tv Diana Henriques A First- Class Catastrophe CSPAN December 30, 2017 6:30pm-7:21pm EST
conversation between diana henriques and joe nocera. it is my pleasure to introduce our author tonight. the first some housekeeping we aren't independent bookstore celebrating the ten-year anniversary last march and coming up four years in the jersey location. the c-span cameras are here there is a period of question and answer and then to help with the signing. tonight we are here to discuss
"a first class catastrophe". october 19, 1987, the 87, the worst day of wall street history. the worst day of 1929. so to shut the foundation of our financial system we had not heeded those lessons at the same time so tonight's authors are uncovering this omission from previous books from the new york times bestseller and a pulitzer prize finalist. and for investigative reporting. and we are honored to know she is in new jersey. in conversation with joe nocera from bloomberg's career spans the new york times.
insiders black monday. to read paragraph but the outsiders black monday and then we will compare and contrast and in 1929. as they came with the images. so the images that those saw as they are disbelieving with the dow jones average. and then to see dozens of middle-class as the dow would flash across the screen. it was the scariest black
monday and then to go back up again. and in the financial district. it had grown so long large and transparent and fidelity complied. and still no one moved. a market induced trance. then those people huddled in the corner they were tired and dazed as in the middle of the all-night poker game. and all they want to do is all they wanted to do was go home and they couldn't.
and then just watching the dow collapse. >> here is the insiders. and of course now i am reading asking the secretary who cut the vacation short to see how the day was shaping up and then to look optimistic. and then looking at the epic decline. and they decided to close their doors completely. but fidelity $9 billion are
the largest off mutual fund in the country how much they would sell when the big board opened. and those from the arbitrage they were struggling into dealing with that day lose. but then never before to say it looks like a very bad market. and to slow that volatility but no action was taken so to very different approaches.
so diana, what drew you to the idea with this side of the regulators and the stock exchanges so not only was black monday far worse than we may remember today but far worse than we knew at the time. the outsiders view scary as it was, was nowhere near as the insiders view. things were far more tenuous and dangerous. eleven hour rescues and improvisation it was not
apparent to the outside world. the rosy memories so i wanted to be behind the scenes you can see how close to the precipice we are. >> so back up a little. but you take us through a series of innovations that don't have to do with individual stocks per se but you lead us to black monday and that gets us to where we come back later so how that
leads to the creation of what they are in way the market starts to change. >> you have to make a decision because it is all one continuing in history. and it was the first crisis i could find in modern rocket history where a crisis in one market like the commodity market or the silver market was rapidly leaping the firewall spreading to other marketplaces. and to start in the tiny
little villages could not see the whole crisis at once. to see the washington regulators desperately trying to come up with that ad hoc cooperation the multi- market crash. when i asked my congressional leaders later how well did you do? they had to answer maybe not. maybe we didn't do as well as we should have. and then the road from there shows you the markets become increasingly interconnected and the players that are in the market to be increasingly volatile. so with that road to black monday to gradually change the
marketplace. to counteract the mythology that black monday was an aberration or a moment of madness. that was absolutely not true. fundamental changes how it worked and what the market did and leading up to black friday. long -- black monday. one of my memories people who pulled out of the market wound up feeling foolish because then we have the internet bubble.
making the lack of communication to have that competitiveness just spend a minute to explain what they did. >> five major operations that is in addition to all 50 states. there is an entity called the community -- commodity futures trading commission with the commodity market almost overnight to become a hotbed of innovation. that has never been part of the market.
after 1929. and then of course the stock exchange with regulatory responsibility. the treasury department has oversight so that was the overlapping jurisdiction. to have that balkanized regulatory system where the blind man and the elephant. >> and unbelievable turf four. to that midwestern members of congress and looking for the
commodity futures trading commission looking out for the sec. they were playing turf wars the regulators were and to make it worse legislation was a mess the cftc constantly interpreted by the courts through the market regulation was thrown upside down. >> but the only vegetable that you could not trade on the commodities market was onions. because there was an onion scandal. >> at the commodities market
and one very powerful member of congress at the time gerald ford had a lot of onion growers in his state and he wrote into the law you could have futures contracts on anything in the world but not onions. >> so that second scandal that i never thought about was the failure of penn square bank and of course it is the bank in oklahoma and texas. eventually folded and so connect that to the larger thesis that leads us to 87.
