15 years of Global Finance: 1987

Global Finance, Jul 2002 by Platt, Gordon

Observers desperately seeking a fundamental trigger for the selling cited the October 14 1987 announcement of a large US trade deficit.

Black Monday Triaaers a Global Panic

October 19 1987, the day that came to be known as Black Monday, was the worst day the US stock market has ever known. The Dow Jones Industrial Average lost 22.6% of its value, far more than the previous biggest single-day loss of 12.9% in the famous crash of 1929 that foreshadowed the Great Depression.

Stock markets around the world suffered similar losses in the 1987 meltdown. A global tidal wave of selling, triggered by no obvious news event, heralded the dawn of a new era in which computers could outrun the ability of their human masters to control them. The only solution eventually implemented was a system of "circuit breakers"-in effect, pulling the plug to shut the system down before it disintegrates.

At the time, there was considerable concern about what the Crash of 1987 would mean for the global economy. As it turned out, there was remarkably little fallout, as central banks intervened quickly to supply liquidity. Much to the chagrin of those who argue that markets reflect real economic activity and measure value, the real lesson of the crash was that the price of a stock sometimes has little to do with its real value.

"What made this market break extraordinary was the speed with which prices fell, the unprecedented volume of trading and the consequent threat to the financial system," said the report of the Brady Commission, a US presidential task force that studied the crash.

In searching for a cause, many analysts pointed to program trading, a system whereby computers automatically sell large blocks of stock based on market trends without human intervention. Others cited "portfolio insurance," which required more and more selling of stocks as prices declined.

Observers desperately seeking a fundamental trigger for the selling cited the October 14 1987 announcement of a large US trade deficit, which led treasury secretary James Baker to suggest the need for a decline in the dollar. Others blamed the fall on a reaction to news of a US attack on an Iranian oil platform in the Persian Gulf.

No doubt, a stock market correction was in the cards.The market had risen more than 30% in the first nine months of 1987, after two years of gains exceeding 20%. What could have been an orderly retreat, however, was turned into a global panic by a new technology that no one fully understood. The crash highlighted the harsh reality that new technology had made stock markets more vulnerable-and riskier-than ever. -GP

15 YEARS OF SUCCESS

A Safe Pair of Hands Alan Greenspan took over as chairman of the US Federal Reserve in 1987. He is widely credited with fostering the longest economic expansion in US history. His ability to handle crises, his determined independence and his cautious use of his power have won him many admirers.

Nomura Surfs a Wave of Japanese International Investment

The cover story in Vol. 1, No. 1 of Global Finance was entitled "Where Japan's Money is Going Next." Investing the awesome supplies of capital generated by Japan's economic boom propelled Japanese securities firms into the global marketplace. Nomura Securities, Japan's biggest securities house, was the top underwriter in the Eurobond market in 1987, a year in which seven of the top 10 banks worldwide were Japanese.

Japanese securities firms enjoyed record profits in 1987 and made significant advances into the domestic markets of other countries. The rise of the yen against most major currencies made it relatively inexpensive for Japanese financial institutions to buy new operations abroad. When some US securities firms found themselves in financial difficulties after the stock market crash of October 1987, rumors spread quickly that they would be taken over by Japanese firms.

In our first cover story, Masaaki Kurokawa, chairman of the US subsidiary of Tokyo-based Nomura, proposed only somewhat in jest that California should be turned into a joint US-- Japan economic community sharing a common currency. Japanese manufacturers could shift many of their operations to California, where real estate was cheaper than in Japan, he suggested. No visas would be required for Japanese citizens to come and go.

The rise of Japan's financial clout was so meteoric that Kurokawa's grandiose musings could be taken seriously. Japanese banks had boosted their share of international loans from less than 10% in 1980 to one-third in 1987. Many observers believed that Japan was about to take over the world with its new financial empire.

A few short years later, however, the situation changed dramatically. A deflationary spiral unfolded in Japan after the Tokyo stock market and real estate bubbles burst. In 1991 Nomura was caught making illegal payments to major clients to partially compensate them for portfolio losses.

Japanese shares lost 50% of their value between 1990 and 1998. Meanwhile, Japan's top banks, laden with bad loans, were seen as such poor credit risks that they briefly had to pay a full percentage point more than Western banks to borrow dollars on global markets.