Black Monday

The technology at the center of Metz's account was new enough that most of the public had never heard of it. The 1980s had seen the rise of program trading — computer systems that could buy or sell large baskets of stocks automatically when certain conditions were met. Bound up with it was a product called portfolio insurance, sold by firms who promised big institutions they could protect their holdings from a downturn. The mechanism was elegant on paper: as the market fell, the insurance strategy sold stock-index futures to hedge the loss, cushioning the client.

The trouble was what happened when a great many institutions held the same insurance at the same time. As prices dropped on Monday, portfolio-insurance models all issued the same instruction — sell futures — in enormous volume. That selling drove the futures market down, which through the linkage of arbitrage dragged the stock market down further, which triggered the insurance models to sell still more. Metz shows how a system designed to protect individual portfolios became, collectively, an engine that manufactured exactly the crash it was meant to guard against.

The most vivid parts of Metz's reconstruction are the human ones. He puts us on the floor of the exchange and in the trading rooms of the big houses, where the day was not a chart but an ordeal. Phones rang unanswered because there were not enough hands. Specialists who were supposed to buy falling stocks watched their own capital vanish and faced a brutal private question: keep buying into the collapse to do their job, or step back and save the firm. Some kept buying and were nearly ruined for it.

There was a particular fear that Metz surfaces again and again — not the fear of losing money, which everyone expected, but the fear that the system itself might not survive the day. Rumors moved faster than facts. Whispers spread that a major brokerage was about to fail, that a bank had pulled its credit, that the exchange might shut. In a market running on confidence, the mere suggestion that the plumbing might burst was enough to make people behave as though it already had.

Step back from the single day and Metz's larger subject comes into focus: a financial system that had grown faster and more intricate than the understanding of the people running it. By 1987 markets in New York, Chicago, London, and Tokyo were wired together, positions were hedged with instruments that had existed for only a few years, and trades moved at a speed no committee of humans could supervise in real time. The system had become, in a real sense, smarter than anyone inside it — and that was precisely the danger.

The reassuring thing about Black Monday, which Metz notes without letting it soften the drama, is that the wider economy barely flinched. There was no depression, no wave of bank failures, no lost decade. The Federal Reserve under Alan Greenspan, only two months into the job, issued a short statement affirming it would supply liquidity, and the market clawed most of the loss back over the following year. The crash was almost entirely a financial event, sealed off from the factories and shops it was supposed to reflect. That disconnection is itself the lesson: the market had learned to frighten itself independently of the world it was meant to measure.

By the close on October 19, the numbers were unprecedented and the mood was apocalyptic, yet within days the immediate danger had passed. The exchange stayed open, the Fed stood behind the banks, and the great feared collapse of the financial plumbing did not come. Traders who had spent the day certain they were watching the end of the world went home, slept badly, and came back to a market that slowly began to recover. The economy on Tuesday was, as it had been on Friday, essentially unchanged.