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Learning from the 1987 Financial CrisisAbdul-Mumin Bapube AbubakarEmail:[email protected] Candidate, School of Business and Enterprise, University of West Scotland, London CampusWorking PaperThis is a paper in progress, the author invites comments/critiques. Please don’t site without acknowledgement.ABSTRACTA complex global financial industry, operating under the canons and acme of capitalism in a democratic environment, will almost always gravitate towards crisis as the end results, and quantitative easing as the most likely prescribed remedy. This study focuses on events surrounding the 1987 stock market crash through to the 2007/8 economic depression. Scholarly investigations into the causes of the financial meltdowns that permeated the global financial industry for this period have attributed to factors such as; speculations, greed in seeking profit, creative accounting, over-exuberance, herd mentalities, and lax regulatory enforcement. By reviewing literature and introducing the Hoover Module, it is revealed that politicians with the fear of losing power, will ‘hoover’ away all tougher regulations meant to strengthen the economy after any financial crisis and introduce measures that will immediately bring relief to the people (quantitative easing). This leads to a puzzling loop with the following coordinates; Capitalism, democracy, quantitative easing, and financial crises. The paper concludes that earlier experiences were blatantly ignored and rendered irrelevant in preventing the 2007/8 depression, and will most likely not stop any crises in 2019 and beyond, as suggested by Brown (2008). On the contrary, employing the Mandala module, the paper strongly asserts that it is possible to make some gains, even during the worst of financial crises (Brady Report 1988, Study III, p. 12).1.0 INTRODUCTIONBrown (2018), suggests that “We are in danger of sleepwalking into a future crisis”. When quizzed to analyze the risk of a possible repeat of 2007/8, the former British prime minister said: “there is going to be a severe awakening to the escalation of risks, but we are in a leaderless world.” (International Financial Review). Amazingly, the 1987 stock market crash led to the 1989 Act, among many regulations; but they were not deterrent enough to have stopped recurrence of significant global financial crises like the Junk bond crash – 1989, Tequila crisis – 1994, Asia crisis – 1997 to 1998, Dotcom bubble – 1999 to 2000 and the Global financial crisis – 2007 to 2008 (Anderson, 2000).The 1987 Stock Market Crash was symptomatic to all the crises that came after it, including the famous 2007/8 depression. It also provided lessons on the fragility of the global financial system; for instance, at the heat of the Stock Market Crash, the indexes that survived were those that closed down operations (Kandiah, 1999a), any other stock index that operated was hit by the crises. Despite its magnitude, nothing seems to have been rectified out of the 1987 crash, hence, leading to a number of significant crises following sooner than expected. After failing to adhere to the measures kept in place in the post-crash era, the 1987 Stock Market crash, exemplifies the fact that both investors and policy makers don’t learn from experience accumulated from history.The 1987 Stock Market Crash is discussed into details in the next page. Aside explaining the latent factors, this piece of work also introduces the hoover module. This module addresses the multimillion question ‘Is there a solution to the recurrent financial crises?’ More so, a Mandala module is employed as a means of suggesting remedies to the recurrent crises. The paper finally concludes by summarizing and stating its view on what to expect, moving forward2.0 THE 1987 STOCK MARKET CRASH2.1 Build up to the 1987 stock market crashIn their analysis of the 1988 Bank of England report, Antoniou and Garrett (1993), noted 6th October as the day security prices began falling continuously for two trading weeks. According to them, the New York Market on the 14th, 15th, and 16th October presented clear signals of the crash as Dow Jones Index lost 95 points, 58 points, and 108 points respectively.Figure 3.1: The Dow Jones Index lost 95 points, 58 points and 108 points on 14th, 15th and 16th October respectively (Bloomberg)Wall Street in the United States experienced a tremendous influx of foreign investors following the seeming increase in share prices (Kandiah, 1999b). There was a substantial growth on the American trade and budget deficit due to an acute pressure on the American