>> to those other banks from new york to seattle to encourage enormous losses from one little bank and what that awakened regulators to is the notion the hidden faultlines they could not see that was built up in the system that they began to shake and rattle nobody knew that it would almost bring down continental illinois. that would be critical to our story because in the days immediately after black monday it would make credit decisions that are brave help holding the system together.
so for the very first time creating these derivatives to bet on a basket of stocks. so to say this isn't stock market buying it is just to gamble and then to have a larger purpose and then to describe and then work in connection. >> you don't need to know how the future contracts work. but i am reminded about the great disney film the sorcerer's apprentice where the wizard teaches a few magic spells then goes off in the
apprentice tries that little bit of magic and getting out of control. that is where the markets were. so that creation of the financial derivative these were low-cost ways what would happen in the real stock market it was a hedging tool and speculative tool. to be a larger and larger portfolio from those gigantic banks investing in the stock market and these derivatives gave them a way to hedge and
added some liquidity to their position. >> tell people what hedging means. >> so to taken a particular asset that you are a little concerned maybe your later or early but to take that offset position that will buffer some of your losses. if you own auto dealer stock gm and chrysler for example what could happen is oil prices could go up, gasoline prices could spike that hurt sales. so to hedge that position what do you do? you will buy oil stock because if oil goes up because oil
prices have gone up so it is in the opposition so that will offset the potential loss it is what the hedging was about. with the futures and options contract to allow giant investors to do that. but what they did without anyone really reflecting because investors using the futures market the futures traders hedge their position similarly with those options so those that were sought out and regulated where different
things traded that is when they realize to move in lockstep one way or the other. >> at the same time the regulators i regulate this but not that. so the head of the stock exchange decided to block those computer orders. so to do complicated computer-driven investment strategy. and then for the little investor but when he did that
from his market was a group of investors and was critical to maintaining balance because of all the people of the futures market these are the guys who were buying in the futures market. and only if they could sell in chicago and when they said no you cannot use the fast track those investors went away. the prices diverged and it was nearly fatal. >>host: there is another invention in retrospect a lot of the blame was portfolio insurance. so i remember certainly at
times reading article after article of portfolio insurance how could anybody think this could work or how that accelerated the problem this is the innervation or device that needed to go away. but you found the people. and they made a nice business for about five years selling it. so tell us what it did and how it relates and from there just going into what happened to black monday? >> portfolio insurance is a hedging strategy relying on computer formulas when to sell
or how much to sell. and it went viral 19841985 or 1986. and then to have these big portfolio stocks that is riskie riskier. >> that would automatically sell? >> yes. the stock portfolio in exactly the right proportions. to attract the s&p 500 to have the right for portions when you would be selling and how much to say in advance how
much of a risk you are willing to take so with a 100 million-dollar portfolio as an insurance salesman, okay i can swallow 5% loss but after that i don't want to lose anymore. so they would design a computer program to manage the sale of your portfolio to the extent by the time the market has fallen all the stocks are sold. so to manage so they would continue to track the market. in some ways it was pretty simplistic but the big problem was if everybody tried to do it meant everybody would try
to sell at the same time. with a 5% drop to the market. who are the buyers going to be? and this disconnect the way the markets traditionally work and the way they wanted to use the market is where we really started to get into trouble. >> talk about that a little bit. but the market. in august 1987 which was a five year bull market. so from the outside perspective you say of course we have a correction the market goes bonkers.
so you would expect even without computerized trading that what happened after august the market started to make these gyrations hundreds of poinsettia time. what was that signaling? when that was going on? >> just to back up a little bit that was not a new phenomenon. markets had been gyrating on inexplicably for almost two years. there were dates on the calendar people would look at you say oh my goodness this is the date when a derivative was expiring and they will slam into this triple witching
investors using high speed order delivery systems, exercise their strategy in the stock market have already started to leave their mark. now as you say with your right peak in august was followed by what looked for the first month like a normal correction. many a market drifted down all through september -- more down days than updays it looked like a normal correction. this is how markets go down. and then in the first week in october it really sank and one week the market was off 6% a substantial amount. and everybody went home at the week and said well okay. we had had had the correction you know we had this crazy market and now it is corrected now things will get become to moral the following week was a 10% drop the worst week anybody had ever seen. and somewhere in that week the psychology of the market
changed. somewhere in that week actually 30, 30 years ago tonight things started to change in how people thought about what the market was doing. i take the title of my book from a statement that john palin made to congress early in '87 when he predicted that all of these new trading strategies that these giant investors were with using were someday going to turn a normal market downturn into a first class catastrophe. >> now what made him say that that an think that? >> january 23rd. because he was seeing these crazy movements in his market. wild swings on upside and downside you know a nose dive at closing bell things that were not normal in his long experience and been on the the floor as a trader so he knew that the market --
machinery was lurching and jerking in ways it had never done before but he was attempting to wake up regulators and policymakers and lawmakers to this genuinely new thing that was -- that was effecting the way his traditional market worked. >> so when black monday took place after this, i guess real question is do you really, do we mow what actually happened? and what was the effect of these options new futures and options how much did just plain old fashion selling of stock by fidelity in investment by states by everybody by vanguard play into it. that, you know, how much of it was old world and how much was it was a world interaction between the two? >> we know that a lot of it was
the interaction between the two and that was the genuinely new thing. we knew that there was some old fashioned selling fidelity investment was within of the few mutual fund houses that had to o sell heavily on black monday those didn't. but it was one of the few that did given investors right to pull money out by telephone and so because they made it easy for newscast tores to panic investor panic so they were an old fashioned seller they were selling to raise cash to give people their money back. but the biggest impact on the market were the interactions between these sophisticated computer driven investment strategies and the marketplace itself. the market was simply not able to stand this torque of this selling, though, it was not built for that kind of selling avalanche. and in the post mortem, some of
you know still dispute it but i don't think there's any dispute about the fact that portfolio insurance was indeed a factor in black monday. as were several other computer driven strategies. they had genuinely changed the way the market worked. another thing that was significant this many the post mortem of black monday is how few big traders had the bulk of the impact on the market. in one of the most mortem they identified ten, ten giant traders who did a substantial percentage of the selling on black monday in the days after. so one of the things we learned after black monday was -- the big guys are here. and when they all run over to one side of the boat, at the same time, it's going to capsize.
