You Thought Monday Was Bad?

By Gordon Bock

Black Monday -- Oct. 19 -- is already notorious as the darkest day in Wall Street history. With good reason: the record 508-point, 22.6% plunge in the Dow Jones industrial average highlighted a disaster that wiped out $500 billion in shareholder assets. The very next day, however, the Dow posted a record 102-point gain. So within 24 hours, everything was suddenly upbeat again, right?

Wrong, according to an in-depth investigation of the crash by the Wall Street Journal. A front-page Journal story last week asserted that the market came closer to "total meltdown" the day after the crash than it had on Black Monday. TERRIBLE TUESDAY, the Journal's headline writers dubbed the dreadful day. Oct. 20 "was the most dangerous day we had in 50 years," Investment Banker Felix Rohatyn was quoted as saying. "The fact we didn't have a meltdown doesn't mean we didn't have a breakdown."

Terrible Tuesday began with traders in a state of despair and got worse. Banks that normally lend heavily to securities dealers had stopped doing so. Some even called in major loans, which edged a number of securities firms perilously close to financial ruin. The crunch came at midday: trading in stocks, options and futures in a variety of markets virtually shuddered to a halt. Many blue-chip issues that make up the 30-stock Dow average, including IBM and Merck, could not be traded because there were simply no buyers for them. Major investment-banking firms urged John Phelan, chairman of the New York Stock Exchange, to shut the exchange to allow the market time to recover. But Phelan refused. "If we close it, we would never open it," he said.

Decisive action by regulators and major investment banks halted the market's downward spiral and apparently prevented a catastrophe. First, the Federal Reserve pumped dollars into the banking system -- a clear signal to nervous traders that the U.S. Government was bent on averting a collapse. Meanwhile, the Journal says, E. Gerald Corrigan, president of the Federal Reserve Bank of New York, telephoned many top bankers to urge them to provide credit to securities firms.

The real turning point, however, may have been a wild upward tick in a little-known stock index futures contract traded on the Chicago Board of Trade. Buying or selling such a contract amounts to a wager on which way the market is going. In this case, the bet was based on the Major Market Index, a group of blue-chip stocks similar to the Dow average. In a five-minute period after 12:30 p.m. on Terrible Tuesday, MMI futures staged their most powerful rally in history, achieving what the Journal calls the "equivalent of a lightning-like 360-point rise in the Dow."

The article cited a study of trading patterns suggesting that a group of major investment houses, the identities of which are not known, made a concentrated -- and perhaps desperate -- effort to buy up MMI futures and turn around the market. Because futures are bought largely on credit, the buyers were apparently able to pour enough money into the contracts to generate a substantial move in their price. Word of the Chicago rally quickly spread to New York, helping spark the phoenix-like revival on the Big Board.

It was, in short, a close call. But the Journal article warns that the near disaster on the day after the dizzying crash "raises the specter that such a crisis could strike again." Perhaps most worrisome of all is that the stock market shot down on that Monday and up again on Tuesday without any compelling political or economic event serving as the trigger. Should a war, assassination or other crisis of serious proportions strike, no one really knows just what it might do to the world's shaky markets.