Stock Markets and Other Financial Markets | |
Bad Policies Triggered 1987 Stock Market Crash |
Yesterday, October 19, was the 10th anniversary of the stock market crash
of 1987, which saw the Dow Jones Industrial Average drop 508 points in one
day -- a 23 percent fall equivalent to an 1,800 point drop today . Next
to the crash of 1929, the crash of 1987, dubbed Black Monday, has been one
of the most thoroughly studied events in financial history. The lessons
learned may be one reason why the market has risen almost continually ever
since (see figure). Initial blame for the 1987 crash centered on the interplay between stock
markets and index options and futures markets. In the former people buy
actual shares of stock; in the latter they are only purchasing rights to
buy or sell stocks at particular prices. Thus options and futures are known
as derivatives, because their value derives from changes in stock prices
even though no actual shares are owned. The Brady Commission concluded that
the failure of stock markets and derivatives markets to operate in sync
was the major factor behind the crash. While structural problems within markets may have played a role in the
magnitude of the market crash, they could not have caused it. That would
require some action outside the market that caused traders to dramatically
lower their estimates of stock market values. The main culprit here seems
to have been legislation that passed the House Ways & Means Committee
on October 15 eliminating the deductibility of interest on debt used for
corporate takeovers. Two economists from the Securities and Exchange Commission, Mark Mitchell
and Jeffry Netter, published a study in 1989 concluding that the anti-takeover
legislation did trigger the crash. They note that as the legislation began
to move through Congress, the market reacted almost instantaneously to news
of its progress. Between Tuesday, October 13, when the legislation was first
introduced, and Friday, October 16, when the market closed for the weekend,
stock prices fell more than 10 percent -- the largest 3-day drop in almost
50 years. In addition, those stocks that led the market downward were precisely
those most affected by the legislation. Another important trigger in the market crash was the announcement of
a large U.S. trade deficit on October 14, which led Treasury Secretary James
Baker to suggest the need for a fall in the dollar on foreign exchange markets.
Fears of a lower dollar led foreigners to pull out of dollar-denominated
assets, causing a sharp rise in interest rates. What the 1987 crash ultimately accomplished was to teach politicians
that markets heed their words and actions carefully, reacting immediately
when threatened. Thus the crash initiated a new era of market discipline
on bad economic policy. Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis,
October 20, 1997.
|
Home | Support Us | All Issues | Social Security | Debate Central | Contact Us
Dallas Headquarters: 12770 Coit Rd., Suite 800 - Dallas, TX 75251-1339 - 972/386-6272 - Fax 972/386-0924
Washington Office: 601 Pennsylvania Ave. NW, Suite 900 South Building - Washington, DC 20004 - 202/220-3082 - Fax 202/220-3096
© 2001 NCPA
