On Oct. 19, 1987, the Dow Jones Industrial Average fell 22.6 percent, the largest one-day fall it had ever experienced in its history.
This signaled the beginning of a widespread recession. Because of this crash, unemployment rose relatively steadily for six years. According to the Bureau of Labor Statistics, the unemployment rate in the United States was close to 7 percent in 1993.
The unemployment rate is only 4.7 percent. That means all is well economically, right?
Perhaps it does. Like most things, it depends on who you ask.
Despite the low unemployment rate, rumor has it that a depressed economy is on the horizon. The Dow Jones Industrial Average has lost 3.8 percent of its value in the past 11 days. According to the Associated Press, claims on unemployment insurance shot up 42,000 to 367,000 for the week ending March 13. This is a higher number of claims than predicted and is above the average.
Investors have taken note of this and seem to be preparing for “recession mode.” When a recession appears to be on the horizon, investors protect themselves from increased inflation with debt instrument investments, such as bonds and certificates of deposit. The bond market is increasing, having reached a four-year high of 5.2 percent on May 12.
To make matters worse, it was recently intimated in a column on British paper The Times’ Web site that market conditions in the United States are similar to those that caused the crash of 1987. According to the column, a report by Barclays Capital finds similarities between today’s market and the one preceding the 1987 crash.
However, there is always more to the market than mere numbers – what the numbers mean is the real question. At the very least, the numbers do not indicate an upcoming crash. At best, they may represent the wisdom of a new Federal Reserve Chairman who is preventing the economy from burning itself out.
Contrary to what Barclays Capital has to say, much as changed since 1987. What happened in 1987 was an anomaly. A crash of that magnitude is unlikely to ever happen again thanks to security measures adopted by the exchanges. For instance, “circuit breakers,” also known as “collars,” restrict trading once an index has suffered a certain amount of loss. Such restrictions prevent panic sell-offs, as happened in 1987.
Ben Bernanke is raising the Prime Rate because he understands that an economy can move too fast, much as it did in the years prior to the 1987 crash. By raising the cost of borrowing money, Bernanke is slowing the economy down so it can grow at a healthy, gradual pace. Greed is not always good, and the market realizes this.
In fact, greed was the problem in 1987. The theory at that time was that businesses could grow exponentially merely by buying up other companies. Junk bonds, which are high risk, and an excessive number of initial public offerings, many of which were either malfeasant or had no fundamentals, allowed companies to raise money to buy up the competition and become major conglomerates.
There is such a thing as a company collapsing under its own weight, however. This was not really understood in 1987. Because of that crash, however, it is known today.
The strategy of buying everything up is being discarded for the simple reason that it does not work – a lesson Microsoft and Google may be taught in the foreseeable future.
Now is the time to buy securities, not avoid them. The real estate market is finding equilibrium. Soon enough those assets will be sold in favor of more profitable investments. The recipient of that money will be stock-based investments.
David Woo, head of global foreign-exchange strategy at Barclays Capital, said, “We are very uncomfortable about predicting financial crises….” Of course, Barclays predicted it anyway, but it’s heartening to know they’re uncomfortable about it.
They have good reason to be.
Jordan Capobianco is a senior majoring in English literature.