dollar in 1985 with Japan and West Germany, deeply concerned as major trading partners (Winkler and Herman 1987a; See also Katzenbach 1987a). The diminishing dollar was, in fact, a serious concern to all members of the Group of Seven (7) industrial nations. With the fear of rising inflation in their respective countries, six among the G7 ministers met in Paris to agree on stabilizing the American dollar as the central business currency.Moreover, the build-up to the 1987 stock market crash could not end without mentioning the US$15bn deficit that was revealed following the publishing of the August 1987 US trade data amidst figures from the IMF simultaneously. The understanding financial markets got from the published figures was that unless the dollar diminishes drastically in value, the immediate future will not see a reduction in the American budget deficit. Also, the Bundesbank was blamed by James Baker, a US Treasury Secretary for allegedly supporting to increase interest rates in Germany and disregarding the Paris Louvre Accord. Baker threatened Germany by saying Americans will pay back by weakening their dollar. The indefinite intervention by the central banks of the G7 nations was not anticipated by international investors, but rather went into panic following the statement by Baker. This led to large sales of shares marking the start of the 1987 crash (Kandiah, 1999c; see also; Winkler and Herman 1987b; as well as Carlson, 2006a).2.2 The market before, during and after the crash the 1987 market crash2.2.1 before the 1987 crashFigure 3.2: NYA Index (New York Stock Exchange, from October 1985 to 1987) (Bloomberg)The Wall Street Journal (1987a), as well as Anders and Garcia (1987a), warned investors of an overestimated market in the build-up to the market crises in 1987. Before the crash, there was an increase in stock market demand which eventually supported prices as a result of new market entrants like the pension funds, among others, (Katzenbach 1987b). Financing corporate buyouts came with some juicy tax treatments like granting firms the choice of deducting interest expenses on debt during a buyout. This went a long way to increase equities, raised the quantity of potential takeover firms being targeted as well as raised the prices of their stocks (Presidential Task Force on Market Mechanisms (Brady Report), 1988a).With an uncertain macroeconomic environment (Winkler and Herman 1987c), there were rising concerns in the patronage of “program trading” plans, where huge numbers of stocks in an index, got traded quickly by programmed computers with certain conditions in place (Brady Report 1988b, p. 7. See also Carlson, 2006b). The morning of Wednesday 14th October, experienced two events that were seen to have triggered the stock market decline, lasting the whole week. Firstly, a report by news agencies made Investors to believe that the legislation filed by the Committee of the U.S. House of Representatives to get rid of tax benefits that had to do with financing mergers was done purposely to make certain companies take-over targets (Securities and Exchange Commission (SEC) Report 1988a, p. 3-10). Secondly, the announcement of the trade deficit by the commerce department in August coursed the dollar to decline and created a hint on policy tightening by the Federal Reserves (Wall Street Journal 1987b). There was also a downward pressure on equity prices, following rising interest rates.The decline in equity market continued on Thursday with some blame on institutional anxieties, the pension funds, among others, were mentioned, leading to a market shift from the risky stock to a more safety bond trading (Wall Street Journal 1987c). Friday followed with the same indicators with a number of index options expiring and by large, hedging was almost impossible in the money option. Future markets received a lot of subscribers as a result, where futures contracts were used to hedge against the dwindling stock. This brought about price differences between futures market and stocks on the New York Securities Exchange (henceforth, NYSE). The last hours of Friday saw a drastic fall in markets (Wall Street Journal 1987d). At this point, everything was pointing to a disaster, prompting an unusual Saturday meeting between traders on the Chicago Mercantile Exchange (CME) in a bid to settle positions and sort out holdings (Wall Street Journal 1987e)2.2.2 during the 1987 crashFigure 3.3: NYA Index (New York Stock Exchange, October 1987) (Bloomberg)The “Black Monday” started on the NYSE with a chunk of its traders selling their orders (SEC Report 1988b, p. 2-13). On the