Begin Reading Table of Contents About the Author Copyright Page Thank you for buying this Henry Holt and Company ebook To receive special offers, bonus content, and info on new releases and other great reads, sign up for our newsletters Or visit us online at us.macmillan.com/newslettersignup For email updates on the author, click here The author and publisher have provided this e-book to you for your personal use only You may not make this e-book publicly available in any way Copyright infringement is against the law If you believe the copy of this e-book you are reading infringes on the author’s copyright, please notify the publisher at: us.macmillanusa.com/piracy For Floyd Norris admired colleague, trusted mentor, cherished friend CAST OF CHARACTERS WASHINGTON BANK REGULATORS AND WHITE HOUSE OFFICIALS Howard H Baker Jr., White House chief of staff (1987–88) James A Baker III, White House chief of staff (1981–85) and secretary of the Treasury (1985–88) Nicholas F Brady, chairman of the Presidential Task Force on Market Mechanisms (1987–88) and secretary of the Treasury (1988–93) C Todd Conover, comptroller of the currency, an independent official within the Treasury Department (1981–85) E Gerald Corrigan, vice president of the Federal Reserve Bank of New York and special assistant to New York Fed President Paul Volcker (1976–80), president of the Federal Reserve Bank of Minneapolis (1980–84), and president of the Federal Reserve Bank of New York (1985–93) Alan Greenspan, chairman of the Federal Reserve System from August 1987 to January 2006 William M Isaac, chairman of the Federal Deposit Insurance Corporation (1981–85) Donald T Regan, secretary of the Treasury (1981–85) and White House chief of staff (1985–87) Paul A Volcker, president of the Federal Reserve Bank of New York (1975–79) and chairman of the Federal Reserve System (1979–87) STOCK MARKET REGULATORS Richard G Ketchum, director of market regulation at the U.S Securities and Exchange Commission (1983–91) David S Ruder, chairman of the SEC (1987–89) and former dean of the Northwestern University School of Law John S R Shad, chairman of the SEC (1981–87) and the former vice chairman of E.F Hutton and Co Harold M Williams, chairman of the SEC (1977–81) FUTURES MARKET REGULATORS Wendy Gramm, chairman of the Commodity Futures Trading Commission (1988–93) Kalo A Hineman, acting chairman of the CFTC (1987–88) Philip Johnson, chairman of the CFTC (1981–83) and longtime legal counsel to the Chicago Board of Trade Susan M Phillips, a CFTC commissioner (1981–83) and chairman of the CFTC (1983–87) James M Stone, chairman of the CFTC (1979–81) and a CFTC commissioner (1981–83) WALL STREET W Gordon Binns Jr., investment manager for the General Motors pension fund (1981–94) Robert J Birnbaum, president of the American Stock Exchange (1977–85) and president of the New York Stock Exchange (1985–88) Roland M Machold, director of the New Jersey Division of Investment and manager of the state’s pension funds (1976–98) John J Phelan Jr., vice chairman of the NYSE (1975–80), NYSE president (1980–84), and NYSE chairman and CEO (1984–91) CHICAGO William J Brodsky, executive vice president and chief operating officer of the Chicago Mercantile Exchange (1982–85), and president of the Merc (1985–96) Leo Melamed, chairman of the Chicago Mercantile Exchange (1969–73, 1976–77), special counsel to the Merc (1977–85), and chairman of the Merc executive committee (1985–91) Richard L Sandor, chief economist and vice president of the Chicago Board of Trade (1972–75), and a former business school professor at the University of California at Berkeley BERKELEY Hayne E Leland, a Harvard-educated economist who joined the business school faculty at the University of California at Berkeley in 1974 John O’Brien, a founding partner, with Leland and Mark Rubinstein, of Leland O’Brien Rubinstein Associates and its chief executive (1981–97) Mark Rubinstein, an options pricing theorist and finance professor who joined the business school faculty at the University of California at Berkeley in 1972 R Steven Wunsch, a vice president at Kidder Peabody in the 1980s, specializing in derivatives, and an informal adviser to LOR Associates AUTHOR’S NOTE It is difficult to convey to a modern audience the emotional impact of the stock market’s gyrations in the 1980s, or indeed in any distant decade, because