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Black Monday, 1987: Inside The U.S. Treasury

Summary:
By Liam McPherson The following exchange took place between President Reagan and reporters after the market close on Black Monday, October 19, 1987.  After visiting the First Lady in the hospital, President Reagan returned to the White House just after the market lost over 20 percent of its value on the day. Q: What about the market? Tomorrow will it go down again?President Reagan:  I don’t know. You tell me. Q: Is the market your fault?President Reagan: Is it my fault? For what, taking cookies to my wife? Q: Reaganomics? President Reagan:  I just told you. Good Lord, we reduced the deficit over last year by billion. And all the other things I’ve told you about the economy are as solid as I told you. So, no, I have no more knowledge of why it took place than you have.

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By Liam McPherson

Black Monday, 1987:  Inside The U.S. Treasury

The following exchange took place between President Reagan and reporters after the market close on Black Monday, October 19, 1987.  After visiting the First Lady in the hospital, President Reagan returned to the White House just after the market lost over 20 percent of its value on the day.

Q: What about the market? Tomorrow will it go down again?
President Reagan:  I don’t know. You tell me.

Q: Is the market your fault?
President Reagan: Is it my fault? For what, taking cookies to my wife?

Q: Reaganomics?

President Reagan:  I just told you. Good Lord, we reduced the deficit over last year by $70 billion. And all the other things I’ve told you about the economy are as solid as I told you. So, no, I have no more knowledge of why it took place than you have.

Thirty-three years ago today, now infamously known as Black Monday, my grandfather, M. Peter McPherson, was Deputy Secretary of the U.S. Treasury and acting Secretary that day, while Treasury Secretary James Baker was in the air traveling to Europe.   McPherson was the most senior Treasury official left in Washington to handle the crisis.

The stock market had already peaked in August after an almost 100 percent rally in the prior two years.  By late August, the DJIA had gained 44 percent in a matter of seven months, raising concerns of an asset bubble, and had become very volatile as interest rates had been rising rapidly for almost a year.

Black Monday, 1987:  Inside The U.S. Treasury

Similar to 1929, where the stock market peaked in early September, the markets had already begun to unravel, foreshadowing the record losses that would develop in the next week.

As the markets around the world began to crash, my grandfather convened with the U.S. Treasury’s Undersecretary of Domestic Finance and the Department Chief of Staff to discuss the government’s appropriate response.  The Dow Jones eventually closed 508 points down, or a 22.61 percent, almost double the historic Crash of 1929, where the Dow fell 12.8 percent in one day.

Government Kicks Into Action

According to my grandfather, the situation demanded that his team put together a plan to calm the markets. The economy was doing fine, and there were no signs of recession.  Real GDP growth came in over 4 percent in 1987.

Jitters about the U.S. trade deficit and the path of the U.S. dollar during the Plaza Accord are oft-cited as reasons that triggered the crash, but nobody knows for sure.  Trees don’t grow to the sky, and neither do markets.  Stocks markets do what stocks markets and keep their own schedule.

The team’s conclusion at Treasury that day was the market was under severe strain for technical reasons and complicated by the new computerized program trading related to portfolio insurance.  Nevertheless, the steep losses were causing significant dislocations in the financial markets.

Many large firms were under heavy liquidity pressure and were dangerously close to not making their margin calls.

My grandfather and his team placed a call to the then-new Federal Reserve Chairman, Alan Greenspan, only a month into the job, to encourage the issuance of a Fed statement that it would do whatever it takes to provide the liquidity to keep markets functioning.

It wasn’t the time to think about the policy’s broader economic implications, such as the potential moral hazard, as the plane was going down and desperately needed a rescue plan.

It was also clear Greenspan had been thinking along the similar lines.

Fed officials drafted much longer statements for release, but Greenspan reasoned that a short, clear message would do the most to stabilize markets.

It is also important to point out that when Secretary Baker arrived in Europe late that day, he immediately be communicating with key finance ministers, such as Germany, Japan, France, and the UK. to coordinate a global response to the financial crisis.

October 20

Greenspan issued his statement the next morning, October 20,

“The Federal Reserve, consistent with its responsibilities as the Nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.” – FRB

In typical Greenspan fashion, the statement was vague in methodology yet resolute in purpose.

The market opened down and continued falling, and appeared, at one point, the global financial system was headed for a complete meltdown. Then about mid-morning, buying came into the OEX futures that turned stocks around.  The rest, as they say, is history.

My grandfather felt that the Treasury’s phone call contributed to Greenspan’s thinking and as he made the decision to issue a statement to calm the market.  The statement was the most critical event in stabilizing the markets and preventing substantial economic damage to the U.S. and the global economy.

My grandfather spoke about how the simplicity of the message prevented speculation while instilling confidence.  Not unlike ECB President Mario Draghi’s, “whatever it takes” July 2012 speech, which saved the Euro currency, the European banking system, and ultimately the European Union during their debt crisis in 2011-12.

The Birth Of Stock Market Moral Hazard   

Some argue, including the some of the authors of this website, the Fed’s response to Black Monday ushered in a new era of faux investor confidence and the moral hazard that the central bank will always backstop falling markets.  Thus, forever distorting market risk and real price discovery and contributing to the current boom-bust asset market cycle the global economy now experiences.

President Reagan’s Confidence And Sense of Calm

During the crisis, President Reagan, whose administration my grandfather served several key roles in, was an excellent communicator and never once conveyed a sense of panic in October 1987.

Though not having a financial background, President Reagan did have a degree in economics and understood the nature of markets and how they coveted a sense of calm and leadership from the government during such a crisis.

The following video is President Reagan speaking to the press at the White House on Black Monday preparing to visit the First Lady in the hospital.

Skip to the dialogue, which starts 5:40 minutes in.

Note President Reagan’s incredibly calm demeanor and sense of confidence after the most massive stock market crash in U.S. history.

Gregor Samsa
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