other hand, most markets were scared and did not open for operation in the early hours of the day. In fact, 37% of shops on the renowned Dow Jones Index opened late (Wall Street Journal, 1987f). Since most stocks were not trading and hence difficult getting up to date price quotes for index calculations, critics were of the view that the indexes could have declined further than what was reported (SEC Report 1988c, p. 2-13). Also, there was a gap between the value of the stock indexes in the future market and in the cash market as a result of the diminishing future market prices and the moth-eaten quotes in the cash market (Chicago Mercantile Exchange, Committee of Inquiry 1987, pp. 18-29).Some traders were reported to have tried taking advantage of the arbitrage opportunity on the NYSE by entering sell-at-market orders but they were disappointed at the turn up of events later and thereby, compelled them to eventually seek refuge in the futures market by participation. This contributed to the decline (Brady Report 1988c, p. 30). There were signals of sales as stocks opened lower and instead of selling in the futures markets only, the institutions sold in the cash market as well (SEC Report 1988, pp. 2-15—2-16). As sales continued, trading was suspended or delayed by the NYSE regulations to correct any anomalies whenever necessary. But with a certain sharp decline in equity prices, most of the big indexes started falling (Brady Report 1988d, Study III, p. 21). At this point, the SEC Chairman made the following comments after a speech and later stated he was misunderstood, after the harm had already been caused. "There is some point, and I don't know what point that is, that I would be interested in talking to the New York Stock Exchange about a temporary, very temporary, halt in trading" (Wall Street Journal 1987f). This news triggered more sales amidst fear that the NYSE was closing down (Wall Street Journal 1987f). Many were those surprised about the record trading on Monday, October 19.2.2.3 After the 1987 crashFigure 3.4: NYA Index (New York Stock Exchange, November 1987 to 2017) (Bloomberg)Tuesday, 20th October, saw the US Federal Reserve making an early morning (before the security markets were opened) commitment to support the economic and financial systems. This statement reportedly boosted the security market sentiments (Murray 1987a). Despite the assurance from the Federal Reserve, the security markets continued to face challenges on Tuesday with almost 7% of stocks closed for business (Brady Report 1988e, p. 45). In a bid to sanitize the system; the NYSE prevented the use of the Designated Order Turnaround (DOT) system by arbitragers to trade, which was believed to have affected the market's depth. As a mitigating measure, the Chicago Mercantile Exchange (henceforth, CME) clearinghouse decided to take some margin payments from their members to make up some loses of the previous day on their open position. Normally completed by midday, these payments are in turn, made to members for an open position with the value improving the previous day. However, by midday on October 20th, two CME clearinghouse members had not received their margin payments, raising fears of defaults payments by CME. This went a long way to deter some investors from trading with CME (Brady Report 1988f, p. 40).With the fear of possibly closing the exchange, the NYSE had most of its stock index derivative products suspended on the Chicago Board Options Exchange (CBOE) and on the CEM, within 30minutes (Report 1988g, pp. 2-20—2-21). However, with a pronouncement of stock buybacks, the financial markets maintained a rise, later in the afternoon (Brady Report 1988h, p. 41). "Corporations had started announcing these programs Monday afternoon, but it was not until partway through Tuesday that a critical mass had formed" (Carlson, 2006c).2.3 Impact of the 1987 stock market crash on other marketsLike a domino, the 1987 stock market crash triggered many economies. Many critics liking it to the October 1929 crash, leaving the investor community thinking over a possible economic recession.Described as a ‘free fall', the NYSE experienced the biggest single-day drop in history with the most revered Dow Jones Industrial Average losing 22.6% on a 605m shares record trading volume.The next domino that fell was the London Stock Exchange. The massive fall lasted till Tuesday, 20 October 1987 that saw a 250 points loss to the FTSE 100. The Australians experienced a massive 25% drop, Nikkei index in Tokyo-Japan fell by 15% and Singapore by 21%. No major stock exchange was left out.Surprisingly, New