This page has been archived and commenting is disabled.
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.
»
- advertisements -
Please, what experience do you need to execute Ctrl-P.
What we really need is a FED chief that can emote and feel our pain, just like Clinton.
Best thing Berstank can do is to take acting lessons because the performances he gives before Congress really stink.
BT Co was a bankers bank. They had a big repo book and were making a bundle. I suspect that somebody "upstairs" said, "Cut it back".
That rumbled all the way down to small fry like me.
Great story Bruce, always fun to read your stuff.
Btw, my lawyers will be in touch with you as I lost a shit load in '87. No wait...scratch that....I lost it that year beingfucked up in Vegas. My bad.
I agree with all those statements.
However -- and it may be my ignorance -- I sense a disconnect between "they were making a bundle" and "somebody upstairs said 'Cut it back'" -- these guys don't leave money on the table until the room is full of smoke and flame.
It would be interesting to know where BT's pain point was. Just a thought.
Thanks, Bruce. But I disagree that there were no external factors that caused the '87 crash. The Fed was tightening and so were other CBs. And Reagan was fading. There were also lots of neubs on WS who had never encountered a crash before.
There is always a wall of worry. There was in 87. But the way it happened on that day was out of proportion to the news on the front page.
Lots of things added up to make it happen. Portfolio insurance was part of the problem. But once the selling started, it happend pretty quick.
Bruce,
Actually the catalyst for '87 crash was the Bundesbank raising interest rates in the face of Greenspan's plea to keep interest rates lower.
Quaint world back then, the Buba had no problem standing up to the Fed.
oil prices had collapsed in '86 as well...and had started rising again in '87. not much...but clearly "nothing a little tightening" couldn't help put the "boot to the neck" to.
Good story Bruce and well told. I'd say you should have saved it for Halloween for it's spooky factor but, "the call" could happen before then.
Fascinating story Bruce, nice prep for the coming months. Many thanks for that !
Thanks for the article, Bruce. Nothing about this market looks right.
What if Castro is a real Zombie?
Good story.
Great personal story, Bruce ... still I imagine you have some nostalgia for the 'old days', when the financial world was more personal, and not yet the nuclear doomsday machine it is now
A perhaps dying Fidel Castro may be having comatose thoughts of being quite the winner, after all ... "We will bury you," said his friend Nikita Khrushchev ... and Castro has lived long enough to see the start of collapse for the whole Western system
"A perhaps dying Fidel Castro may be having comatose thoughts of being quite the winner, after all ... "We will bury you," said his friend Nikita Khrushchev ... and Castro has lived long enough to see the start of collapse for the whole Western system"
He did make it to #7 in Forbes magazine 'Richest heads of state' list as of 2009 (net worth $900million....double the net worth of Queen Elizabeth II). He's also alledgedly drunk more beer, pissed more blood, and banged more beaver than the combined staff of most US investment banks .... not that there are many left.
It's a tough job to be a man of the people, but someone's got to do them.
BRUCE YOU SHOULD HAVE SHORTED THE MARKETS AS YOU SOLD YOUR JUNK!
JUST LIKE........TODAY. (Oh wait the Bernank Put.....will.....only.....work....for...so long.)
Not like today. We have an election to get through first. Then they'll let the shit fall to pieces.
2008 anyone? Once TPTB have figured who is going to win they pull the plug. Obama had it in the bag by September of 08. They need a financial crisis to stump break Romney.
+100 The second recession won't be announced till 1 week after the election R wins - 3 months O wins. It will still be Bush's fault
bush and clintons.