On This Day In History: The Fed Put Is Born

Via Global Macro Monitor,

Or, at least, went into labor...

Wow,  three decades and one year today, I was a young economist at the World Bank.  My friend and I, now the chief economist at the FDIC, were graduate students and walked by the White House on our way to lunch.  The stock market was down somewhere between 5-10 percent in the morning.  I looked through gates on Pennsylvania Avenue and thought to myself, “I wonder if President Reagan is up to the challenge.”

My Boss In The Oval

The president was 76 years old, and rumors were floating around he was already losing it.  Little did I know, I would be working for the man who was briefing the POTUS in the Oval about the crash on that morning just a few years later at a major money center bank.

He was the Deputy Secretary of the Treasury, who was acting Secretary on Black Monday as James Baker was in Europe beating up on the Germans over exchange rate policy.

Over lunch in 1989 or 1990, my boss shared with me the play-by-play in the Oval on October 19, 1987.  He said President Reagan was sharp, impressive, calm, and proactive, jumping up from his desk, “What do we need to do to calm the markets?”    How America misses that kind of leadership even if you agreed with the president’s politics, or not.

Money & Banking Class

I was also a young adjunct professor at George Mason University teaching money and banking courses.   I had been warning my students that a major crash, as in 25 percent, was highly probable.

I think my classes were on Tuesday and Thursday.  I walked in the next day after Black Monday  and they were impressed.  Interest rates were spiking for almost a year, and coupled with the increased volatility, which began in August after a two-year stock run, almost straight up, were clear warning signals.

The stock market was in a speed wobble and free fall even before it crashed.  Ditto for 1929.

I also can’t remember any of my students’ names but one was a big blonde dude, very bright, and another a young woman who said she worked at the C.I.A..  I can’t remember the exact details of the path of how I walked to class that day,  or any of my students name, but I am 100 percent certain it took place, Senator.

One In A Zillion? 

WTF?  Wasn’t the volatility spike on October 19, 1987 like a one in 11 billion probability, or something like that?

I later worked with options traders who were short calls on the OEX that day and lost money, so they said.   The vega (volatility derivative) swamped the delta causing the price of the call option to increase in price even as the price of the underlying fell over 20 percent.  That is frickin’ hard to believe.

The Morning After

The next morning, Terrible Tuesday,  the market was still in free fall.  Volume had already exceeded the prior day.  No bid.  The market makers were abandoning ship, some were thought to be insolvent.

Many Wall Street firms put pressure on the NYSE to close the market but President Reagan, under pressure from the Fed, would not allow them claiming executive privilege.

…the president of the United States would very much prefer if the New York Stock Exchange could see its way clear to remain open.”  – Howard Baker, Chief of Staff

All of a sudden, I believe after lunch, a phantom buyer came into Chicago and bought the Major Market Index (MMI), which stabilized prices and the market hasn’t looked back since.   Market psychology is a real bitch sometimes.

Thank you, Alan Greenspan.   Can’t say for sure it was him and them but it is widely believed to be the birth of the Fed put, and later the Plunge Protection Team (PPT).

Recall, the Dow didn’t recover its September 1929 high until 1954.

Now The Addiction

The problem now is we are addicted to and expect the Fed crack or Xanax with every little market hiccup.  The economy, and, now, especially, monetary policy is determined, in large part,  by asset prices.

It’s stunning to see the POTUS and pundits, such as Jim Cramer,  whining the Fed is “too crazy tight” when the real effective funds rate is still negative.

Crazy stupid.