Zealand and Hong Kong did not experience the crash. It was however reported that they had to close down their respective stock markets to escape the crash. It was difficult to predict when the spurious selling of shares would stop and most importantly, the state the global financial market would be left in, after the dust had settled (Kandiah, 1999d).3.0 THE UNDERLYING FACTORS OF FINANCIAL CRISES3.1 The Hoover ModelHistorically, it is proven that ruling governments are not always happy with the realization of an occurrence of financial crises. Such news is often seen as bad omens (Chwieroth and Walter, 2010a) that will more likely hinder their chances of retaining power. Democracies are mostly characterized by the capitalist’s way of doing business; trading forex and operating financial markets. These business models are mostly associated with financial crises at the end, and because these happen in mostly democracies where elections are held at stipulated times, the incumbent governments, for the fear of losing political power, (Achen and Bartels, 2004a), turn down any ideal solution that might cause the electorates to experience some short to medium term difficulty. They rather employ soft and temporal but potentially destructive measures that will enable them to stay in government. For instance, the supposed romantic response from the US Federal Reserve; easing monitoring policy, reassuring banks of their commitment to revive affected entities and went ahead to make money available to the banks and also slashed interest rates by 1% through the open market operations.(National Council on Economic Education's Learning, Earning, and Investing – High School publication) was just a means of keeping electorates happy. These recurring acts by incumbent governments, have led to the creation of a loop with; democracy, capitalism, financial crises and quantitative easing as the coordinates. This research has named this loop as the ‘Hoover Model of financial regulations’ and presented it below.Figure 3. 1: The Hoover of financial regulationsCapitalismQuantitative EasingF. Markets/crisesHoover ModelDemocracyFigure 4.1 above, is described as the Hoover Model of financial regulations. This above loop is the tool used by politicians to cleverly hoover all financial regulations that are meant to stop further crises in the long run but might bring short to medium terms hardships to the people. With the fear that voters will retrospect blindly (Achen and Bartels, 2004b) and punish ruling governments, (Anderson 2000; Lewis-Beck 1988) politicians see quantitative easing as a safe haven.4.0 SUGGESTED REMEDY USING THE YING YANG MODEL4.1 The ‘Mandala’ analysis of some of the financial crisisMandala, a product of the Sanskrit language is largely patronized by the Hindus and the Buddhists as a religious symbol that represents the integrated organizational structure of life (Ancient Symbols).Looking at the financial crises with a “Mandala lens”, we can see that they weren’t entirely bad omens as we are made to believe; but rather we could draw some beneficial lessons or better still, take advantage of the situations to make some investment decisions. Roger Ibbotson, a finance professor at Yale University and chairman of Zebra Capital, on the 1987 Stock Market Crash; “The whole week was chaos,” he said. “The futures market was a mess, but you could actually make good money if you were up for some risk. A lot of people tried to set up brokerage accounts to take advantage of some of the valuations.” True to the words of Roger, arbitragers made money as a result of the price difference between the value of stock on the NYSE and the stock index in the money market caused by the rise in sales of the futures contract (Brady Report 1988i, Study III, p. 12)The head of corporate and investment bank at Societe General, Jean-Pierre Mustier was a key figure in cleaning the mess after the 2008 crisis including managing the €4.9bn losses of Jerome Kerviel’s. He believes the crisis was a blessing to banking as it has facilitated new regulations and introduced simpler structures for businesses. Among the lessons learned according to Mustier is the use of common sense and not the irrational applications of models by traders (International Financial Review). Fig 10 below is the Mandala symbol illustrating the good and bad of the financial crisis.Figure 4. 