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Black Monday

Black Monday is the name ascribed to Monday October 19, 1987. On that day, the Dow Jones Industrial Average fell 22.6%, the largest one-day decline in recorded stock market history. This one day decline was not confined to the United States, but mirrored all over the world. By the end of October, stock markets in Australia had fallen 41.8%, Canada 22.5%, Hong Kong 45.8%, and the United Kingdom 26.4%.

(The terms Black Monday and Black Tuesday are applied to October 28 and 29, 1929, the follow-ups to Black Thursday, which started the stock market crash of that year.)

There is a certain degree of mystery associated with the 1987 crash. Many have noted that no major news or events occurred prior to the Monday of the crash, the decline seeming to have come from nowhere. Important assumptions concerning human rationality , the efficient market hypothesis, and economic equilibrium were brought into question by the event. Debate as to the cause of the crash still continues many years after the event, no firm conclusions having been reached.

In the wake of the Crash, markets around the world were put on restricted trading, in many cases because sorting out the orders that had come in was beyond the computer technology of the time, and it gave the Federal Reserve and other central banks time to pump liquidity into the system to prevent a further downdraft. While pessimism reigned, the market bottomed, leading some to label Black Monday a "selling climax", where the excess value was squeezed out of the system.

The effects of the crash rippled through the financial system, eventually causing a crunch in the insurance industry and the Savings and Loan crisis in the United States. The downturn hit New England and Texas specifically, because these two regions were most linked to the S&L and Insurance industry for financing of expansion. Two years later the 1982-1990 expansion began to unravel, in no small part because of tax increases required to bail out the Savings and Loan crisis.

Causes of the Crash

In 1986 the United States shifted from a rapidly growing recovery to a slower growing expansion, there was a "soft landing" as the economy slowed and inflation dropped. As 1987 wore on, and it seemed that recessionary fears were behind the US economy, and there was a boom ahead, the US stock market advanced significantly, peaking in August of 1987. There were a series of volatile days, with the market sliding downwards. In late August some observers warned that an "Ohmstead Break " had been reached, and the market was now in a cyclical "bear" mode. However, this view was not widely subscribed to even as the market reached wider and wider swings.

Potential causes for the decline include program trading, overvaluation, illiquidity, and market psychology. These theories must explain why the crash occurred on October 19, and not some other day, why it fell so far and fast, and why it was international in nature and not unique to American markets.

The most popular explanation for the 1987 crash was selling by program traders. Program trading is the use of computers to engage in arbitrage and portfolio insurance strategies. Through the 1970s and early 1980s, computers were becoming more important on Wall Street. They allowed instantaneous execution of orders to buy or sell large batches of stocks and futures. After the crash, many blamed program trading strategies for blindly selling stocks as markets fell, exacerbating the decline. Some economists theorized the speculative boom leading up to October was caused by program trading, while others argued that the crash was a return to normality. Either way, program trading ended up taking the majority of the blame in the public eye for the 1987 stock market crash.

Economist Richard Roll believes that the international nature of the stock market decline contradicts the argument that program trading was to blame. Program trading strategies were used primarily in the United States, Roll writes. If program trading caused the decline, why would markets where program trading was not prevalent such as Australia and Hong Kong have declined as well? Though these markets may have been reacting to excessive program trading in the United States, Roll points to observations that would indicate otherwise. The crash began on October 19 in Hong Kong, spread west to Europe, and hit the United States only after Hong Kong and other markets had already declined by a significant margin.

Another common theory states that the crash was a result of a dispute in monetary policy between the G-7 industrialized nations, that the United States, wanting to prop up the dollar and restrict inflation, tightened policy faster than the Europeans. The crash, in this view, was caused when the dollar-backed Hong Kong stock exchange collapsed, and this caused a crisis in confidence.

External link

  • Black Monday -Read about Wall Street's Worst Day Ever!
  • Black Monday 1929 -Read about the first Black Monday.

Last updated: 02-07-2005 10:04:03
Last updated: 04-25-2005 03:06:01