Stock Market Crash of 1929 and 1987

Introduction

The stock market crashes of 1929 and 1987 are similar in terms of the economic reasons that led to financial instability, however, they differ in the degree of crisis, and fiscal and monetary policy undertaken by the government to correct the situation and the consequences on both U.S. and global economies. To be ready to handle global crises, it is important to compare the 1929 and 1987 crashes and draw necessary conclusions.

These two crashes have certain similarities and certain differences. They have much in common in terms of their economic reasons and causes. On the other hand, they are distinctively different in terms of the degree of the crisis, and policies undertaken by the governments to improve the situation. Also, there is a distinction in the consequences which followed after the crisis in 1929 and 1987.

Conditions of 1929 and 1987 crashes

The conditions in which the crisis of 1929 and the recession of 1987 occurred were similar in some ways. The time of 1920s was the period of the fast development of new technologies and products, like automobiles and radio, and the period of 1980s was the time when there was an intensive process of implementation of computers and the Internet. So, in both cases it was the time of intensive development of the global industries, these two crises had devastating impacts on the global industry. “The Great Depression of 1930 was a worldwide phenomenon, great not only in the sense of “sever”, but also in the sense of “scope”, – these words show the vastly negative impact of the stock market crash in 1929. (“The Stock Market Crash and Its Aftermath” Monthly Review, 1988, p.1)

To compare, the following thing was written in the article “The Big Picture of the Great Depression” on the effect of the stock market crash in 1987: “The market break on October 19 set off a chain reaction that became even more ominous on the following day. What prevented this chain reaction from developing into a fullscale meltdown was the prompt intervention of the Federal Reserve, which poured many billions of dollars into the system” (Garraty, 2003, p. 90). These words show that the government took efficient measures to stop the dissemination of the crisis; these measures had a positive impact on the situation. So, in 1929 and 1987 the economies were booming and developing, which is the main similar condition. However, the situation after the crashes in 1929 and 1989 was different, when in 1929 the there was an insufficient set of actions taken by the government, while in 1989 the government has taken the correct measures and used the right instruments.

Causes of 1929 and 1987 crashes

The causes of each of the crashes were numerous and together they compiled one significant drawback on the way to the further development of the global industry.

The stock market crash in 1929 was pushed forward by a series of price declines, which made the main global investors retreat. And the main cause of the stock market crash in 1987 was very similar to the one in 1929 because the price graphs of that time almost resembled and overlapped the graphs in 1929.

It is important to understand, that the human, or to be a more precise psychological factor, played a significant role in both cases of stock market crashes and it was a mainly negative impact on the economical forces of the stock market. To support this statement, that’s what was published in the article “The Supply-Side Effect of a Stock Market Crash” by Dean Baker on the issue of the stock market crash in 1987: “At any point in time, stock prices are governed by psychological factors for which economics provides no special insights.” (Baker, 2000, p. 107).

If we compare the opinions of the observers from both periods, John Kenneth Galbraith wrote in the article “The Great Crash: 1929”: “There was excessive speculation in stocks and the market was too high. The Federal Reserve Bulletin of February 1929 stated that the Federal Reserve would restrain the use of “credit facilities in aid of the growth of speculative credit” (Galbraith, 1955, p. 27).

On the other hand, here is a point of view of the group of specialist, expressed in the article “The New Speculative Stock Market: Why the Weak Immunizing Effect of the 1987 Crash”: “The October 1987 crash was described as a unique event in which a normal market adjustment, in response to negative news, triggered “mechanical, price-insensitive selling by several institutions employing portfolio insurance strategies,” which “encouraged some aggressive trading-oriented institutions to sell in anticipation of further market declines”. (Patrick Raines, Charles G. Leathers, 1994, pp.33).