and these were new futures of the market they hadn't risen overnight that's why i start my story when i do. but they had fundamentally changed the way the market machinery worked. and that's what we learned. >> so why didn't we wind up with a total collapse? of the market in other words why did it recover? >> well that's one of the most exciting chapters in the book, joe. [laughter] that's why i asked you about it. >> it was -- luck. improvisation, personality. there were deals struck in the middle of the night on a handshake that prevented a firm in chicago from defaulting there was a banker in chicago who defied his washington regulator to prop up his options clearing firm and keep it from breaking the options market. there was a -- a banker in new york that head of the new york fed who was leaning on the bank of england of all people to try to give
wall street firms break from a very bad deal they had gotten stuck with. there were last minute cliff hangers those people don't know although i know you do that more than a week after black monday regulators did not know if charles one of the most iconic names on main street at the time was going to be able survive this crash. it had been hit with a ruinness law out of its hong kong office, it was desperately trying to recover that money from that crazy trader over there. and if it had not been able to, it was going to be forced to close its doors and regulators who kept all of this quiet kept it all behind closed doors -- were terrified if that shh swab america would hand and everybody would leave market at the same time. so there were -- there was a moment on tuesday
morning in chicago where the chicago mercantile exchange was 500 million short of the money it had to have to open its doors that day. and if it hadn't opened its doors futures market would have been in peril same bankers at continental, illinois, over the phone was three minutes to spare lone them the money so they could open their doors so how did we get through it? personal relationship, improvisation, accidental leadership, a lot of luck. some -- some arm twisting and sub here and there it was a near run thing and you could never write the rule book for how to do it e again. it was -- it was just too much care care
you can't count on those relationship and last minute rescues getting us through the next time. >> so speaking of the next time -- let's talk about that or for a second. you know we have the same regulators. we have the same turf battle as far as i can tell. we have vastly more sophisticated instruments. vastly larger investor as we found yes. found out in 2008. yep. >> so there were -- putting aside leadership issues -- if there were another event like 1987 which seems like certainly could be. i guess there are two questions really. one is, is the market better at dealing with trading with the back and port with the strategy with the interconnection of the market than it was 30 years ago? that's one, and then second you know is the government better at
understanding the interconnectedness and importance of understanding how one market effects the other? >> well certainly black monday wasn't totally wasted on the regulatory in wall street community. but one of the most stressing things about my research wases seeing how little effect what knowledge has had this the aftermath of black monday, one of the best blue ribbon panel recommended that one of the premier steps it needed to be taken to strengthen the market was we needed a june if id regulatory system. a regulator who could have a 360-degree view of the whole marketplace and we needed that right away. this bulk nice system was dangerous and couldn't work. that was in the brady commission report in 1987. fast forward to 2008, as you know many in the congressional hearing after 2008, federal
regulators chris cox in fcc former treasury secretary johnson now testified before congress that one of the big problems they had in 2008 was -- we had this fragmented regulatory system no one could see us 360-degree view and what needed to change it was dangerous and we needed to fix. just a few weeks ago in early october -- the new treasury department in the trump administration released a report on u.s. capital market and right there on page 9 and 10 of the executive summary it says that among the significant challenges facing u.s. capital markets today, overlapping mandates jurisdiction friction dig fragmented regulatory system that we had so i don't know what has to happen for us to finally wipe the board clean and build a regulatory system for the market we actually had had. it hasn't happened yet and i hope that it doesn't have to be
worse than black monday for it to happen. but we really have to recognize this. as a -- critical issue so -- it is that seeps over into your politics question. of where is leadership in washington to get this donesome and i wish i could be or more optimistic. there just does not seem to be the bandwidth many our political environment is right now to undertake a -- a stem to stern renovation of our regulatory system, however, overdue it is however desperately we need it so i'm not optimistic to sail into the next crisis in a sturdier ship. >> basically counting on banks and creators to kind of recoil thelses. >> hoping they'll be good -- hold on one second.
