How can one forget? I was a freshly minted Harvard MBA working in “govies” (government securities) on the Fixed Income trading floor of Bear Stearns, soon to cover an entire city block in midtown NYC at 245 Park Avenue. On “Black Monday” or October 19, 1987, the DJIA fell 508 points (23 percent), accompanied by crashes in the futures exchanges and derivatives markets. This was the largest one-day percentage drop in the history of the DJIA. Significant selling created steep price dislocations throughout the day, particularly during the last 90 minutes of trading. Normally a cacophony of shouting, on that afternoon hundreds of us sat on the trading floor silently in shock, watching our trading screens as equity markets globally crashed—you literally could have heard a pin drop on the massive trading floor. Then Bill Michaelcheck and Vinny Mattone, heads of Fixed Income and members of the Management Committee of the firm, came out of their shared office on the edge of the floor and shouted–“BUY—BUY everything you can—BUY NOW!!—the Fed will cut rates”. And the floor buzzed back to life—and we bought and bought—and the firm made millions of dollars getting longer as the profits on many fixed income trades soared with lowered rates.
We now know that in 1987 the Fed provided support to the Treasury securities market by injecting in-high-demand maturities (known as “specials”) into the market via reverse repurchase agreements, and allowing the federal funds rate to fall from 7.5 percent to 7.0 percent. So one obvious difference of 1987 with today is with the current fed funds rate at 0.25 percent, there is not much room for the Fed to lower rates and still be in positive territory.
And one similarity between 1987 and today is the Fed taking actions to provide liquidity “to support the economic and financial systems”. For example during COVID, the Fed has provided both practical and psychological support for various financial instruments and sectors including our banking system, reduced the target range for the federal funds rate by 1.5 percent, helped to provide liquidity by purchasing nearly $2 trillion in securities, and set up facilities to support credit flow in the economy.
And another similarity with 1987 is that everyone from hedge fund titans to retail investors seems to make money in the markets.
The S&P 500 index was up nearly 40 percent YTD through September 15, 1987—versus up about half that amount—or 20 percent—for YTD 2021. Yet even at a lower YTD 2021 return level, the S&P 500 is on pace this year to set a record for higher closing records. Through yesterday YTD, the S&P 500 has over 50 all-time closing highs in 2021—a pace if continued that would surpass the record 77 closing highs set in 1995.
We cannot know whether 2021 will hold a financial crisis. But we can know that when the next crisis occurs, it will differ from the crisis of 1987—or the crisis of 1998 with Long Term Capital—or the crisis of 2008 with mortgages and derivatives leverage. For major financial dislocations are unique—which is why they create crises.