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Posted on 6 April 2011 | 6,364 views

Government Bought Stocks After 1987 Crash on Greenspans Advice

Alan Greenspan assumed his most important public position on August 11, 1987, replacing Paul A. Volcker as chairman of the Board of Governors of the Federal Reserve System. Less than two months after assuming office, Greenspan was faced with such a financial market crisis — the 1987 Stock Market Crash.

After the Dow Jones Industrial Average peaked at 2,722 in August of 1987, the index of 30 major industrial stock prices floated downward by 17 percent over the next month and a half. Suddenly, on “Black Monday,” October 19, the market collapsed by more than 500 points as terrified sellers dumped millions of shares. Falling stock prices automatically triggered millions of additional sale orders owing to computerized program trading. Buyers that had previously bought stocks “on margin” — borrowing some portion of the purchase price using the stock as collateral — were then subject to margin calls and forced to provide additional collateral when these stock prices fell. Many of these stock holders were thus also forced to sell.

What consequently resulted was the largest one-day drop in stock prices in U.S. history, with over 20 percent of the New York Stock Exchange wealth evaporating overnight. The securities firms (brokerage firms and dealer-brokers) that as middlemen provide for orderly trading in stocks on the New York Exchange were hard-pressed to find operating capital as Black Monday wore on, particularly when major domestic and foreign banks withdrew their loans as the alarm spread. The financial system neared collapse from a lack of ready cash (a “Liquidity Crisis“). Many other financial institutions would have faced insolvency had the market continued to drop the following day.

Acting quickly, Greenspan met with top Fed officials and mapped a strategy for easing the cash crunch, using the Fed’s virtually unlimited reserves to bolster the troubled financial institutions. Before the market opened on Tuesday, October 20, Greenspan announced the Fed’s “readiness to serve as a source of liquidity to support the economic and financial systems.” With the full force and power of the Fed backing these institutions, fear of a general collapse receded and the Dow-Jones industrial average rebounded with a rally of over 100 points on that day.

Incidentally, the bull market of the “Roaring Twenties” had collapsed on October 29, 1929, with again the Fed, acting through the New York Regional Federal Reserve Bank, providing needed short-term liquidity to stop the financial panic from spreading to other sectors of the economy. In contrast to 1987, however, the Crash of 1929 foretold and contributed to a long-term economy-wide collapse. This was partially due to infighting over monetary policy at the Fed, which allowed the money supply to fall by a third over the period from 1929-1933 and which contributed to banking panics that led more than a fifth of the nation’s banks to suspend operation.

What ultimately saved Wall Street was the Government buying securities under the direction of Alan Greenspan through the “Plunge Protection Team“, also known as “The Working Group on Financial Markets” which was created by Executive Order 12631, signed on March 18, 1988 by United States President Ronald Reagan. Under Greenspan’s direction, the team would buy millions of dollars worth of securities to provide confidence in the stock market and then slowly get out of those securities when Wall Street stabilized.

The Group was established explicitly in response to events in the financial markets surrounding October 19, 1987 (“Black Monday”) to give recommendations for legislative and private sector solutions for “enhancing the integrity, efficiency, orderliness, and competitiveness of United States financial markets and maintaining investor confidence”.

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