the most popular measures of market value have grown so much in the intervening years For example, on the worst day of the 1929 crash, the Dow Jones Industrial Average lost about 38 points, an insignificant move in modern markets But on that day, the Dow had opened at just under 300 points, so that 38-point drop represented an unprecedented 12.8 percent decline That record stood until the crash of 1987 Similarly, the Dow’s daily point swings in this story may sound unremarkable at a time when the index is calculated in five digits At this writing in early 2017, the Dow has surpassed 20,000 points, but for much of the early 1980s, the index hovered between 1,000 and 1,500 points To feel the modern punch of the market’s gyrations in those years, double the long-ago Dow points and add a zero—thus, a loss of just 50 points back in early 1981 would be roughly equal to a 1,000-point drop in early 2017 For Dow point changes for the years after January 1987, when the index hit 2,000 points for the first time, just add a zero to the older figure—thus, a 100-point drop in late 1987 loomed as large as a 1,000-point drop today This rule of thumb, while not precise, will give some sense of how people in the 1980s perceived the market’s historic moves Of course, the percentage changes can provide a more exact comparison Time also has blurred the scale of monetary sums cited in this story To get a general sense of the modern magnitude of those figures, triple the dollar amounts before 1985 and, thanks to declining inflation, double the dollar amounts after 1985 PROLOGUE On that historic autumn Monday, it seemed possible that the entire American financial system would crack apart The next day, it seemed certain that it would The storm had not come out of a cloudless sky There had been years of heedless expansion, months of growing anxiety, weeks of looming trouble and fading options Then, Monday dawned—a day so terrifying that those uneasy months and weeks seemed placid by comparison Global markets teetered High-speed computer trading, driven by mathematical models, outran the pace of mere humans Poorly understood derivatives set off depth charges everywhere, revealing hidden links that bound together the banks, insurers, giant investors, and big brokerage firms that populated Wall Street Those connections stretched across all the regulatory borders that rival government agencies defended so fiercely At the edge of the cliff, some questionably legal steps saved a key firm from collapse, a failure that would have tipped a crisis into a catastrophe For many, this chronology instantly calls to mind the financial meltdown that erupted on Monday, September 15, 2008, with the collapse of the Lehman Brothers brokerage firm The day after “Lehman Monday,” the U.S Treasury Department and the Federal Reserve were fighting frantically to rescue the massive insurance firm AIG, which neither agency officially regulated but which was linked to other giant firms around the world through a set of financial derivatives called “credit default swaps.” Those events triggered widespread panic that eclipsed almost anything the markets had seen since 1929 Almost anything Because the events just described, the events at the core of this story, did not happen in the harrowing weeks of September 2008 They happened on October 19, 1987, a day almost immediately dubbed “Black Monday.” On that single day, the Dow Jones Industrial Average, the pulse rate of the most prominent stock market in the world, fell a heart-stopping 22.6 percent, still the largest one-day decline in Wall Street history That was the equivalent of an urgent midafternoon news flash today screaming, “DOW FALLS NEARLY 5,000 POINTS!” A one-day decline of 22.6 percent is almost unthinkable for us now It was truly unthinkable for the men and women of 1987 We can look back on their experience, but when they looked back, they super-voting stock and index futures index options individual investors Black Monday and DOT system and growing invisibility of index mutual funds institutional investors vs witching hours and inflation insider trading institutional investors insurance companies interest rate futures interest rates interest rate swaps Interior Department International Commercial Exchange (ICE) International Monetary Fund (IMF) International Monetary Market (IMM) investment banks Investment