On October 19, 1987, the stock market experienced one of “…the largest one-day stock market crashes in history.” The Dow fell by a value of $500 billion, or 22.6%. Additionally, the Nasdaq Composite lost 11.3% and the S&P 500 Index lost 20.5%. The crash was intensified by a bull market that began in 1982, characterized by merger mania, hostile takeovers and leveraged buyouts. In order to raise capital to execute company buyouts, companies issued junk bonds (very risky bonds with high rates of return) and initial public offerings (IPOs). In the 1980s, microcomputer technologies were booming. These advances glorified the economic opportunities for investors in many, many companies.
Unfortunately, in early 1987, the Securities and Exchange Commission (SEC) began investigating illegal trading activities and fraudulent IPOS. Strong economic growth, fueled by investor buying and selling, prompted the Fed to raise short-term interest rates. The increase in interest rates caused brokerage houses to use portfolio insurance. Unfortunately, brokerage houses now stand to benefit from the market downturn. The market became unstable, people were trying to sell like crazy, but there were no people who wanted to buy stocks because of the market instability. This was a downward spiral. Consequently, the Fed reduced short-term interest rates, thus signaling the recovery of the market, implemented by the repurchase of the companies’ own shares due to the undervaluation of the shares.
Another factor leading to Black Monday was securities derivatives which include index options and futures markets where shares are not actually bought but only rights to buy and sell. The inability of the real market and the derivatives markets to stay in sync was a factor causing the drop. Computer trading by large institutions is another factor in which large numbers of shares are scheduled to be purchased when computers detect certain trends in the market. Another factor is the illiquidity of stocks when a large number of people wanted to sell shares but could not find buyers. Another factor was a large US trade deficit. The deficit weakened the US dollar, prompting foreign investors to pull out. The high yield of investments in long-term US bonds meant that fewer people were willing to risk fortunes in the market. The overvaluation of stocks in the months before the crash may or may not have been a factor in the Black Monday crash.
However, one of the benefits of one of the biggest one-day stock market crashes in history was the establishment of the circuit breaker system, which now prevents stock trading when a stock plunges a substantial amount in one day. Furthermore, one of the stark differences between Black Monday and the great stock market crash of 1927 was that in the days following the great downward spiral, the US experienced record rallies. Furthermore, within 2 years, the markets fully recovered to the status quo before Black Monday.
Unfortunately, when it comes to Black Monday, the US was not the only economy affected. Black Monday also negatively affected international markets. Some of the causes that instigated the collapse include: rapidly rising short-term and long-term interest rates, rising US government debt, declining value of the US dollar compared to foreign currencies, weakening deficit US current account balance a high price-to-earnings ratio and a bull market characterized by optimistic investors.
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