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How I Caused the 1987 Crash
I got a chuckle from the biz blogs and TV yesterday with the rehash of the 1987 stock crash. Twenty-five years is a very long time. I’d forgotten most of the events of that day.
I was at Drexel, and at that time, Drexel was a powerhouse. The firm had plenty of capital and huge capacity to borrow money to fund positions. Money was rolling in; risk taking was encouraged. I was working with a small group of people on one of the screwier sub-sets of the high yield bond market. It was referred to as LDC debt (Less Developed Country debt). These were the busted bank loans of all of the countries in South America.
You might wonder why anyone would spend time mucking around with the debts of Brazil, Mexico, Argentina and Chile. Actually, it was a great business. We were coining money. The key to our (and others) success was the ability to make a price on illiquid assets. If some regional bank needed to sell $25Mn of Brazilian debt, we would make a bid on the phone. If a company were in need of some Mexican debt that would be used in a debt for equity transaction, we would offer the paper to the buyer, even though we did not own it.
My old days of currency trading came in handy as some of the paper we traded was denominated in currencies other than the dollar . The fact that I had a “license” to trade currencies gave me the opportunity to speculate pretty freely, and I/we did. The shop that I worked in was no different than any other on Wall Street. We had a “book” of positions. Some were outright specs, others were hedges against commitments we had made. To hold this book together, we required equity (cash).
The Crash of 1987 happened on a Monday. But the crash really started the week before. The S&P tanked 9% on the week, Friday was a particularly bad day. The big move in stocks set things in motion over a very nervous weekend. I got the call from the controller’s office on Saturday. It went like this:
Controller:
Hi, Sorry to bother you, but we have some issues with our bank lenders (It was Bankers Trust that first pulled the plug on street liquidity). They are nervous, and want to cut back our funding lines. You are using a fair bit of capital in your trading book. Can you tell me what all this money is being used for?
BK:
Sure. We have a matched book of longs and shorts on the prop trading side. We also have some open currency positions. We have an inventory of hedges against open client positions. We also have some naked longs.
Controller:
Ah, can you be more specific?
BK:
Sure. We are long Brazil, Mexico and Chile; we are short Ecuador, Peru and Venezuela. We are naked short the USDHK$ and have $60Mn of Cuban bonds in inventory.
Controller:
You’re shitting me! What is that junk? Is any of this liquid? Can you sell this book of crap?
BK:
I might be able to run things down a bit. How much time do I have?
Controller:
Cut it in half by Monday night.
And that is how the crash of 87 happened.
Sunday night October 19, at the opening in Tokyo the HK$ position was closed off (at a loss of course). I got up at 2am and started the calls to London where there was a market for LDC paper. I was hitting bids on anything I could. The prices for the long assets were getting clobbered. There was no liquidity in the markets I was short. It was about minimizing losses and cutting a book. There was no finesse about it.
Of course I was not alone in those early morning hours. Hundreds of players from NYC were on the phone hitting bids on all sorts of squirrely assets. The folks who make markets in London were never dopes. When their phones lit up with Americans looking to lighten up, they voted with their feet. Bids for everything dropped like a stone. By eight o’clock in NY everyone knew that wholesale liquidations were going on, and that stocks were going to get beat to a pulp when the market opened up.
I think I stood all of that day. The phones rang and rang. Both buy and sell side clients were panicked. Most were sellers; the buyers went on strike. Prices were dropping without any trading taking place. The brokers were all, “offered without the bid”. It was next to impossible to get trades off.
Some where’s around 2pm NY time, the Cuban paper got sold (more losses). There was not much more that could be done. So I sat down and watched the Reuters screen and the Dow tape for the rest of the day. I’d had next to no sleep, drank a ton of coffee and smoked too many cigarettes. I'd sweated all day, and stank. I left before the 4pm close.