Dealers’ Digest Iran Iran-Contra scandal Iran hostage crisis Isaac, William M Jacobs, Bruce I Jacobs, Harry Japanese banks Japanese yen Jarrell, Gregg Jas H Oliphant and Company Jiji newswire Johns-Manville pension fund Johnson, Philip Johnson, R Sheldon Jones, Ed J.P Morgan junk bonds Justice Department Kaiser Aluminum Kansas City Board of Trade Kaufman, Henry Kemper Financial Services Kennedy, John F Ketchum, Richard G “Rick” Kidder Peabody Kirkland and Ellis Knight Ridder newswire Koch, Ed Kodak stock laissez-faire approach Latin America Lebeck, Warren Lehman Brothers Leland, Hayne E Leland O’Brien Rubinstein (LOR) Associates leverage contracts Levine, Dennis Levitt, Arthur Loeb, Thomas London stock exchange Longstreth, Bevis Los Angeles Times Lugar, Richard Machold, Roland Morris Magellan Fund Mahlmann, Karsten “Cash” Major Market Index (MMI) futures options Manufacturers Hanover Bank margins and margin calls market discipline market-on-close orders market power Markey, Ed Markowitz, Harry Martin, Preston Martin Marietta Corporation Maryland S&Ls Massachusetts S&Ls Meese, Edwin, III Meet the Press (TV show) Melamed, Leo Mellon Capital Merrill Lynch Mexico debt crisis Michigan National Bank Mid-America Club Milken, Michael Mnuchin, Robert Mobil corporation money market mutual funds Morgan Guaranty Bank Morgan Stanley mortgage-backed securities futures Mullins, David W., Jr mutual funds Nasdaq market National Association of Cattlemen New Deal New Jersey Division of Investment, pension funds New York Commodity Exchange (COMEX) New York Futures Exchange (NYFE) New York State insurance laws New York Stock Exchange (“Big Board”; NYSE) See also Dow Jones Industrial Average; Standard and Poor’s 500 index; Wall Street brokerage and securities firms; and specific firms and individuals Birnbaum heads Black Monday Black Monday aftermath and Black Monday lead-up Brodsky and Chicago vs crash of 1970 and crash of 1986 DOT system and drop of January 1981 drop of January 1987 drop of January 1988 Drysdale and fears of meltdown financial futures and (see also specific products) First Options and fixed commission rates and global financial system and insider trading and institutional investors and interest rates and leverage and scale problems modernization and NYFE and one share, one vote rule and Penn Square and Phelan heads populists and private hedged funds and problems of 1982 and program trading and Reagan and rules of SEC vs CFTC and settlement schedules Silver Thursday and stock prices and super-voting stock and takeovers and trading floor and trading halts and trading volume and upstairs trading and volatility and witching hours and New York Times Nixon, Richard North Carolina S&Ls Northwestern University School of Law NYSE Composite index futures Obama, Barack O’Brien, John O’Brien Associates O’Brien 5000 index OEX (Standard & Poor’s 100 index option) off-exchange derivatives, unregulated Office of the Comptroller of the Currency Ohio Deposit Guarantee Fund Ohio S&L crisis oil one share, one vote rule onion futures Options Clearing Corporation over-the-counter market Pacific Stock Exchange Paine Webber program trading guidebook Paris stock market payment system (financial electronic network) payoff liquidations by FDIC Continental Illinois and Penn Square and Penn Square Bank Pennsylvania S&Ls pension funds Pensions & Investment Age Persian Gulf Phelan, John J., Jr Phelan, John J., Sr Phillips, Susan M Phillips Petroleum Pickens, T Boone Pitt, Harvey portfolio insurance precious metals premium, defined Presidential Task Force on Market Mechanisms President’s Working Group on Financial Markets Preston, Lewis T primary dealers, defined program trading proxy votes Prudential-Bache Securities Prudential Insurance quantitative analysts (quants) Quinn, Linda Rand, Ayn random walk method rational investor See efficient, rational market hypothesis Reagan, Nancy Reagan, Ronald real estate services recessions Regan, Donald T regulatory fragmentation See also bank regulators; and specific agencies Black Monday and Brady report on crisis of 2008 and derivatives and Drysdale default and entangled financial entities and Glass-Steagall and Penn Square crisis and Reagan and Shad-Johnson Accord and silver Thursday and swaps and repo market Republican Party Rockefeller family Roos, Lawrence K Roosevelt, Franklin D Rosenberg, Barr