To summarize the similarities of both crashes, it should be said that in both cases it was the collection of reasons, like prices decline, investors’ retreat, psychological factor, stock speculation. However, the main one was the panic over the price declines. Despite the similarities, both crashes were distinctive in terms of the consequences and the government’s actions. In particular, the 1929 crash led to a long-lasting and devastating recession, also known as Great Depression, and Roosevelt took the right decision by closing and then reopening banks with a greater level of limitations in the banking system. In 1987 market crash did not lead to such negative consequences as in 1929, causing a short-term crisis, and Federal Reserve managed to handle it quickly by using monetary policy and reassuring banks.

By 1929, the Fed raised interest rates several times to cool the overheated stock market. By October, the bear market had commenced. On Thursday, October 24, 1929, panic selling occurred as investors realized the stock boom had been an overinflated bubble. Margin investors were being decimated as every stockholder tried to liquidate, to no avail. Millionaire margin investors became bankrupt instantly, as the stock market crashed on October 28th and 29th. By November 1929, the Dow sank from 400 to 145. In three days, the New York Stock Exchange erased over 5 billion dollars worth of share values! By the end of the 1929 stock market crash, 16 billion dollars had been shaved off stock capitalization.

Comparing events of 1929 and 1987 crashes

Both days of Black Thursday and Black Monday were days full of chaos and panic. Describing events in 1929, just during one day many millionaires have become bankrupt. The Dow Jones Industrial Average sank from four hundred to one hundred forty-five. During that period, New York Stock Exchange lost over 5 billion dollars worth of share values. “The day of reckoning then fell on October 29, which until the recent events were seen as “the most devastating day in the history of the New York stock market,”- this statement again highlights the scope of the crash. (Galbraith, 1955, p. 116) Moreover, many banks had a huge amount of investments in the stock market. After the crash of the stock market, these banks did not have any more of this money. Trying to withdraw and save the deposits, they had worsened the chaos on the market.

Looking at the events of 1987, during one day the Dow Jones index lost over 500 billion dollars. Markets in different countries were collapsing one after another in the same type of fashion. Thousands of investors were trying to reach their brokers to withdraw their money; however, it was impossible to control the situation anymore. Furthermore, the tendency of holding the money played an additional negative role and made the situation even worse: “Our concept of demand for this consolidated market is a demand to hold rather than a demand to buy” (Eagle D, 1994, p. 60).

Predictions on 1929 and 1987 crashes

It can not be denied, that both stock market crashes were devastating for the global economy of those times, however, the question of their probability and possibility to predict these events remains an issue. There were warnings that the economic world would not be always safe and these events would sooner or later occur with unpredictable extents and reactions. “On the first of January of 1929 as a matter of probability, it was most likely that the boom would end before the year was out,”- John Kenneth Galbraith, in the article “The Great Crash: 1929” is convinced that the stock crash was just the matter of time. (Galbraith, 1955, p. 29).

The period before the stock crash of 1929 was the time of speculative boom when almost everyone in the United States of America was somehow involved in the process of buying or selling shares, making an amazingly big amount of money: “The mass escape into make-believe, so much a part of the true speculative orgy started in earnest”. (Galbraith, 1955, p. 16-19) Most of the investors believed that the best type of investment was the stock, which was a true assumption but the stock was not the safest investment.

Analyzing the situation of 1987, the public was again engaged in the euphoria of buying profitable stock. There was a never-ending process when companies were expanding and growing by just the process of buying out other smaller companies. Then they would sell junk bonds to the people, which interest rates were very high, however, it was a risky process too. There was an assumption that microcomputer was a very profitable field to invest in, so the public was taking advantage of this technology of the future and was eagerly buying the stock of the companies involved in this field.

“There are two reasons that a stock market crash could have substantial supply-side effects. The first reason is that a significant number of the workforce now expects to receive a large portion of their compensation in the form of stock options. In extreme cases, such as Internet start-ups, the wage or salary that workers receive might be the smaller portion of their expected compensation; they anticipate that most of their compensation will come from cashing in on stock options,-” Dean Baker analyses the overall situation of that time in his article “The Supply-Side Effect of a Stock Market Crash”. (Baker, 2000, p. 107).

