Stephanie Mehta is a deputy editor at Vanity Fair. She has worked as a staff writer and editor for the Wall Street Journal, Fortune and Bloomberg.
Sandwiched between the Great Depression and the financial crisis of 2008, Black Monday doesn't get the attention it deserves. Though Wall Street suffered its largest single-day loss on Oct. 19, 1987, history textbooks and 1980s retrospectives tend to characterize the crash as a coda to Reagan-era excesses. And lawmakers and investors searching for ways to strengthen the markets and prevent future catastrophes often look mainly to repair the cracks exposed by the most recent debacle, which explains why we have the (now-imperiled) Dodd-Frank reforms that require banks to show they are strong enough to survive a 2008-like financial downturn.
But ignoring the events of 30 years ago, and the factors that led to that crash, is a terrible mistake, Diana B. Henriques argues in her meticulously researched new book. The conditions that preceded the market meltdown — new and complex financial instruments, technology-powered trading, the rise of powerful institutional investors, squabbling government agencies, and deregulatory zeal — haven't gone away. In fact, they've grown more pronounced. "The road from Black Monday could have led to a different outcome, to broader, deeper, more coherent markets operated for the public good," writes Henriques, a respected financial journalist who also wrote "Wizard of Lies: Bernie Madoff and the Death of Trust." "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."
The title of Henriques's book comes from a comment that John Phelan, then the chairman of the New York Stock Exchange, made to Investment Dealers' Digest, a periodical popular among the finance crowd, published in March 1987. He'd seen market activity grow in volume and volatility, and he fretted about program trading, or the use of computers to automatically trade stocks based on a set of rules, a precursor to today's algorithmic trading. Program trading had become widespread among arbitrageurs and purveyors of a product called portfolio insurance, which promised to help investors limit their losses by buying index futures when the market was up and selling futures when the market fell.
Phelan said he feared that program trading could lead the market to shed hundreds of points. "At some point you're going to have a first-class catastrophe," he warned. Of course, the New York Stock Exchange had done its part to facilitate program trading by automating its order processing system, allowing members to transmit large order volumes. And Henriques notes that Wall Street's institutions had profited tremendously from program trading. "Don't fix things that aren't broken," Alan "Ace" Greenberg, the irrepressible chairman of Bear, Stearns, declared.
By Wednesday, Oct. 14, the stage was set for the meltdown Phelan predicted. Jittery institutional investors started to sell stocks and allocate money to the bond market. Individual investors started to reallocate their retirement portfolios, causing mutual funds to sell. And several computerized trading models kicked into sell mode, too. Nonetheless, regulators and White House officials projected confidence. Alan Greenspan, the relatively new Federal Reserve chairman, met with President Ronald Reagan and key White House advisers. According to Henriques, Greenspan and Treasury Secretary Jim Baker vouched for the soundness of the market.
When the markets opened on Black Monday, sellers flooded in. Rumors of a temporary trading halt sent stocks plummeting further. The only people who seemed blase were the folks in charge. Greenspan flew to Dallas to give a speech. Baker was en route to Sweden. The chairmen of the Securities and Exchange Commission and the NYSE kept appointments and entertained visitors, even as the market tanked. Phelan met with the chief executives of Wall Street's biggest firms and reported that they "didn't seem to have any inkling of how bad the situation really was." It was bad: The Dow Jones industrial average fell 508 points (equal to about 4,000 points by today's standards), or about 22.6 percent.
In the days after the crash, regulators and officials sought to reassure investors. The Fed said it would provide liquidity, then worked with banks to make sure they would lend money to financial institutions facing margin calls and in need of credit. The equity desks at Salomon Brothers and Goldman Sachs pledged to buy major stocks while they were down, an opportunistic move that nonetheless helped restore confidence and buoyed the market. (The head of equity trading at Goldman Sachs was Robert Mnuchin, father of current Treasury Secretary Steven Mnuchin.) Henriques posits that these kinds of informal, behind-the-scenes deals, not shrewd regulatory policies, prevented the calamity from getting far worse.
Indeed, the author bemoans the government inaction that followed the crash, which wasn't for lack of introspection. An exhaustive report about the causes of Black Monday by Wall Street veteran Nicholas Brady (who would go on to serve as treasury secretary under Reagan) determined that the meltdown could be blamed only partly on technology and financial innovation. Poor oversight and cooperation by the government and the financial industry played a significant role. Despite being widely panned in Washington, mostly by regulators who felt they were being called out, the report was eerily prescient. Shortly after the fall of Lehman Brothers in September 2008, former treasury secretary John Snow complained to Congress: "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."
Henriques invested considerable time in research and interviews for the book, and she has nearly 100 pages of footnotes to prove it. Occasionally she will trot out an anecdote or scene to underscore the depth of her reporting. A meeting between Walter Gordon Binns Jr., head of General Motors' pension fund, and his counterpart at AT&T shows off unsurprising details of the GM office ("thick hall carpets and brass doorknobs" ) gleaned from the recollections of Binns's daughter. But details of the meeting itself are scant, and the AT&T executive, so grandly introduced, never reappears. The book would also benefit from a bit of historical and cultural context. Henriques sometimes moors her tick-tock of the months leading to Black Monday with tidbits of the non-financial news of the day, such as the Iran-contra scandal or the racially motivated attacks on three young black men in Howard Beach, N.Y., in January 1987. But these milestones — so helpful in suggesting time and place — are rare. As we bounce through gyrations of the market, we would hardly be slowed or distracted by small reminders of what songs were on the radio and what television shows Americans were watching in the pre-Spotify and pre-Netflix 1980s.
The hard-core student of markets would hardly miss such grace notes. Henriques has produced a first-class cautionary tale that should be on every financial regulator's and policymaker's desk — and many an investor's, too.
By Diana B. Henriques
Holt. 393 pp. $32