Rosenthal, Benjamin Rosseau, Robert Rubin, Robert Rubinstein, Mark Ruder, David S Salomon Brothers Sandor, Richard L Sarbanes, Paul savings and loans (S&Ls) Ohio crisis Schwab, Charles “Chuck” Sears Seattle First National Bank (Seafirst) Securities and Exchange Commission (SEC) Black Monday and budget cuts and computer-driven arbitrage and Continental Illinois and corporate mergers and crash of 1986 and crash of 2008 and crisis team deregulation and Drysdale and election of 1980 and financial futures and fixed commissions and Glass-Steagall and insider trading and jurisdiction of, vs CFTC mutual funds and national market system rule and New York office options and President’s Working Group and program trading and reform proposals and regulatory structure and Ruder heads settlements and Shad heads Shad-Johnson Accord and Shad resigns Silver Thursday and single-industry index futures and stock index futures and takeovers and Treasury market and witching hours and Securities Industry Association Securities Law Institute Seevers, Gary L settlements Seventh Circuit Court of Appeals Shad, John S R Shad, Pat Shad-Johnson Accord shadow banking system shareholder democracy Shearson Lehman Brothers Shopkorn, Stanley short selling Silicon Valley silver futures Silver Thursday (1980) Singapore market single-industry (narrow) index futures Skadden, Arps, Slate, Meagher and Flom Smelcer, Wilma Smith, Roger B snowball effect Social Security commission Solomon, Anthony Sommer, A A., Jr “Al” South Africa South Sea Company Soviet Union Spear, Leeds and Kellogg specialists speculators Sprague, Irvine H Sprinkel, Beryl stampedes Standard & Poor’s 100 option (OEX), offered by CBOE Standard & Poor’s 100 index futures price limits Standard & Poor’s 100 index options Standard & Poor’s 500 index Standard & Poor’s 500 index futures (spooz) Black Monday and index arbitrage and price gap between stock cash values and price limits set trading “at a discount” vs “at a premium” trading halts and Standard & Poor’s 500 index options Standard & Poor’s Energy Index futures Stanford University state-chartered banks state insurance laws state pension funds St Germain, Fernand “Fred” stock futures stock index futures See also specific indexes CFTC vs SEC and margins and real-world prices vs stock index options See also specific indexes stock options call and put, defined defined Stoddard, Richard Stone, James M Stone, Oliver stop-loss order “Strategy for Limiting Portfolio Losses” (Greenebaum) subprime lending Summers, Lawrence sunshine trading SuperTrust super-voting stock swaps Swiss banks Switzerland synthetic put option Taiwan market takeovers taxes Taylor, David G Texaco Thatcher, Margaret Theobald, Tom Time Tokyo stock exchange trade deficit trading halts Transportation Department Treasury bills futures Treasury bonds futures Treasury Department bank holding companies and Black Monday and Brady heads Continental Illinois and crash of 2008 and crisis team and dollar and Drysdale and financial futures and government bond market and James Baker heads Mexican debt crisis and options and Penn Square and President’s Working Group and Regan heads Silver Thursday and swaps and Treasury futures and Volcker’s threat to resign and Treasury securities futures options “Trials and Tribulations” (Shad) uninsured deposits U.S attorney’s office in New York U.S Congress U.S House of Representatives Agriculture Committee Banking Committee Commerce Committee Energy and Commerce Committee Glass-Steagall hearings Penn Square and Silver Thursday hearings swaps and Ways and Means Committee U.S Senate Agriculture Committee Banking Committee election of 1980 and SEC and U.S trade representative University of California at Berkeley University of Chicago University of Minnesota Unruh, Jesse upstairs trading Value Line index futures Vanguard mutual fund family Volcker, Paul A Boesky and Continental Illinois and Corrigan and deregulation and Drysdale default and Fed Board and financial crises and financial futures and foreign currency markets and Glass-Steagall and inflation and James Baker and later career of Ohio S&L crisis and Penn Square crisis and resignation of Silver Thursday and stock index futures and Volume Investors clearing firm Wall Street brokerage and securities firms See also specific crises; financial products; firms; and stock exchanges back offices and