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The
1987 Stock Market Crash
The stock market crash of 1987 is the largest
crash in recent United States History. Although there was a
minor crash at the turn of the 21st century, it was nothing
in comparison to the end of the 1980s. In fact, the 1987 crash
is the worst single day in American financial history. There
was a 22% loss in the market on October 19, 1987 or Black Monday.
That is almost double the 12% loss experienced by investors
in 1929 on Black Tuesday.
The 1980s, similar to the roaring 20s, was characterized by
a period of financial growth and excess in the United States.
The psychology of the time was “spend, spend, spend” and rampant
consumerism drove the national economy and stock market to
record highs.
1986 and 1987 were record years for the stock market. The
bull market that started in the summer of 1982 was being carried
through to create record markets 5 years later. The market
was being primarily powered by hostile takeovers, leveraged
buyouts and what seemed to be merger fever. The most important
thing for many companies was to raise capital in order to buy
other companies. It was thought that companies would grow exponentially
by purchasing other companies. In leveraged buyouts, a company
would raise capital by selling junk bonds to the public. Junk
bonds are bonds that have a high-risk rate, and therefore a
high interest rate. The capital from selling the junk bonds
was used toward the purchase of another company.
Another common phenomenon was the use of IPOs. An IPO, or
Initial Public Offering, is when a company issues stocks for
the first time. The burgeoning computer industry was created
with many IPOs in the market and people were investing in personal
computers because they saw potential for great profit.
This created an inflated market with lots of stock at low
and reasonable prices available for purchase. Even the most
timid investor was tempted to get involved in the market.
Unfortunately, the bull market also created an opportunity
for many scam IPOs and conglomerates to take advantage of uninformed
investors. The SEC had its hands busy trying to keep up with
the shady companies. In early 1987, the SEC began investigating
illegal insider trading. This created wariness in investors
and slowed the market. There was also a fear of inflation due
to the strong economic growth that occurred in the previous
five years. To compensate, the FED raised short-term interest
rates to prevent inflation. This effected stocks negatively
as well.
Many large firms began using portfolio
insurance as a way
to protect against further stock dips. This practice uses futures
contracts as an insurance policy on a stock portfolio. If the
market crashed, people with futures contracts could profit
and stabilize the market by offsetting the losses in stocks.
The use of portfolio insurance worried many common stockholders.
They saw it as a sign of an impending market crash. Many experts
believe that the common perception during the time was that
the market was beginning to resemble the 1929 market. This
caused panic, and led people to sell their stocks immediately.
The fear became a self-fulfilling
prophecy and as thousands
tried to sell simultaneously on October 19, 1987, the market
crashed because their simply weren’t any buyers. Within that
day over 500 billion dollars left the Dow Jones index. The
effect of the US crash affected every country around the world
producing a global market crash.
Many people lost millions in a matter of minutes. Most investors
didn’t even know why they were selling; they just heard that
everyone else was selling and followed suit. Most futures ands
stock exchanges were shut down for the day. In some extreme
cases, the duress brought on by the loss of massive amounts
of money caused some investors to kill their brokers. There
were several instances of clients entering brokerage firms
and opening fire.
Fortunately, the crash of 1987 did not result in a similar
depression. The Federal government stepped in and lowered short-term
interest rates to avoid a banking crisis. The market returned
to a bull market rather quickly. Companies buying back their
undervalued stocks fueled this new prosperity.
The addition of the circuit breakers system is a lasting impact
of the 1987 crash. The system prevents stocks from trading
if they plummet too quickly. This will prevent any future vertical
drops in the market.
# # # # # SolveYourProblem.com : 2007
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