To me, there are today many similarities to the market conditions that triggered the 87 crash. These two ring a bell:
In 87 I bet on Cuban paper. The rumor at the time was that Castro was sick. The thinking was that when he died, the bonds would increase in value. I’d bought the bonds at around 5 cents on the dollar. Exactly the same bet, for the same reason, is being made today:
The Hong Kong dollar was pegged to the USD in 1983. Four years later guys like me were betting that the central bank could not hold the peg. Money was flowing into Hong Kong; the central bank was forced to intervene in the market to keep the lid on the HK$. This same trade is popular today:
The most important comparison has not yet shown up yet in 2012. In 1987, over the course of a weekend (and many panicky phone calls), market liquidity and the ability to finance off-the-run assets dried up. It started at the bottom of the rung of asset quality, by the end of the day it had spread to the most liquid stocks.
On Thursday, October 15, 1987, the farthest thing from my mind was a squeeze on the equity capital I was using to support a book of business. If anything, I was (everyone was) being encouraged to put more money to work. That vaporized in hours. It was one giant “risk off” event.
There were no external factors of significance that led to the 87 crash. The market did itself in on that day. All it took was a few calls that said, “I want you to cut back at open”.
The repo markets that fund the zillions of assets (good and bad) in 2012 are exponentially larger and more complex than in 1987. If anything, that market is more vulnerable today to the call that says, “Cut it back”.
Note:
Of course I didn't really start the 87 crash. I was a small cog in a very big wheel. There were thousands of folks who were scrambling on that day.
On Monday night, 10/19/87 the Fed (Greenspan) called the heads of the big banks and told them to open the spigots. The Repo markets were flush with cash on Tuesday morning.
From my perspective, it was much ado about nothing.
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Smart money is nothing but short.
I suddenly feel like watching Margin Call again.
http://www.imdb.com/title/tt1615147/
thank God we've gotten rid of leverage this time around. Oh, wait...
We are poised on top of the roller coaster.
As someone famously once said.,,,,,,whether you are on a tight rope 200 metres off the ground or getting a blow job from an 80 year old toothless woman.....the advice is always the same.........don't look down."
We certainly could have crashed Friday but you know who bought you know what.
Fuck you Ben!!
On this October 19 crash anniversary, it is good to remember that Dow theory followers were spared. By how much? The details here:
http://bit.ly/WxeDdT
On this October 19 crash anniversary, it is good to remember that Dow theory followers were spared. By how much? The details here:
http://bit.ly/WxeDdT
It is nostalgic to look back on but no fun to go through. Like Vietnam.
Only with less bullets and more collateral damage.
Whining snivelet.
One assumption here is that there will be a "Cut it back" call. Who will make this call? Back then, banks like Bankers Trust could get away with such things. Not in the TBTF world, where banks cannot exist without government largesse. And they know that government largesse will plug any holes in their balance sheets and provide stimulus to drive their profits, so why should they cut back? Risk managers? LOL, talk about captive. Margin calls? Every time something starts melting, the exchanges just drop margin requirements.
I think the error here is that you assume we exist under the same set of capitalist rules that existed in 1987. We do not.
I do believe 1932 is rushing towards us like a freight train. I just don't think it will happen like this.
In fact, I suspect that instability will lead to more flooding of the markets with government liquidity to avoid those "Cut it back" calls, and that liquidity will actually cause the crash, when certain foreign holders of US assets decide the unlimited liquidity will lead to a USD tailspin, and begin hitting bids on massive portfolios of USD-denominated assets, especially US govies.
'87 finished flat on the year and turned out to be one the great buying opportunities of a lifetime. the "great disinflation" was about to begin as the collapse of the Berlin Wall, the disintegration of the Soviet Union, the bankruptcy of Russia, the American victory in the first Gulf War and the great tech boom of the 90's all lead to one of the greatest moments of wealth generation in history. speaking of which why are those commodities doing so well again? and why am i long distressed debt again? and why when cash is so worthless as to be non-existent are interest rates and gold...eh, forget it...
