Finance Professor Bates Studies the Mysterious Crash of '87
"It's still rather mysterious," said David Bates, a professor of finance at the University of Iowa's Tippie College of Business who studies market crashes. "There was no big news that day or other monumental event, nothing to suggest that the market was overvalued by 23 percent the previous day, so we just don't know why it crashed."
This Friday, Oct. 19, is the 20th anniversary of the day when the Dow Jones industrial average nosedived 508 points, losing 22.6 percent of its total value in the greatest percentage loss Wall Street ever suffered in a single day. That loss outpaced even the Black Monday collapse that signaled the start of the Great Depression in 1929, when the market lost only 12 percent of its value.
The Dow was not alone as the crash was a global event, with nearly every major stock market in the world losing significant chunks of their value that day for reasons that analysts are unable to agree on.
But Bates said mystery is not unusual when it comes to market crashes. While some market collapses are easily traced to a single event (the collapse on Sept. 17, 2001, for instance, when the Dow fell 7 percent on the first day of trading after the Sept. 11 terrorist attacks), most are caused by a factor or series of factors that remain elusive and unpredictable.
After the 1987 crash, a federal commission headed by Nicholas Brady concluded technology was partly responsible. It cited computerized trading by institutional investors that triggered automatic sell-offs as stock values fell below certain benchmarks, accelerating the rush downward.
It also blamed the New York Stock Exchange's inadequate information technology system that was overwhelmed by the number of orders that day, causing hours-long delays in fulfilling transactions.
In response, the NYSE board of governors established new rules to limit computerized trading and upgraded the IT systems.
"But since we don't know what caused the market to crash in the first place, we don't know if the measures they took to prevent it from happening again will work," Bates said.
In the end, Bates said the crash had little long-term effect on the economy or the stock market. The Dow began to rebound immediately in 1987, gaining back 5 percent of its value on Oct. 20 to start a bull run that would last 13 years and take the Dow from one record high to the next. Today, the Dow sits at around 14,000 points, more than 12,000 points higher than its Oct. 19 low of around 1,800 points.
Bates partly credits Alan Greenspan, who at the time had been chairman of the Federal Reserve for only two months, with preventing a 1929-like meltdown.
"Greenspan immediately promised the Fed was ready to step in and inject liquidity into the markets and that did a great deal to calm investors," said Bates. "The Fed's failure to intervene was one of the mistakes made in 1929, and that lesson was put to good use in 1987."
Contact: Tom Snee, UI News Services, 319-384-0010