Robert J. Samuelson: Lessons From the 1987 Crash
The stock-market crash of 1987 was horrifying even to Americans who weren't shareholders. On Oct. 19, the Dow Jones industrial average dropped 508 points, which was 22.6 percent and nearly twice the largest one-day decline during the 1929 crash. A comparable free fall today would be almost 3,200 points. Twenty years later, the crash of 1987 has changed the way we think. It's stripped us of the illusion that financial panics are a thing of the past: they remain a clear and present danger for the economy.
Let's be clear. A financial panic is not just a big price decline. Since World War II, there have been plenty of those. From early 1973 to late 1974, the stock market dropped roughly 50 percent (almost identical to the fall from early 2000 to late 2002). Nor is a panic simply the "popping" of a "bubble," though it might start that way. In a panic, fear takes control. Herd behavior swiftly triumphs. There's a stampede. People want cash—"liquidity," in finance lingo.
Americans thought they had immunized themselves against financial hysteria. Bank runs—depositors wanting their money—were the major form of panic, and Congress had dealt with them. In 1913, it created the Federal Reserve to lend to solvent banks. When that didn't prevent bank runs in the 1930s, Congress added deposit insurance so that a run on one bank would not cause a chain reaction. As for the stock market, the Securities and Exchange Commission, created in 1934, policed for the financial fraud that had often triggered panics. Finally, full-time portfolio managers for "institutional investors" (pensions, mutual funds, insurance companies) and investment houses dominated markets. Better informed, these professionals seemed less susceptible to herd behavior.
On Oct. 19, these comforting beliefs vaporized....
Read entire article at Newsweek
Let's be clear. A financial panic is not just a big price decline. Since World War II, there have been plenty of those. From early 1973 to late 1974, the stock market dropped roughly 50 percent (almost identical to the fall from early 2000 to late 2002). Nor is a panic simply the "popping" of a "bubble," though it might start that way. In a panic, fear takes control. Herd behavior swiftly triumphs. There's a stampede. People want cash—"liquidity," in finance lingo.
Americans thought they had immunized themselves against financial hysteria. Bank runs—depositors wanting their money—were the major form of panic, and Congress had dealt with them. In 1913, it created the Federal Reserve to lend to solvent banks. When that didn't prevent bank runs in the 1930s, Congress added deposit insurance so that a run on one bank would not cause a chain reaction. As for the stock market, the Securities and Exchange Commission, created in 1934, policed for the financial fraud that had often triggered panics. Finally, full-time portfolio managers for "institutional investors" (pensions, mutual funds, insurance companies) and investment houses dominated markets. Better informed, these professionals seemed less susceptible to herd behavior.
On Oct. 19, these comforting beliefs vaporized....