banks and Black Monday and commodity firms and computerization and decline of 1970s derivatives and systemic risk firm stock declines fixed commission and futures markets and growth of individual vs institutional investors and in-house traders pension funds and regulators and Sears competition with swaps and ties with commodities market and banks Treasury bond trading and upstairs trading and Wall Street Journal Wang, Nina Wang, Teh-huei “Teddy” Wells Fargo Bank Wells Fargo Investment Advisors Williams, Harold M Wilshire Associates Wilson, Woodrow Wirth, Timothy E witching hours (third Friday phenomenon) triple Wunsch, R Steven Yeutter, Clayton ALSO BY DIANA B HENRIQUES The Wizard of Lies: Bernie Madoff and the Death of Trust The White Sharks of Wall Street: Thomas Mellon Evans and the Original Corporate Raiders Fidelity’s World: The Secret Life and Public Power of the Mutual Fund Giant The Machinery of Greed: Public Authority Abuse and What to Do About It ABOUT THE AUTHOR DIANA B HENRIQUES is the author of the New York Times bestseller The Wizard of Lies: Bernie Madoff and the Death of Trust , which has been made into an HBO film starring Robert De Niro and Michelle Pfeiffer A writer for The New York Times since 1989, she is a George Polk Award winner and a Pulitzer Prize finalist Her work has also received Harvard’s Goldsmith Prize for Investigative Reporting and the Worth Bingham Prize, among other honors She lives in Hoboken, New Jersey You can sign up for email updates here Thank you for buying this Henry Holt and Company ebook To receive special offers, bonus content, and info on new releases and other great reads, sign up for our newsletters Or visit us online at us.macmillan.com/newslettersignup For email updates on the author, click here CONTENTS Title Page Copyright Notice Dedication Cast of Characters Author’s Note Prologue PART ONE: VANISHING BORDERS 1 Silver Thursday 2 Bright Ideas 3 Chicago vs New York 4 Shifting Gears 5 A Deal in D.C 6 Stock Futures, Bond Failures PART TWO: TITANS AND WIZARDS 7 A Plague from Oklahoma 8 Bulls and Banks 9 Chicago Rising 10 Arbitrage and Accommodation 11 Banks on the Brink PART THREE: CONTAGION 12 Mergers and Mutations 13 Berkeley Rising, Banks Falling 14 Witching Hours 15 Rational Markets? 16 Pandora’s Portfolios 17 January Omens, July Alarms PART FOUR: RECKONING 18 The Worst Weeks Ever 19 508 Points 20 Juggling Hand Grenades 21 Placing Blame, Dodging Reality Epilogue Notes Acknowledgments Index Also by Diana B Henriques About the Author Copyright Copyright © 2017 by Diana B Henriques All rights reserved For information, address Henry Holt and Co., 175 Fifth Avenue, New York, N.Y 10010 A FIRST-CLASS CATASTROPHE www.henryholt.com Cover design by Phil Pascuzzo The Library of Congress has cataloged the print edition as follows: Names: Henriques, Diana B., author Title: A first-class catastrophe: the road to Black Monday, the worst day in Wall Street history / Diana B Henriques Description: First edition | New York: Henry Holt and Company, [2017] | Includes bibliographical references and index Identifiers: LCCN 2017002890 | ISBN 9781627791649 (hardcover) | ISBN 9781627791656 (electronic book) Subjects: LCSH: Stock Market Crash, 1987 | Financial crises—United States—History—20th century | Stock exchanges—United States—History—20th century | Finance—United States—History —20th century Classification: LCC HG4551 H425 2017 | DDC 332.64/273—dc23 LC record available at https://lccn.loc.gov/2017002890 e-ISBN 9781627791656 First Edition: September 2017 Our e-books may be purchased in bulk for promotional, educational, or business use Please contact the Macmillan Corporate and Premium Sales Department at (800) 221-7945, extension 5442, or by e-mail at MacmillanSpecialMarkets@macmillan.com ... assassination in 1963 A Treasury official called the leadership at the New York Stock Exchange several times that day to assess how it was faring in the storm The fear in Washington and on Wall. .. AS DRAMATIC AND unprecedented as it was, Black Monday would become the Cassandra of market crashes a vivid warning about critical and permanent changes in the financial landscape, but a warning... percent, still the largest one -day decline in Wall Street history That was the equivalent of an urgent midafternoon news flash today screaming, “DOW FALLS NEARLY 5,000 POINTS!” A one -day decline of 22.6