CRASH OF '87: TAKING STOCK 508-point drop spelled end to excesses of '80s trading, start of real estate bust

THE BALTIMORE SUN

NEW YORK -- Five years ago, Richard Cripps spent his Sunday worrying about the stock market. On the previous Friday, the market had dropped more than 100 points and trading volume had set a record -- ominous signs to the Legg Mason Inc. broker as he waited for Monday's opening bell.

"I didn't get much sleep that weekend; we knew that something was up. But Monday was so awesome that we couldn't believe it. It was panic selling, a circus," recalls Mr. Cripps, who is director of equity marketing for the Baltimore-based investment-management company.

When the three-ring event ended at 4 p.m. Oct. 19, 1987, the stock market's high-wire act was over. The 508-point, 23 percent crash broke all records for a one-day fall and rocked exchanges in Europe and Asia. Some of Wall Street's biggest brokerages were rumored near insolvency. And economists warned a depression could follow, just as one had come after the 1929 crash.

Effects of the 1987 drop did not turn out to be so dramatic. But the day did mark the end of an era, as the extravagant 1980s crashed to a close and triggered a real estate slowdown that continues today. It also prompted brokers to examine how they do business and to rein in some sophisticated trading tactics that made the plunge worse.

Such lessons make experts confident there will be no more one-day crashes, which is important today, when a sky-high market seems out of touch with the dismal economy.

Still no guarantees

As the market skips and stumbles, investors depend on safeguards effected since 1987 to protect their stocks from a dramatic decline. And the market certainly is volatile -- on Oct. 5, the Dow Jones industrial average dropped 104 points in the first two hours of trading before recovering to close with a 22-point loss.

"This doesn't mean that we can't have a bear market, but it would be over time, not in one day," says Hildegard Zagorski, a market analyst at Prudential-Bache Securities Inc.

Among the changes implemented by the New York Stock Exchange since the 1987 crash are "circuit breakers" that shut down or slow trading when the Dow drops beyond a certain point.

If the market dropped 250 points, a one-hour trading halt would allow panicky traders to cool down and the exchange's computers to catch up with backlogged orders. A further 150-point drop would trigger a two-hour halt. Neither has been used.

In addition, restrictions on program trading are designed to prevent the computer-driven waves of sell orders that helped drive the 1987 frenzy. After a 50-point drop, a "collar" is put on arbitrage programs, which profit by buying and selling massive amounts of securities to take advantage of minute price differences between two or more markets. The collar slows such large trades.

This limit on program trading has been used 56 times since 1988, most recently during the Oct. 5 slide. Ms. Zagorski credits the collar with slowing down the program trades that day so that the two-hour drop didn't turn into a rout.

Others are not so sure. Tom Allen, the 36-year-old president of Advanced Investment Management Inc. who helped pioneer program trading in the mid-1980s, says the rules could make matters worse.

"If you know you're going to get shut down at a certain point, you'll probably sell more quickly to get out," says Mr. Allen, who often faced off with New York Stock Exchange managers after the 1987 crash.

Mr. Allen says stock exchange officials, who want the market to be seen as a safe, reliable investment, seized on program trading as a scapegoat after the crash. He credits the exchange with modernizing computers to handle higher volume but says slowing trades through artificial restrictions could give the impression that there is cause for panic.

"If slowing things down is good, then we should go back to stone tablets as trade tickets," he says.

Whether or not the technical changes make a difference, all sides agree that economic fundamentals are very different from those of 1987. The key difference is that interest rates are low, says Robert Gulick of the New York Institute of Finance.

Five years ago, rates were rising. When institutions and other investors realized they could get good returns from bonds and other less risky investments, they deserted the stock market and triggered the 1987 crash. Rates could go up next year, but they are at historically low levels, meaning that investors have no place else to go but the stock market, Mr. Gulick says.

In addition, the market had risen 40 percent during the months preceding the 1987 crash. This year, the market has been flat.

Although the 1987 crash is unlikely to be replayed, its effects are still being felt in many ways.

Few would draw direct comparisons to 1929, when the economy slipped into the Great Depression. Back then, the market crash triggered a collapse in banks, commodity prices and, ultimately, a contraction in industrial output. In 1987, such effects were limited and the economy grew for three more years until a recession set in.

A key similarity, however, is that both crashes caused severe problems in the real estate market. Dr. Charles Kindleberger, professor of economics emeritus at the Massachusetts Institute

of Technology, says a wobbly stock market can right itself in a short period but that a real estate slowdown usually drags on for five to eight years.

The long deflation in real estate continues, Dr. Kindleberger says. The drastic cutbacks by brokerage firms and other financial institutions that followed the 1987 crash hurt big developers such as the Reichmann brothers of Canada.

The Reichmanns, who control Olympia & York Developments Ltd., took a beating in their World Trade Center Two project in Manhattan and are still hurting after the flop of London's huge Canary Wharf.

"In many ways, Canary Wharf is today's Empire State Building, which was completed in 1930 but never fully occupied until 1940. Both were completed just after a crash and were white elephants for years," Dr. Kindleberger says.

Less clear cut is the effect of the 1987 crash on the market's traditional role as an economic indicator.

Although the Dow industrial average is flashed on television and read by radio announcers like a baseball score, the stock market may not have much to do with the nation's economic health. When the market crashed in 1987, for example, the economy was doing well. When it hit an all-time high this summer, the economy was in the doldrums.

One explanation may be that the stock market acts as a six- to 12-month leading indicator of what will happen in the economy, says Mr. Gulick of the Institute for Finance. By this reckoning, though, the economy should have turned down in 1988 and should blossom next year.

Because the economy didn't fall in 1988 and probably won't boom next year, some argue that the stock market is more divorced from reality than ever.

That feeling was reflected in a study this month by the marketing firm Ogilvy Adams & Rinehart. The company, which conducted a similar study shortly after the 1987 crash, found that the stock market had become a more attractive investment for 14 percent of investors, while 41 percent said it was less attractive.

Such dissatisfaction contrasted with the high number of respondents who have stock investments -- 47 percent said they had more in the market than five years ago.

Ogilvy Adams spokeswoman Christiana Allair says those responses, along with the fact that 20 percent said they were investing for the very short term, indicates that many are not committed to the market and are likely pull out if bonds and other investments pick up, or the market continues its slow leak.

"This doesn't portend well for future growth," Ms. Allair says. "Many are ready to jump ship."

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