New York Stock Exchange role in 1929 and 1987

It would be appropriate to remark the role of the New York Stock Exchange in these two crashes. New York Stock Exchange is one of the largest stock exchange markets in the global market of stock; it is the leader by dollar volume. Its volumes today are impressive and its global capitalization makes up over twenty-three trillion dollars.

“In the autumn of 1929 the New York Stock Exchange, under roughly its present constitution, was 112 years old.”- New York Stock Exchange already existed and had a reputation of the steady organization with a low possibility to collapse. (Galbraith, 1955, p. 130)

However, New York Stock Exchange survived and continued to operate successfully, until the year 1987, when similar crises occurred. “The immunizing effect of the 1929 crash was substantial and long-lived. When the low point was reached in summer 1932, the value of the stocks traded on the New York Stock Exchange had declined 86 percent from the pre-crash level,”- the article “The New Speculative Stock Market: Why the Weak Immunizing Effect of the 1987 Crash” describes the situation in New York Stock Exchange in 1987(Patrick Raines, Charles G. Leathers, 1994, p. 33). The fact, that NYSE can overcome such a global crashed, proofs the stability and high level of reputation of this organization.

Effect of “bubble” in both crashes

One more thing in common in both crashes is the effect of “bubble”. In both cases, the speculation with prices caused it, when the price level was too high, and then a sudden drop of prices followed. “On the whole, the great stock market crash can be much more readily explained than the depression that followed it. And among the problems involved in assessing the causes of depression, none is more intractable than the responsibility to be assigned to the stock market crash. Economics still does not allow final answers on these matters. But, as usual, something can be said,”- as stated, the depression followed after the effect of the bubble, and global efforts were put together to overcome it. (Galbraith, 1955, p. 189).

Measures of government in 1929 and 1987

The next issue, which should be described in this article, is the issue of steps, which the government took to handle these crises. The set of steps, taken in 1929 and 1989, are different, probably due to the fact, that world already had an experience of dealing with such crises. So, in 1989 the set of actions was much more efficient.

Franklin Roosevelt’s measures after 1929

Franklin Roosevelt, who became a president in 1933, had to take very accurate and responsible actions to overcome the stock market crises and to revive the banking system in the country, which would consequently positively affect the situation in the world, since the United States of America, with its largest New York Stock Exchange, was one of the world’s greatest investor.

Roosevelt had taken the next actions: he gave banks three days “holiday”, to re-open them later but with stricter limitations on the process of making withdrawals. Some time has passed and the system was revived- those banks, which survived, proved their ability to operate and perform further economic functions. There were certainly taken steps to prevent a similar crash. For example, the federal government established Federal Deposit Insurance Corporation. There was a new philosophy that ensured the safety of deposits of the investors, even if the bank failed; the government reimbursed all the depositors’ money.

“If the stock market crash teaches anything, it is that the mess the economy is inflows not from excessive consumption but capitalism’s ruthless pursuit of unlimited wealth by any available means, whether or not these have anything to do with satisfying the needs of real human beings. The only remedy for this situation is a truly revolutionary reconstruction of the whole socioeconomic system,”- the author suggests that the crash of 1929 had to be regulated, and the regulation had to consist of several methods and instruments. (“The Stock Market Crash and Its Aftermath” Monthly Review, 1988, p. 1) As far as it can be judged all measures taken by the global society, and the Federal government in the United States, in particular, were successful and beneficial for the world’s situation.

Taken measures in 1987

Moving on to the actions during 1987, it can be said that there were much more significant and efficient measures taken. First of all, to prevent future market decreases and panics, circuit breakers were used in 1988. The issue of their usage remains controversial even today, because many critics say, that the circuit breakers don’t make the price of share less changing, on the contrary, they make their price even higher.

