After the Great Depression, started with the famous stock market crash of 1929, American people became so afraid of losing again all their saving that they left the markets, being replaced by institutional investors, such as insurance companies, pension funds, hedge funds, mutual funds and commercial banks.

Moreover, the Securities and Exchange Commission (SEC), created by president Franklin Delano Roosevelt after the depression, was actively working to prevent further crashes and fraudulent practices that had infected the stock market in the past.

In the early 1960s and 1970s, however, investors started to look not at the value of the company, but mostly at the appeal of its public image and the words used to describe it; even vague illustrations left the public infatuated with these firms, giving life to a growing bullish attitude.

During the 1980s, investors continued to believe that the potential for these companies was limitless; as a consequence, hostile takeovers and conglomerates ruled on the headlines of newspapers.

The SEC was unable to halt the IPOs and conglomerations, so the market continued to rise throughout all the decade.

Then, in early 1987, there was a rash of SEC investigations into insider trading, that caused investors to move out of the stock market, considered crooked and corrupt, and into the more stable bond market.

As people began the mass exodus out of the stock market, trading programs, largely employed by the majority of Wall Street firms at the time, began to do the same, selling a huge amount of shares almost at the same time.

The instantaneous transmission of so many sell orders overwhelmed the system and caused it to crash.

After five days of  intensifying stock market declines, on October 19th, 1987, later named “Black Monday“, the Dow Jones Industrial Average (DJIA), the most important stock market index in the United States, lost 508.32 point, the 22.6%, vaporizing $500 billion, in what is still today remembered as the largest daily lost on an index in US financial history.

Black-Monday-the-Stock-Market-Crash-of-1987-NYT
The headline of The New York Times the day after the crash

While the crash started as a US phenomenon, it quickly affected stock markets all around the globe, which saw declines of 20% or more.

Fortunately, the new chairman of the Federal Reserve, Alan Greenspan, prevented the enlarging of the crash into a real crisis by assuring commercial and investment banks about their insolvency and grating them federal aid in case of necessity.

The market seemed to understand that the situation was far different from that of 1929 and rapidly recovered.

The 1987 crash was a hard but useful lesson for investors and regulators, specially with regards to the dangers of trading programs, where human decision-making is taken out of the equation, while buy and sell orders are generated automatically based on information taken by the markets.

Black Monday teaches us that in financial markets human beings are needed even more than computers and software, because they are the only ones that can assess any situation and possibly avoid imprudent decisions taken by the trading program.

Sources:

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