1: Yin and Yang's Mandala Symbol (PNG Library)From the figure above, the dark side with a little white spot on the right-hand side depicts the fact that, although the financial crisis did cause monumental destruction, there was a little room of positivity (represented by the little white spot). Conversely, the white side with a black spot explains the fact that at the point the markets were doing well without crises, one could still trace some elements of doom (depicted by the black spot). These small loses could be explained as the daily downward movement of stock prices on the various indices.In all, the Mandala simply gives the explanation that no situation is excellent in its entirety or so bad in its totality.5.0 RECOMMENDATIONSFirstly, after the revelations of the Mandala module, it’s clear all is not lost during financial crises, politicians are hence advised to hold hands in terms of financial crises by holding the bull by the horn. Incumbents should be supported by the opposition to look out for long-lasting solutions rather than having to please voters.Secondly, the polycentric system of banking should be encouraged to give banks the monopoly of operating and dealing with their mess should it happen. That makes them more responsible for their actions.Thirdly, there should be an enforcement of accounting regulations that were specially drafted after the major crises to prevent future crises from happening.Fourthly, the investor community should be more rational, there should be a regulation on speculation to avoid unnecessary panics to the disadvantage of naive investors.Lastly, the world should adapt “global standards and supervision because the flows of capital are global, then supervision can no longer just be national but has to be global” (Brown, 2008a).6.0 CONCLUSIONThe paper did mention it was going to discuss the world financial crises from the 1980s which it did discuss. It went ahead to pick the 1987 stock market crash and explained into details with pictorial evidence from Bloomberg to back its explanation. More importantly, the paper contributed to knowledge by introducing the Hoover model to prove an endless cycle of financial crisis in the current capitalist economy. The Mandala model was employed to illustrate the fact that, the financial crises were not entirely bad as some people were made to believe but there existed some lessons that were positive and needed for our future development, as suggested by Matthews (2009) and Brown (2008b). The paper believes that if the recommended ideas are properly adhered to, it is possible to have a reversal of the Hoover Model. Proper implementation of the recommended ideas will abolish quantitative easing, which means financial markets will in turn be very careful (because there will be no bail out). Capitalist on the other hand will be forced to operate moderately and finally, we will have a decent democracy. It is further believed that investors and policy makers in sub-Saharan Africa especially Ghana, that have been affected by the activities of Ponzi schemes in recent times can also draw some important lessons from this publication. Yes, it is possible to stop the cycle of crashing and repairing with discipline, otherwise, “We are in danger of sleepwalking into a future crisis” (Brown, 2008c)7.0 REFERENCEAchen, Christopher H. and Larry M. Bartels, 2004. “Blind Retrospection: ElectoralResponses to Drought, Flu, and Shark Attacks.” Estudio Working Paper 2004/199.Anders, G., and B. Garcia (1987): “Raging Bull, Stock Market’s Surge is Puzzling Investors; When Will It End?” Wall Street Journal, Jan. 19, p. 1.Anderson, S. (2000). A history of the past 40 years in financial crises: International Financial Review. Available from http://www.ifre.com/a-history-of-the-past-40-years-in-financial-crises/21102949.fullarticleAntoniou A. and Garrett I, (1993). To What Extent did Stock Index Futures contribute to the October 1987 Stock Market Crash? : The Economic Journal, Vol. 103, No. 421 pp. 1444-1461.Available from http://www.jstor.org/stable/2234476 [Accessed: 16-10-2017 10:42 UTC]Bloomberg.Brady Report (1988).Brown, G., (2008). Gordon Brown's speech in full: The Guardian. Available fromhttps://www.theguardian.com/politics/2008/sep/23/gordonbrown.labour1Brown, G., (2018). The world is sleepwalking into a financial crisis. The Guardian. Available from https://www.theguardian.com/politics/2018/sep/12/we-are-in-danger-of-sleepwalking-into-a-crisis-gordon-brownCarlson M, (2006). A Brief History of the 1987 Stock Market Crash with a Discussion of the Federal Reserve Response.: Finance and economic discussion series. Available from https://www.federalreserve.gov/pubs/feds/2007/200713/200713pap.pdfChicago Mercantile Exchange, Committee of Inquiry (1987): Preliminary Report of theCommittee of Inquiry. 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