Secondly, there was a certain increase in the communication between the markets and those, who are in charge of its regulation. For example, the chairmen of the Federal Reserve Board, the Commodity Futures Commission, and the Securities and Exchanges Commission had permanent meetings with the goal of preventing and predicting the next chaos. There was a new instrument, called the “squawk box”, which contributed positively to the overall situation, by making all changes and new developments available to the public.

“In 1987 the product sold as portfolio insurance was a dynamic investment strategy based on the Black-Scholes option pricing formula. This strategy attempted to replicate a put option in stocks”, – the author of the article “The Equivalence of the Cascading Scenario and the Backward-Bending Demand Curve Theory of the 1987 Stock Market Crash” explains the strategy used in 1987. (Eagle D, 1994, p. 60).

“The stock market crash of 1987 was relatively painless largely because the Federal Reserve moved quickly to ease monetary policy and reassure banks,”- the author underlines the efficiency of actions used by the Federal government to cope with the crash (Jane S. Lopus, 2005, p. 70).

Also, there were manuals to have the plan of action if the market should decrease. The level of decline affects the scheme of necessary procedures. Today the importance of the high level of capacity of phones and internet is recognized, because one of the main problems of the crash of 1987, as well as 1927, is the fact that investors were not able to call to the when they wanted to check the stock prices or other details. On the day of Black Monday, the telephone lines could not cope with such a great level of calls. Nowadays, international corporations have increased the capacity of their telephone lines, in the first place; secondly, there are trained teams, who would cope with the exceedingly high level of calls in case of another crash.

“Economists disagree about the causes of the stock market crash of 1987. They agree, however, that no single cause dominated events at the time, and that many factors worked together to bring the market down,”- the author again underlines that it was a collection of reasons, causing the stock market crash in 1987, that’s why it was important to take a collection of measures on different levels to overcome its consequences. (Jane S. Lopus, 2005, p. 70).

Summarizing the set of instruments and methods, used in both cases, it is obvious that global society has learned from the sad lesson of the stock market crash in 1929 and 1987, and now the possibility of such expansive and significant crises is very low, though the possibility still exists.

“The second supply-side effect of a stock market crash does not stem directly from the crash itself, but rather from the large overvaluation in the stock market that precedes it. A seriously overvalued stock market allows for an enormous transfer of wealth from those buying into those cashing out”, – the crash of the stock market brings many changes in the current global situation, affecting all the levels, in negative and somewhat in positive terms. (Dean Baker, 2000, p. 107).

Consequences of 1929 and 1987 market crashes

Moving on to the next section of the paper, which concerns the overall impact on the global and local economy in 1929 and 1987, it is essential to highlight the fact that the consequences of the stock market crash in 1929 had a much more serious and significant impact on the economy of the world. Here is what is written in the article “The Stock Market Crashes of 1929 and 1987: Linking History and Personal Finance Education?” by Jane S. Lopus about the 1987 crash: “The 1987 crash was not followed by a depression or even a recession. Although there was the largest one-day drop in stock prices in the twentieth century, several newspapers and officials did not even call it a crash, preferring terms such as “market interruption”. (Jane S. Lopus, 2005, p. 70).

The main reason, why the consequences of 1929, which led to the Great Depression, were different from the consequences in 1987, lies in the experience of the global society to deal with crashes and in the overall economical conditions in 1929 and 1987.

Here is how the conditions in 1929 were described: “Had the economy been fundamentally sound in 1929 the effect of the great stock market crash might have been small. Alternatively, the shock to confidence and the loss of spending by those who were caught in the market might soon have worn off. But business in 1929 was not sound; on the contrary, it was exceedingly fragile. (Galbraith, 1955, pp. 204).

