“The markets in a panic are like a country during a coup, and seen in retrospect that is how they were that day,” wrote a young Salomon bond salesmen named Michael Lewis, of the chaos he witnessed. “One small group of people with its old, established way of looking at the world is hustled from its seat of power.”
As Bloomberg details, most of the people willing to share their memories count themselves as winners who seized the moment as an opportunity not only to make money, but also to insert themselves in the new financial order – Paul Tudor Jones, Stanley Druckenmiller, Nassim Nicholas Taleb. Their story, and the story of Black Monday, is the birth story of modern financial markets – a wild ride of shock, angst, and, for some, glory.
In the weeks before Black Monday, a few investors spotted patterns that gave them pause.
The most confident were Paul Tudor Jones and Peter Borish, young partners at a small hedge fund in Lower Manhattan. In a prescient Sept. 24 note to investors, Jones even signed off with “caveat emptor” – buyer beware.
PETER BORISH, head of research at Tudor Investment Corp. and Paul Tudor Jones’ No. 2:
We were tracking exponential moves in the equity market. The main one was the equity move in the 1920s, and the market in 1987 looked almost identical. The week before Black Monday, the technical and fundamentals aligned, and so we thought Monday would be the day.
ALLAN ROGERS, head of government bond trading at Bankers Trust Co.:
In the first half of 1987, the bond and stock markets diverged for seven months. Bonds went straight down, equities straight up. These sorts of divergences always get my attention. In August and September, I persuaded management to cover all of our hedged short positions in sovereign fixed income, and we built up a long position in notes and bonds.
MICHAEL LEWIS, bond salesman at Salomon Brothers:
A week or two before Black Monday, Salomon announced job cuts. They chopped a few departments, including the municipal and money-market groups. It felt ill-considered and rushed. Nobody completely understood why.
Nippon Tel, the Japanese telephone company, was going to do an IPO in mid-August. I thought that would pull money from other segments of the equity market. In early October there was another IPO, which I think was a very large British company. These IPOs were a big deal to me, because the main thing I pay attention to is changes in global money flow.
Many people thought that Japan would crash before the U.S., because Japan was more extended on fundamentals; they would be long U.S. and short Japan. We looked at the 1920s, and it was Britain, the older bull market, that went first. So we said, “No, the old goes first, because people have more hope on the new.” By the way, Japan didn’t go until 1989.
STANLEY DRUCKENMILLER, founder of Duquesne Capital Management, who was also running several funds for Jack Dreyfus’s mutual fund company:
On Friday I placed a bet that U.S. stocks would rally, on the thinking that the week’s 9 percent decline in the Dow had been overdone. Over the weekend, after studying trading charts and talking to Jack, I knew I was wrong.
While Druckenmiller considered his options that weekend, U.S. Secretary of the Treasury James Baker III told his German counterparts: “Either inflate the mark or we’ll devalue the dollar.”
PAUL TUDOR JONES, founder of Tudor Investment Corp.:
When Baker threatened a devaluation of the dollar over the weekend, it was apparent the Acapulco cliff dive was on for Monday.
JIM LEITNER, Bankers Trust FX trader:
During the day, the noise level in the trading room got quite ferocious. The chairman of the bank, who at one point had been a trader, walked onto the trading floor and stood behind my chair, which was a first.
I remember walking from the 41st floor down to the 40th floor. The 41st floor was this cathedral of bonds, and then you walked down to 40 and were in this cramped, low-ceiled, dark place that was the equity department, with a lot of guys who were named Vinny and Tommy and Donny. They’d been around forever, and they had Brylcreem in their hair and big guts and they smoked too much and they were lovable. And they were all going through this visceral animal experience. People were screaming and going absolutely crazy in ways I’d never seen before. It was the first time in my career at Salomon Brothers where I was actually interested in standing beside the equity department and watching these people do their job.
There was red everywhere, and all I could think about was how cornered the portfolio insurers were.
HOWARD MARKS, head of the high?yield bond department at Trust Company of the West:
Portfolio insurance convinced people that they could somehow own more stocks without increased risk, which is fanciful. And like all silver bullets, it didn’t work.
HARLEY BASSMAN, mortgage trader at Merrill Lynch & Co.:
As a mortgage trader, I was watching stocks in what seemed like an out-of-body experience—and yes, I was thinking 1929.
The friends and counterparties I was speaking with were gripped with complete fear.
BLAIR HULL, managing partner of Hull Trading Co., a Chicago-based market-making firm specializing in options:
The 1987 crash is the only time I’ve ever seen the market makers scared to death.
I canceled my meetings and went to a friend’s office. The few times I tried to enter orders, I couldn’t get through. The structure of the market was dependent on these technologies that were voluntary. I was trying to cover my shorts and a buyer is what they were looking for, but people were not picking up the phones. So basically I sat on my hands, which turned out to be the right thing to do.
I check into my hotel, and there’s all kinds of security. I asked what was going on: Alan Greenspan and Margaret Thatcher were both checked in as guests. I get to my room and I’m trying to call New York, but I can’t get through. I had to go to another friend’s office, because the Fed chief and his staff had basically subverted the hotel switchboard.
We were concerned about a lot of the counterparties and their liquidity, so the best place to be was in fixed-income futures, because if worse came to worst, we could always take delivery of the bonds.
Greenspan lands in Dallas, and the story is that when he got off the plane he asked where the market ended up. The response was “Five oh eight” and Greenspan replied: “Oh, good, it had a nice rally.” He thought it was 5.08. He had only been in office since August, so I think he was a bit of a deer in the headlights.
I was so scared that I got $10,000 out of the bank, took it home, and stored it in the rafters. When I moved out, I forgot that I’d stashed the money. I think it’s still there.
I was feeling guilty about our success. I thought we were going into the Great Depression.
I had 1929 on my mind. Paul and I were concerned about our friends and people who were struggling that day.
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And here is Paul Tudor Jones’ infamous live interview as the dust settled…
So what was learned from the Crash of ’87? Not much in my opinion.
As John S Lyons summed up perfectly, for starters, the laws of human nature have yet to be repealed. Additionally, high frequency trading is today’s version of program trading. Only now, instead of transmitting an order through a stock broker, who sends it to a floor broker, who give it to a trader, who takes it to a specialist at the post where the stock in question is trading, high frequency computer generated orders are automatically entered at the behest of complex algorithms and are executed and reported back in milliseconds. Witness the May of 2010 “flash crash” where the market lost about 1000 points and then mostly recovered all within 15 minutes.
In summary, risk cannot be removed from the stock market. The Crash of ’87 affected everyone. Crashes will occur again. Wear a seat belt!
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Could never happen again …