A Pleasurable Plummet: Commemorating the 20th anniversary of the Great Stock Market Crash of 1987

Originally Published In:

Fairfield County Weekly (10/19/07) Link

Do you remember where you were when the stock market crashed on Monday, October 19, 1987, plummeting more than 20 percent in a single day? What lessons have we learned two decades later? Can this sort of thing ever happen again?

I was 12 at the time, sitting in my eighth grade Social Studies class. When the clock ticked 9:32 a.m., the assistant principal poked his head in the room and pulled me out. This was well before cellphones and the internet and any other way of communicating other than calling the school with a message.

When I got to the principal's office, he relayed the news from my parents: my brother Allan had been born fifteen minutes earlier. I didn't know or care that the market had crashed until years later. How's that for perspective?

A big deal was made out of the crash at the time and retrospectives every decade make it seem like it was the end of the world. Statistically, indeed, it was extraordinary.

The principal model of stock market movements is that of a random walk, which for historical reasons is always described as a drunk man stumbling away from a lamp post. During each interval, he lurches forward either to his left or his right. The size of his steps are on average three feet but sometimes he takes a smaller step, sometimes he takes a larger one.

That's a pretty good model of stock prices, which go either up or down, often about one percent a day, but sometimes less and sometimes more. But what happened on October 19, 1987, when the market moved more than 20 percent in a single day is the equivalent of the drunk somehow stumbling 60 feet, about half the length of an Olympic size swimming pool, in a single bound.

What's more is that later that week the market corrected upwards almost as violently. Even excluding Monday, that week was one of the most volatile in Wall Street history.

To this day, nobody really knows what happened. Some blamed and continue to blame arbitrageurs and so-called "program trading," orders placed by computer that tend to sell when the market falls, thus exacerbating any random fluctuations. It's like little kids running around the drunk: when he lurches left, they push him a little more to the left, making him stumble even more in the same direction.

Still it's hard to imagine those kids causing such a large leap purely randomly. Economist Richard Roll makes a persuasive case that program trading was not the culprit at all. Program trading was primarily an American phenomenon, he says, and the crash actually began in Hong Kong, moved to Europe, and arrived in the U.S. that Monday morning.

Another way of thinking about this is to consider Brownian motion, the phenomenon that occurs when you put small things in a liquid. The example here is pollen particles in water. For some reason, the pollen starts to fidget around. Each little water molecule is so small relative to the pollen that it can't possibly budge it. The mystery is solved when you realize there are thousands of little molecules pushing in all directions and sometimes, there are more on one side than the other, so it fidgets a little. But you will never see a pollen particle jump from one side of the glass to the other, which is basically what happened on Black Monday.

So what really happened twenty years ago? I think of it sort of as a compression of time, kind of like what would happen if the Flash traded stocks. Every minute seems to take as long as a day, so there's no mathematical way to distinguish a drunk stumbling three feet per step for an hour, or the same drunk swerving in a car a couple of hundred feet at a time.

Just as we learned from the Great Depression, there is no reason the same sort of thing can't happen again. But what about politically?

Were the New Deal and Great Society plans of FDR and LBJ the equivalent of a market crash, when suddenly government increased regulation of its citizens by an enormous amount? Perhaps the wars of GWB are similar in that they've certainly increased government power at our expense.

The philosophical lesson is you don't have to participate in the crashes. You don't have to buy or sell, and you don't have to vote left or right. You can withdraw from the market by putting your money in gold, but it's virtually impossible to withdraw from big government. A change in prices of securities around the world, whether it's 5 percent or 20 percent or even 50 percent, is not the end of the world. But an increase of government by the same percentage is quite likely to do harm. At the end of the day, the important things in life aren't securities prices or federal budget line items, they're family and friends and life and love.

So happy birthday, Allan.