okay, sure. the people that have the most capital many the market had power many keeping it from being regulated because it seems that had every crash that happen hads someone is benefiting greatly. and you know there's incentive to not fix it because we always seem to bounce back and people forget about it. >> right. so i'm wondering if there's -- if that is what's going on here if it is not just turf war or by design. >> well that's a very good point because certainly -- wall street has been resistant to regulation since the 1930s. there's a long history of that.
part of the reason they are resistant i'm a little bit sympathetic too because they feel like a lot of these regulations are drawn up for a world that doesn't exist then they're right. you know, lawmakers in washington are writing rules for a market they barely understand. and a wall street is saying you know that -- that doesn't fit reality. okay. i got that. but wall street is not sitting down with washington and trying to municipal with a regulatory system that will fit reality, and after the -- scale and the side of the big guy, it is staggering how big be the big guy today are. >> yeah. two major money managers a firm called black rock and vanguard mutual fund house two of those together manage $10 trillion. so that is, that is a figure which would have blown the circuit in 1987, and it was, it's a figure that would have
been outsized and frightening in 2008. and yet we have not found a way through regulation. we have not found a way to tamper the growth of these bewho wonder around in our marketplace you realize that investors like us we're just the mice on the elephant's dance floor here if the elephants start to boogie you better get out of the way because they're so big that their impact on the market is really hard to anticipate. >> you know, vanguard are interesting because there's fundamentally indexing most everything. >> right. and that gives me no comfort whatsoever. >> so which is to say they're all trying to track specific market indexes. which means they are all buying and holding this same stock and if they have to come up with
cash to give you your money back -- they'll all be selling it, selling the same stock at a same time so indexing while perhaps a low risk strategy for you or me for the marketplace is everybody is indexing, we're in a lot of trouble. because it means everyone is going to be buying and selling the same limited collection of stock at the same time. >> but that is rue of everything in the market. i mean, that is -- fundamentally what happens in the market is that -- same thing with portfolio instrument same thing with -- using stock index pooches to hedge is you get a strategy that makes sense. everybody does. then everybody starts to do it and it doesn't make any sense anymore because it everybody is doing it once things turn, it is beginning to -- who is on other side of the trade? >> and you're absolutely right just this -- you forya that we see in the
market. time and time and time again are are -- is the notion that it is different this time. this time everybody can do the same and it will be the same one of the professor who is invented portfolio insurance and one of the poignant group of people that i talked with told me he thought very early on in this creative process he said, well how will this turn out if everybody does it? and he said, i didn't like the answer i got. but he truly didn't believe that everybody would do it, in fact, far more people did it than he ever dreamed and became far more destabilizing i asked question about index funds what happened if everybody is index fund. what happens if everybody is in index-related etf in exchange traded funds? we get these fads in the
marketplace that where we say well if a little is good more of them is better and backed up to a point that's true and then after that point, more of them is just more of them and more and more people driving to try to get through the same l doorway at the same time. so we need to be alert as individual investors. to win that what had is happening to win markets have overdone a good thing. too much of a good thing is a market crisis. >> another question. one more question. i guess this is just speculative but, you know, in the 90s they have that internght bubble while we were many it everybody thought that the future was really bright and then it crashed and we're like this was an internet bubble and housing bubble same thing so i'm wondering -- as someone who has done a lot of research about this. what -- bubble are we with in that we're
not paying enough attention to? is there any -- >> i'm a little bit afraid joe can argue with me on this because i'm afraid we're in indexing bubble. i think we -- embraced one market strategy to the expense of a lot of others and that that needs to be examined and we immediate to stress test our markets marketsw well they're going to handle that. i'm especially concerned about the index-driven etf that are becoming so op as individual investments so those are are the two thingses that worry me. >> i don't disagree with that but i would also add if you lock at stocks facebook, alphabet, that have outsized -- outsized stock prices, i would be nervous about those too. >> if you see something grow that much --
slow it down to the bubble. >> so that they're -- the idea of fads and mania are always going to be dangerous in the stock market. >> that's all of the questions i thank you guys for coming down to work and having this very interesting conversation with us. >> thank you it was a pleasure. it was fun. thank you. >> thank thank you guys. [applause] booktv it on wirt and facebook, and we want to hear from you, tweet us, twitter.com/booktv or post a comment on our facebook page, facebook.com/booktv. good afternoon. we're boing to try this again. a beautiful saturday, right? barnes & noble good afternoon.