Morgan Stanley, showed up at 6 a.m.--two hours early--and found many colleagues already at their desks. “I think I was late,” he said.
Brady also was prepared. He made an unusual appearance at the White House Monday morning. In addition to meeting with President Bush, the Treasury secretary sat in on the daily meeting of senior White House aides--and, according to those present, urged that an upbeat face be put on the situation.
Although there is a limit to what a President can do to influence the stock market--beyond rhetoric--there is one drastic option he has at his command: He can order a halt in trading.
White House spokesman Marlin Fitzwater would not say whether such an option was even considered, not wanting to advance any speculation that could make things worse.
In fact, it was a comment during the stock crash of 1987 by then-SEC Chairman Ruder that “anything was possible” regarding a possible trading halt that Brady cited in his report on the crash as having driven stock prices down even more.
President Bush, asked if he was concerned about the market, said, “I’m not worried . . . . The Federal Reserve and the SEC and the secretary of the Treasury are monitoring the situation, and that’s where it stands right now.”
Before the market opened, major investment firms were already quite busy advising customers to buy stock, with Shearson, Merrill Lynch, Dean Witter Reynolds and others weighing in with bullish recommendations.
Merrill Lynch suggested that clients boost stock holdings to 50% of their portfolios from 45%. In particular, it recommended investments in such industries as energy, health care, pollution control equipment and capital goods.
“By our measures, stocks are undervalued relative to bonds by 3% to 5%,” said Charles Clough, the firm’s chief investment strategist.
When the stock market opened, the Dow industrials started off with a moderate loss. But tension mounted because many stocks had not opened for trading. In edgy trading, the index descended steadily to show a loss of 65 points after about 40 minutes.
Then something startling happened.
The December Standard & Poor’s 500 futures contract, whose decline had been instrumental in pushing down stocks on Friday, began trading at a level above the price of the underlying stocks in the index. That would apply strong pressure on stocks to rebound, as traders buy stock to profit from the difference between futures prices and stock prices. Apparently, futures traders--reassured by the government’s statements and believing they had overreacted on Friday--felt the decline had gone far enough.
That sent a message to other institutional investors that a crash was not in the offing. Reassured, they began buying. Within 15 minutes, the Dow had risen 90 points.
Then the Fed, as promised, injected about $2 billion of funds into the banking system at roughly 20 minutes to noon Monday--its normal time.
The Dow average was up 88 points by day’s end. But by no means is the episode over.
Declining stocks outnumbered rising stocks by about 5 to 4. And many analysts say the market hasn’t bottomed out yet.
Peter Anderson, president of IDS Advisory Group, a Minneapolis money management firm that has been expecting a market fallback of 10% to 20% and is saving its cash, said he expects the market to drop an additional 200 points or so before it bottoms out. “We will take a further hit.”
Staff writers Tom Redburn and Art Pine in Washington and Jonathan Peterson, Jesus Sanchez and Linda Williams in Los Angeles contributed to this story.
