Twenty-five years ago this week, American stock markets suffered one of its largest three-day declines in history, with the S&P 500 loosing 28. As during the run-up to the financial crisis of 2008, Wall Street was in the 1980s growing enamored with new methods for hedging risks. At the same time, all panics are essentially made of the same stuff. It is a label borrowed from the world of options trading for a widely held view: when financial markets unravel, count on the Federal Resere and its chairman Alan Greenspan (eventually) to come to the rescue reddit stock market trading. There have been few periods in its history that have been more dynamic than the past quarter century. Central Bank Intervention Alan Greenspan assumed the role of Federal Reserve Chairman in August 1987, just a few months before the crash. And twenty-five years later, computers continue to play a crucial but controversial role on Wall Street. One need only look to Europe — and to the fear with which bankers and policy makers eye the possibility of financial contagion spreading from European to American banks — to see how this issue remains a problem today. Back to the Future The Wall Street of 1987 was surely a very different place than it is today. Computers were an auxillary tool in the late 1980s, while today they dominate every aspect of the business. Â The total loss of wealth over that period was approximately $1 trillion, according to a Presidential Task Force report on the crash. The dollar had been declining for several years due to an international agreement in 1985 to devalue the dollar in order to help American exporters. But as a Federal Reserve paper from 2006 puts it: âThe macroeconomic outlook during the months leading up to the crash had become somewhat less certain. â ( Computerized Trading It wasn’t just that the derivatives being traded were themselves poorly understood by many market participants.
Look more deeply at the causes and repercussions of the crash, however, and you find many that ârhymeâ with those of the 2008 crisis. No matter how much the Street changes, there will always be a tug of war between overconfident traders armed with new hedging mechanisms and the regulators tasked with keeping them in check. This may be best illustrated by the great crash of October 1987. Money managers would use these index futures as a means to hedge their portfolios, through the use of computer programs that would automatically sell index futures if the market declined. Wall Street is not immune to this phenomenon. Multinational banks dominate the landscape and investors can buy stocks and bonds across borders with relative ease. According to Geisst, this action spooked the markets, which had gone through a painful period of high rates in the early 80s. According to Geisst, the 1987 crash spread internationally in âa matter of hours,â and was quickly a global phenomenon reddit stock market trading. trade deï¬cit and decline in the value of the dollar were leading to concerns about inï¬ation and the need for higher interest rates in the U. This internationalization of the capital markets, of course, has only accelerated. And financial markets across the globe are interconnected in a way that would have seemed inconceivable twenty five years ago. âThere was new stuff being developed like stock index futures and the techniques of arbitraging between them and developing portfolio insurance — that stuff did not fall under regulation. The fact that computer programs were being used to trade them was also a prime contributor to the crash. The shiny new financial instrument back then was a derivative called a stock index future, which is tied to the value of stocks that make up the S&P 500 and other indexes.
Itâs impossible to pin down for certain the cause of the â87 market crash, but the most important ingredient was an overvalued stock market. Global regulations and standard practices increasingly allowed âtrading stocks away from their home exchanges,â Geist says. As a report in 2000 from The Financial Times described the phenomenon: âSome stock traders now call it the Greenspan put.Veritaseum.. Yet even with all these changes, the essence of The Street has stayed the same. Tax laws figure very prominently into valuations of companies, and this caused investors to reconsider the value of their holdings. In fact, some estimate that upwards upwards of 75% of all trades made on a given day are initiated by computers. At first glance the convulsions in the market in 1987 bear little resemblance to the financial problems we face today. In addition, it was the first modern economic crash to be a truly international phenomenon, as it spread from New York across the globe almost instantaneously. Fearing that the dollar had fallen too far, Greenspan took measures to raise interest rates to defend the dollar. But these new techniques hadn’t been tested in volatile conditions. One was the rumor of imminent interest rate hikes in defense of the dollarÂ by the new Fed chairman, Alan Greenspan. Increasingly, humans will struggle with how to deploy computers to make markets more efficient without having those computers hijack the process. ( For instance, some of the main causes of the 1987 crash were new and untested financial instruments deployed in the market by computer programs. .