Actually I agree with most of what you say, but still believe that the lack of liquidity was the contributing factor (obviously not the only factor) but the one that pricked the bubble so to speak.
In 1987, the crash day was indeed caused by the programs and the fact that no one had the ability to take the other side of the trade. The fed made it clear the next day and ordered the banks to provide all of the liquidity (loans) necessary to allow the NYSE specialist and the B-D community to support the market, without regard to the normal fed margin requirements. I'm not clear on the exact details and whether it is still true, NYSE specialists can borrow using only 5% margin. Thus a large one day move can dry up the normal borrowing power of a somewhat leveraged specialist. However, the market had already declined by around 20% prior to the crash, when Greenspan raised rates in the midst of that decline to show that he had the balls of his predecessor, Paul Volcker. Big mistake that had to be quickly reversed. Broker dealers, specialist are kind of like banks with their leverage, so each hike in rates is a cash flow drain that tends to lead to stock selling (or less stock holding)by the dealers to equalize their positions. If you have ever been on full margin, you know what I'm talking about. I think BDs are always on full margin, so higher rates cause these adjustments to reduce exposure.
After the 1987 crash, capital requirements on specialists were supposedly increased. With the consolidation of financial players across the board, I do believe that we are in better shape on the liquidity front that in 1987.
Your derivatives point is a good one. I agree 100% about the Fed insuring the member bank profits. This is why these international crises have been bullish (1982-Mexico; 1997 Asia; 1998 Russia,take your pick). Liquifying the banks was the driving force behind the large rate declines from 1990-93, allowing banks to arbitrage the short and long term gov securities. In my former securities attorney life, I diligenced a few small banks for stock offerings and could see that strategy at work vs. making too many real loans. By 1993, banks had come out of hibernation and began making more real loans.
On California real estate, I agree narrowly, however, being from AZ, we had taken a hit long before Cal. I viewed Cal as the last real estate domino to fall. The midwest, my former home, was very consistent through the 80s and 90s with steady real estate appreciation not colored by excess S and L liquidity.
In 1990, the Fed did not believe we were in a recession and refused to lower interest rates when we were in fact in a statistical recession. Remember the "headwind" language of Greenspan back then. Behind the curve so to speak. After reading the two fed books, there is definitely a permanent bias to the tighter side of monetary policy in this era, so these behind the curve easings will be a fact of life.
1990 is definitely the weakest case in my rantings, since we did have a real, although mild, recession. Recent fed policy certainly was not the sole factor there. I still feel that the fed was behind the curve and asleep at the wheel in this time frame more than all the other cases.
For 1998, I agree with your assessment, but still blame the fed in part. With rates far too high in the US, a worldwide ripple effect is felt in foreign debt that must compete with ours and in the currencies which tend to be worth less the higher our rates go, meaning the foreign debt must yield so much more than if our rates were lower. These problems overseas are not caused solely by high US rates, but they are exacerbated at the margin. It is the marginal money that keeps this floating crap game of the US market going. Take that away and prices fall in half right away. As interest rates rise, money comes out of the game, and prices erode.
Agree again with your last point about human nature. It's all a matter of magnitude with the stock market swings, and the fed policy has a tremendous effect on that magnitude both ways.
With the strong noninflationary economy, the market in retrospect has not been overvalued at any time throughout this decade (except maybe for now-but we won't really know until we see what the earnings are for the next few years) and the fed did not need to take away the punch bowl, particularly in 1994. |
