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Minyan Mailbag: Why Did the Crash of '87 Occur?


Leverage, or borrowing money, creates higher risk.

Prof. Succo,

I just read your article,
outlining what happened in '87 and your thoughts on whether it could happen again.

As a non-Wall Streeter (I'm a systems analyst for a clothing retail company), with a 401(k) and IRA that will hopefully get me through retirement, I have a couple of questions and comments.

Reading your article, I understand very little of the explanation, because I do not understand puts, calls, derivatives, etc. I had very little money in the market in '87, having only worked in the programming world for a couple of years and living the single life at that time. In the case of the 2000-2002 crash, my wife's and my IRA lost close to half its value, which very recently we finished gaining back. We are now slightly ahead of where we were 7 years ago. I am guessing that we are typical "Main Street" investors.

It seems to me that much of what happened in 1987 was caused by firms on Wall Street doing things that most people knew nothing about but assisted by handing over large sums of money to the firms, hoping for great returns. We don't participate directly in these kinds of transactions, and aside from universal greed, we end up suffering for the traders' actions. What can those of us without any direct involvement do to protect ourselves from something like this happening again? Hiding money under the mattress seems a bit unproductive, but I strongly considered it in 2000-02 when I gave my $200 a month to my financial advisor and watched my statement lose $300 a month for two years.

I do still have an advisor, and I do think he is working well for me, but our money is still in Wall Street, and if some financial mathematician genius-type comes up with another new way to get greedy, where do we end up?

Minyan K

Minyan K,

First of all, the only person who has the right intentions for your money is you. Unless you just want to sock it in Treasury bills (but you are still exposed to the dollar, unfortunately), you need to learn as much as possible to protect yourself. This is what Minyanville is about.

I suggest you read through MV archives. Many of your questions will be answered as to what options and other derivatives are and how they can affect leverage in the system.

I would say this as a tenet for you to remember as you read: leverage, or borrowing money, creates higher risk. Mr. Practical has never told anyone to short stocks, but he has repeatedly reminded Minyans that as stocks have soared these last few years they have done so on increasing credit. This is what has fueled them. As debt grows things become riskier. The stock of a levered company is riskier than that of an unlevered one. A levered consumer has more risk. The stock market in 1987 was levered due to cheap derivative prices.

Today we have more debt in the system than ever before, by factors. Our society is more tolerant of debt as it has been institutionalized. That has become evident even to the most financially uneducated. Risk has never been higher.

I believe there has never been a resource as good as Minyanville over the last few years in explaining how we got here and where we might be going. This has nothing to do with short term stock fluctuations. This has everything to do with ones personal financial success and possibly survival. The middle class of this country is getting slowly cooked by a declining dollar and loss of jobs due to globalization. The rich are benefiting from it.

Risk has never been higher.

-Prof. Succo

For further reading about the 1987 crash, please see the following: Black Monday: What Happened?, How Confident Are 1987 Comparisons? and What Happened in 1987, Could It Happen Again?

Click Here to Purchase John Succo's "A Derivatives Primer: Options, Futures and Structures"

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