508.32 points, 22.6%, or $500 billion lost in one day. The largest one-day percentage drop in history.
Wall Street Becomes Popular Again
The Great Depression left such a scar on the collective memory of America that stocks became a largely institutional game. Companies and funds invested in stocks, but most people were more likely to access the market through a pension, insurer, mutual fund or even the more recently developed index fund. The Securities and Exchange Commission was brought into existence by President Franklin D. Roosevelt after the depression was established and actively working to prevent further crashes and fraudulent practices that had infected the stock market in the past. By all accounts, the SEC was doing a fine job after the war and its progress finally coaxed tentative individual investors back into the market.
The SEC, however, could take investors to the proper information but couldn’t make them think. In the early sixties and seventies, investors looked not at the value of the company but at the appeal of its public image and the vernacular used to describe it. The following kinds of over-embellished company sketches would attract the public eye:
“Synergy Space-Bovubetribucs forges a new frontier in the introduction of organic entities into the ecosystem of the lunar-scape in order to promote greater synergy. This triumphant new paradigm will be enacted through a leveraged advantaged momentum initiator.”
Even though these illustrations were vague, investors were infatuated with these companies – something that we could scoff at now if most of us weren’t similarly caught up in the dotcom boom. The SEC required companies to state explicitly that they had no assets or even a fighting chance at getting any, but investors continued to believe that the potential for these companies was limitless. This bullish attitude, despite frequent bumps and insolvencies, continued into the eighties when conglomerates and hostile takeovers were the golden children of a finance-hungry media. Under the math of the new economy, firms would grow exponentially rather than incrementally simply by picking up other companies,
The Market Can Only Go Up
The SEC was unable to halt the shady IPOs and conglomerations, so the market continued to rise unabated throughout the ’80s. Even institutional investors and large mutual funds, increasing their dependency on program trading, began to adhere to the mantra, “if a stock isn’t gaining big time, find one that is.”
Then, in early 1987, there was a rash of SEC investigations into insider trading. For the most part, people were aware of the tendency of Wall Street to look out for itself, but the barrage of SEC investigations rattled investors. By October, investors decided to move out of the crooked game and into the more stable environment offered by bonds or, in some cases, junk bonds.
As people began the mass exodus out of the market, the computer programs began to kick in. The programs put a stop loss on stocks and sent a sell order to DOT (designated order turnaround), the NYSE computer system. The instantaneous transmission of so many sell orders overwhelmed the printers for DOT and caused the whole market system to lag, leaving investors on every level (institutional to individual) effectively blind.
Herd-like panic set in and people started dumping stock in the dark without knowing what their losses were or whether their orders would execute fast enough to keep up with plummeting prices. The Dow plummeted 508.32 points (22.6%) and 500 billion dollars vaporized. Fortunately, the newbie chairman of the Fed, Alan Greenspan, was around to help fight off a depression by preventing the insolvency of commercial and investment banks. The market recovered, and some modest refinements were made, including a circuit breaker that cuts out trading programs if the market slides to a set level.