Here is another article, describing the overall situation in 1987: “The stock market crash of October 1987 occurred during a period of relative prosperity. Real GDP was increasing at an annual rate of 3-4 percent, and the inflation of the early 1980s had largely been contained.” (Jane S. Lopus, 2005, p. 70) Or here is one more opinion on the consequences of the crash, expressed in the article “The New Speculative Stock Market: Why the Weak Immunizing Effect of the 1987 Crash”: “In asserting that the 1987 crash was not a panic, but rather was “the restoration of sobriety and rationality” (Patrick Raines, Charles G. Leathers, 1994, p. 33).

It is essential to analyze the time after the stock market crash in 1929, also called the Great Depression. It was a time of recession, continuing from October 1929 and to the middle of the 1930s. The stock market crash caused mass poverty, due to the high level of unemployment and low level of salary. Former international companies had collapsed and left hundreds of high-skilled workers without a job. The statistical data states that more than one-third of people in the USA lived below the poverty line.

“After the stock market crash of 1929, things only got worse. By the end of 1929 the market recovered somewhat, but in general stock prices continued a downward spiral until 1932. By 1932, average stock prices had fallen more than 75 percent and people had lost an estimated $45 billion in wealth. The market did not reach its 1929 peak level for another 25 years”, – it was the time of the Great Depression, which affected everyone- the poor and the rich. (Jane S. Lopus, 2005, p. 70).

The positive impact of 1929 and 1987 crashes

Surprisingly, there were people, who made a fortune in the times of depression in both 1929 and 1987. For example, Jesse Livermore had accurately predicted the economic depression and used this information to make more than one hundred million dollars. Another example is Joseph Kennedy, who sold just before the chaos and managed to keep millions of dollars. So, overall it was a matter of the correct forecast to make such an amount of profit, and those who believed in the statement that the speculative boom would not last long had made the right decisions.

Conclusion

In the end, outlining the similarities and differences between the stock market crashes in 1929 and 1987, the most important thing is to make the right conclusions and work out an adequate system of reaction.

“Are markets driven by rational pricing, as the EMH suggests, or by speculative psychology?”- This is a question from the article “Economists and the Stock Market: Speculative Theories of Stock Market Fluctuations”, which refers to the fact that in 1929 and 1987 speculative psychology, or the desire of people to enrich themselves as fast as possible, significantly affected the situation. (Sinclair Davidson, 2001, p. 419).

The pattern of the financial bubble is very similar in 1987 and 1929; there is a collection of reasons which stimulated the emergence of this pattern. So, if we learn how to deal with this psychological factor in the future, we will prevent the possibility of stock market crashes and global crises.

References

Baker, Dean. “The Supply-Side Effect of a Stock Market Crash.” Challenge 43.5 (2000): 107.

Bierman, Harold. The Causes of the 1929 Stock Market Crash A Speculative Orgy or a New Era?. Westport, CT: Greenwood Press, 1998.

Davidson, Sinclair. “Economists and the Stock Market: Speculative Theories of Stock Market Fluctuations.” Economic Record 77.239 (2001).

Eagle, David. “The Equivalence of the Cascading Scenario and the Backward-Bending Demand Curve Theory of the 1987 Stock Market Crash.” Quarterly Journal of Business and Economics 33.4 (1994).

Galbraith, John Kenneth “The Great Crash: 1929”, First Published 1955; 1961 Reprint, Boston, Houghton Mifflin.

John A. Garraty “Historical Viewpoints: Notable Articles from American Heritage” Volume 2 (From 1865), 9th Edition, 2003.

Lopus, Jane S. “The Stock Market Crashes of 1929 and 1987: Linking History and Personal Finance Education.” Social Education 69.2 (2005).

Raines, J. Patrick, and Charles G. Leathers. “The New Speculative Stock Market: Why the Weak Immunizing Effect of the 1987 Crash?.” Journal of Economic Issues 28.3 (1994).

“The Stock Market Crash and Its Aftermath.” Monthly Review Mar. 1988: 1.

Wadhani, Sushil B. “The US Stock Market and the Global Economic Crisis.” National Institute Economic Review (1999).