Okay. So this time it's the same but for different reasons. Gotcha.
O/T: Just listened to this: http://www.youtube.com/watch?v=JnGOARFOQV0
had to share. JIMIIIIII !
Wall Street gangsters are going to slaughter the market prior to the election. Poor Obama!
"Satan's Got Your Nose"
Bankers Trust: hands down winner for most misleadingly named company.
Bruce's well-told story just goes to show, many of the "masters of the universe" doing "God's work" have balls the size of Rice Krispies and the morality, integrity, and fortitude of rats on a sinking ship (not directed at BK, but the people above him).
called "Duetche Bank" now...and trust me, they're still unwinding those trades.
No worries. The FED will and the taxpayers (and the machines) will buy whatever you got.
Tanks fo' da memories Bruce. Great story and storytelling. I remember TV images of exhausted floor traders at the end of the day. They were wiped.
Wakanda,
They were wiped alright.
Can you imagine what they ganno look like after this game is up? When they have to get a real job to justify there miserable existance?
Come on down parasites, 2012, the year the bankers had to get real fucking jobs........
Oct 19, 1987 was my very first day on the floor as a retail stockbroker with EF Hutton. The local paper ran a photo of me with my head in my hands. I had no clue what was happening but I suspected it was bad.
Then Hutton was bought by Shearson, then American Express, then Lehman got in the mix...hilarious.
Would that be Hutton Hornblower Weeks Kuhn Loeb Rhodes Shearson Hayden Stone American Express Lehman Brothers?
+ Hemphill + Noyes
On further research, I also found + Adam and Eve. Big damn firm. And think of all those merger fees, albeit for a now extinct entity.
and thinking wtf did I just get myself into.
-Ned
Best to be positioned to provide bids rather than hit them after the "cut back" call comes in, which I imagine it will fairly soon.
BK The 4 1/2s of 77 ( defaulted in 1959 for those who dont recall Batista ) traded then in the 20s-40s. Cowen & Co remains the largest holder. Good luck to the hedgies, that accrued has NO chance in hell as the rules always change in the middle of the game. All Uncle Sam needs do is forgive the debt in exchange for a new Gitmo facility and free plantains & mangos.
Great info Bruce for one like me that was not following the market during '87. Through the eyes of my new vicarious experience (your story), I'm trying to envision the mechanism of the next unraveling of our present "market". It seems that a key takeaway from your story is: the banker was the first to know when to pull the plug.
If you understand what money is under our current monetary system, this is always the case.
Great read, and all too similar to today, Bruce.
That old fool Fidel might live another 25 years. I always heard as a child, that the devil takes care of his own.
BK, thanks for those personal stories...great insight into the mentality that triggers financial avalanches.
Margin calls are not "mentality"...a better analogy would be potential energy.
This is a great story! Thanks
I smiled big at the comment: I hadn't slept in days... This was a fun story. & yes, there is great apathy right now in the market. Massive, MASSIVE, disconnect between predictive and realized volitlity, and unprecedentedly low equities volumes. There are some large firms that are going to say goodbye very soon, as they will quickly realize that the vix shorts they have been raking it in on, are really a meat blender for big swinging dicks... This could be an awefully fun one, goog and aapl popping at the same time, if I were a bitch I'd be more wet than a pcp addict at a dust dealer's crack house. QE3 and potentially QE4 could end up being the trigger for the world's financial avalanche- too many suckers holding flaming bags of shit... All the while forgetting... an infinite nothing of infinity ([808] ;D), is all that QE is. You can ride a market to 100,000 dji, but if the paper it pays is worthless, then the only one buying it to 100,000 was the fed. Whoever panics first wins in this game, and I'm glad to say, if this bitch goes, there is going to be an EPIC short squeeze in 30bonds, and while I perhaps made the wrong play yesterday going long bonds, I'm pretty sure the shorts are going to be running for the hills on the next "lil" dip.
