Black Monday

Context/Description: The 1980s bull market was driven by financial deregulation, declining inflation, corporate restructuring (leveraged buyouts), and technological innovation. Computerized trading became widespread, including "portfolio insurance"—algorithmic strategies that automatically sold stocks or futures when prices fell, intended to limit losses. The Dow had risen 44% in 1987 alone by mid-year. Markets were increasingly globalized and interconnected.

Warning Signs:

• Overvaluation: Stocks had risen too far, too fast
• Rising interest rates: The Federal Reserve was tightening monetary policy
• Trade tensions: U.S. trade deficit concerns; Treasury Secretary James Baker threatened Germany over interest rate policy
• Dollar weakness: International currency instability
• Program trading concerns: Market observers worried about computer-driven selling
• Derivative complexity: Portfolio insurance strategies were poorly understood and untested at scale

The Problem: Markets were overvalued after the rapid 1987 rise. Portfolio insurance created a hidden vulnerability: these programs were designed to sell when markets fell, but if many programs sold simultaneously, they would overwhelm buyers and accelerate declines—a feedback loop. The systems weren't designed for the scenario where everyone used the same strategy at once.

The Trigger: Markets declined modestly in the days before October 19 due to interest rate and trade concerns. On October 19, Asian markets opened down, and the selling spread to Europe. When U.S. markets opened, portfolio insurance programs triggered massive automated sell orders. The technology that was supposed to protect investors instead created a cascade.

The Cascade: Computer programs sold stocks and futures faster than humans could process. Market makers couldn't keep up with order flow. Liquidity evaporated—there were sellers but few buyers. The Dow fell 22.6% in a single day (508 points), the largest one-day percentage decline ever recorded. Roughly $500 billion in market value vanished. Global markets crashed in synchronization.

Results/Impacts:

• Immediate: Worst single-day crash in stock market history by percentage
• Brief economic uncertainty, but recession was averted
• Federal Reserve (Chairman Alan Greenspan) immediately pledged liquidity
• The "Greenspan Put"—Fed willingness to support markets—began here
• Surprisingly limited long-term damage: markets recovered most losses within two years

Regulatory Changes:

• Circuit breakers: Trading halts implemented when markets fall rapidly
• Scrutiny of program trading and derivatives
• Improved coordination between stock and futures markets
• Better market maker obligations for maintaining liquidity

The Lesson: Technology can create unexpected vulnerabilities when everyone uses the same automated strategies. Liquidity can vanish instantly in computerized markets. However, swift central bank intervention can prevent crashes from becoming depressions. Black Monday proved markets could survive shocks that would have been catastrophic in earlier eras.