Nicholas Brady does not look like a revolutionary. He looks like the patrician, thoughtful gent he is, a cross between a law professor and a yachtsman.
Nevertheless, the document that bears his name is in fact a thoroughly revolutionary, radical, iconoclastic document. The Brady Commission Report on the causes and cures of the October 19, 1987, crash may not make radical proposals. But in its explanation of just what moved the market on that dark Monday, it challenges the most basic assumptions of how a free market system works, and just what financial markets do and are good for.
Stripped to its essentials, the commission report says that there were a number of exogenous factors that unsettled the market in the week before the crash.
These factors included continuing concern about the Reagan budget deficits, a seemingly intractable and large foreign trade deficit, and a committee draft of a revenue bill that would have complicated and hindered corporate takeovers.
However, the commission report makes clear that these were not overnight news flashes. Unsettling disturbances had been developing for months, and in some cases for decades. Besides, even collectively, these outside pieces of data were at most curtain raisers for the Big Event.
An economic Chernobyl
What caused the "near meltdown," to borrow New York Stock Exchange Chairman John Phelan's neat phrase, were purely facts internal to the market: primarily and overwhelmingly the unleashing of huge sell orders on the stock futures markets as part of "portfolio insurance," and the concomitant use of program trading to even up cash and futures prices--or try to--as the futures prices sucked the market into a near abyss.
What triggered the portfolio insurance programs was a set of guidelines that said when the market had fallen by a certain small percentage, portfolio insurance would be employed to "guarantee" the gains already taken in the portfolio.
That, at any event, was what triggered the first round of portfolio insurance futures sales on the Chicago Exchanges. When those sales pulled the rest of the prices on the Big Board toward Antarctica, panic took over. Even greater amounts of portfolio insurance were unleashed, and large holders began to dump the cash items as well. This, in turn, led to sell orders of a magnitude far greater than the ability of the specialist system to deal with them.
When the carnage was over, the market had lost over 500 points on the Dow, or almost 22 percent of its value, in one day. Nationwide, according to news reports about $3 billion worth of value had been destroyed.
All of this had happened almost entirely as a result of factors unrelated to the economic climate or to the value of stocks as an investment medium. The bloodshed happened, so to speak, in a bubble sealed off from the outside world and its real economic facts of life. That is the basic message of the Brady
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