Can I getta, "Amen Brother Junkyard!"? www.youtube.com/watch?v=eX9UurI-nR8
Although ZH says I'm crazy and that Bonds are about to trip downward. To that I will say, there's almost always a last gasp before a bubble busts a nut.
So your argument is that with LIBOR and Fed lending both effectively at zero, CB debt propping, and QE, there will be a liquidity crisis?
More likely, a run on a major currency. Or maybe as Taleb says, "the unknown, unknown", that which can't be hedged or quantified.
what?that was rumsfelds saying, taleb stole it
Actually, cultish Warner Erhard has been rambling about the unknown unknowns since at least the early 80's.
"Think of the circle I have drawn here as containing all knowledge. The circle is divided into three sections. The first section of all knowledge is called, 'What I know that I know'" We all know what to do with what we know that we know – we put it to use. The next section of all knowledge is called, 'What I know that I don’t know.' Again, we all know what to do with what we know that we don’t know – we learn. Finally, there is this vast remaining section of all knowledge called, "What I don’t know that I don’t know." What to do about what we don’t know that we don’t know is something of a dilemma. And, what we don’t know that we don’t know about human beings is an important question when it comes to individual and social transformation.
This quote comes from 2006, but I distinctly recall having a gigantic spiked mullet and a gray tiger print sweatshirt on when hearing it live.
Soooo Donald Rumsfeld was chanelling Warner Erhard? I do not recall the mullet...
bank run in the Euro-zone. All the markers are there...the only thing we've been waiting for is for interest rates to collapse thus destroying the ability of the Banks to support their sovereign...and vice versa. http://www.youtube.com/watch?v=iaWmsSqD2Bg
Been watching that. The big boys write it off as trivial. Nothing that can't be replaced with bits/loans/ersatz money, but bleeding out is cumulative. When you least expect it, the paper boy laughs at your paper money, and it's over.
When push comes to shove, the CBs save themselves and the banking system through printing. That is the pattern they have been following. It keeps their system and their power intact. The worse it gets, the more they print. I don;t expect them to just roll over and die.
Sooner or later, somebody blinks.
The key difference is that in 2012, unlike in 1987, there's Fed, ECB and BoJ that will buy anything and everything to preserve the "wealth effect" and the apperance that the prevailing asset prices indeed reflect the "underlying value." They will fight the markets until the demise of their respective currencies. They will lose, but it will take longer than 2 month (1987 market slide from the highs in Aug to Oct 19) to bust the Central Banks.
yeah but they're screwing up. by driving rates lower and lower and lower they're driving they're financially driven economies into oblivion. the fool of course "runs off to the third world." you want to buy into the great LANDED economies...Royal families for all you ladies and gents out there. But also RAILROADS in North America and anything having to do with "Government land grabs." What interest rates are telling me is that prices are going to FALL...and quite dramatically depending upon what the Federal Government allows/can prevent. I think the Fed has (insanely in my view) driven interest rate spreads to about as low as they can go given the current and now expanding war effort. it's time for the industrialists to step up and "start moving the war machine forward"...the only direction it knows i might add.
Bruce, that was a great read. It must have been a nerve-wracking and life-shortening rollercoaster, but I'd bet that many of us envy your ride.
A great hype for the 25th.Anniversary! Lets wait the coming days when the next generation in this business will be confronted with a similar scenario. Only minimum 100 times bigger, hasta la vista!
This is the type of first-hand account that gives some real insight -- and some understanding of why 25 years in academia plus 0 years of real-world street experience may not be the best (or even penultimate) resume for a Fed chief.
Of course, noting that the "market did it all on its own" without any external shock begs the question:
Why did Bankers Trust get cold feet?
Or were they in the same position, with someone breathing down their necks to dial back on the "crap" positions that had, until the prior week, been considered a savvy calculated risk?
What really happened to their P&L the week before?