Origins

The U.S. Securities and Exchange Commission, SEC, that had been set up after the great depression had worked effectively at preventing crashes and fraudulent practices throughout the stock market and had even convinced cautious investors back into the markets in the 1960s and 70s. The problems were they could lead the horse to water but couldn’t make it drink i.e. they could bring the investors to all the information about companies but couldn’t make them invest in the best ones. 

Investors could be easily persuaded by the public image of a company and not the value. The SEC tried to prevent this by making all companies announce what assets they had if any but investors would believe that these companies had limitless potential and so consistently backed them. This continued into the 80s even though there were regular bumps and insolvencies, where companies did not reach their financial goals and expectations. Conglomerates and hostile takeovers were popular in this “new economy” and it was said that companies “would grow exponentially rather than incrementally simply by picking up other companies”.

The market kept rising through the 80s and SEC were unable to stop these conglomerates and there became a huge dependence on program trading, which is computerised trading set to occur when index prices rise or fall to a certain level which can create very volatile situations.

At the start of 1987, the SEC started investigations into insider trading, news of which began to unnerve investors, even though some investors may have been aware of this insider trading.

Bonds or even junk bonds became a more attractive proposal than the corruption being publicised in the stock markets. This led to a huge departure from the market and the program trades began to take control with their stop loss features being activated. These were settings that would automatically sell stocks if their prices fell to a certain level. With a vast number of stop loss features sending orders to the NYSE computer (designed order turnaround, DOT) it made the system freeze and lag. This left every investor effectively blind. Then panic set in with more and more people selling stock even though they were unaware of what losses were made and if the order would happen quick enough to keep up with falling prices.

The New York Times, above, sums it up well what happened as it led the Dow Jones to fall by 508.32 points which was 22.6% and $500 billion disappeared.

In my next posts I’ll discuss the different causes and what Government intervention was taken to stop history repeating itself.