Black Monday 1987: what caused the stock market crash of October 19, 1987

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Black Monday was October 19, 1987, the day the Dow Jones Industrial Average fell 508 points, or 22.6%, in a single session. It remains the largest one-day percentage fall in the Dow's history, yet the market recovered most of the ground within two years and the economy did not go into recession.

The crash is a case study in how trading mechanics can turn a bad week into a collapse, and in how a central bank can keep a market panic from spreading. For the wider history, see our guide to stock market crashes.

What happened on Black Monday?

The selling had started the week before. On Wednesday, October 14, two pieces of news hit the market: reports that the House Ways and Means Committee had filed legislation to remove tax benefits for financing mergers, and a trade deficit for August well above expectations. By the close on Friday, October 16, the S&P 500 was down more than 9% for the week, according to a Federal Reserve Board study by Mark Carlson.

On Monday, prices gapped down at the open and kept falling, with the steepest declines in the last hour and a half. The Dow, the S&P 500 and the Wilshire 5000 all lost between 18% and 23% on the day, and the S&P 500 futures contract fell 29%. The volume was more than the systems could handle: on the New York Stock Exchange, trades were reported more than an hour late, so investors did not know whether their orders had gone through.

The Nasdaq Composite fell less on the day, 11.4%, but it lost another 9.0% on Tuesday and kept sliding for longer. In the St. Louis Fed's data it closed at 455.26 on August 26, 1987 and at 291.88 on October 28, 1987, a fall of 35.9%.

What caused Black Monday?

The official histories point to several causes acting together.

A fast rise beforehand

By late August 1987, the Dow had gained 44% in seven months. The Federal Reserve History essay notes concerns that an asset bubble had formed, which left the market sensitive to bad news.

Portfolio insurance

Portfolio insurance was a computer-driven strategy meant to limit an investor's losses. Models told the investor to cut exposure to stocks as prices fell, usually by selling stock index futures, which was cheaper than selling shares. One investor doing this is a hedge. Many doing it at once becomes a feedback loop: falling prices trigger sales, which push prices lower and trigger more sales.

On October 19, selling was highly concentrated. The ten largest sellers accounted for 50% of non-market-maker volume in the futures market, and portfolio insurers made roughly 40% of non-market-maker futures sales, figures from the presidential task force report cited by Carlson. One large institution sold stock in thirteen blocks of just under $100 million each, $1.1 billion in total. Carlson also notes that many sellers were not portfolio insurers, so the strategy cannot carry all the blame.

Market plumbing

Prices in the futures market fell below those in the stock market, and the gap pulled the stock market down as traders tried to profit from it. The Federal Reserve History essay adds that the stock, options and futures markets cleared and settled trades on different timelines, and that international investors had become more active in US markets, so selling pressure came from more directions.

How did the Federal Reserve respond?

Alan Greenspan had become chairman of the Fed earlier in 1987. Before the market opened on Tuesday, October 20, the Fed issued a one-sentence statement:

"The Federal Reserve, consistent with its responsibilities as the Nation's central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system." (Federal Reserve statement of October 20, 1987, quoted in the Federal Reserve History essay)

It backed the words with action. Open market operations pushed the federal funds rate down to around 7% on Tuesday from over 7.5% on Monday, and the Fed kept adding reserves for several weeks. The New York Fed also urged banks to keep lending to securities firms so they could meet margin calls. The ten largest New York banks nearly doubled their lending to securities firms during the week of October 19. A contemporary newspaper report quoted in Carlson's study says Citicorp's lending to securities firms jumped to $1.4 billion on October 20, from a normal $200 million to $400 million, after a call from the New York Fed's president, E. Gerald Corrigan.

Markets steadied. In the two sessions after Black Monday, the Dow regained 288 points, 57% of its loss. The National Bureau of Economic Research records no recession: the expansion that began in November 1982 ran until July 1990. That outcome is the main contrast with 1929, when a recession was already under way and the banking system later broke down.

What changed after the 1987 crash?

The most lasting change was the circuit breaker. After 1987, exchanges developed rules allowing them to halt trading during a steep fall, so buyers and sellers could regroup. Exchanges also moved to unify how trades were cleared across stock, options and futures, and options pricing models were revised.

Circuit breakers have been rewritten since. Before the 2012 overhaul, the market-wide thresholds were set on the Dow at 10%, 20% and 30%. Rules approved by the SEC on May 31, 2012 switched the reference to the S&P 500 at 7%, 13% and 20%. Those rules halted trading four times in March 2020, as described in our page on the 2020 crash. A different kind of automated selling caused the 2010 flash crash, which led to limits on single stocks.

The market's recovery was quicker than after most crashes. The Federal Reserve History essay says US stock markets passed their pre-crash highs less than two years later, and the Nasdaq Composite closed above its August 1987 peak on August 3, 1989. A fall this fast was still a bear market by the usual 20% definition, even though it lasted only weeks.

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