REVISITING THE CRASH SITE October 17, 1997 NEWSHOUR TRANSCRIPT

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On Black Monday -- October 19, 1997 -- one trillion dollars invested in the stock market evaporated as the Dow Jones plunged 508 points, or almost 22.6 percent of its total value. It marked the single largest drop in the history of the market. Following a background report on the '87 crash, Paul Solman discusses the likelihood of another major stock market crash.

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A RealAudio version of this segment is available. NEWSHOUR LINKS: October 27, 1997 Participate in an Online Forum on the state of the stock market 10 years after the crash. October 17, 1997 A background report on the crash of 1987. October 14, 1997 This year's Nobel Prize winners for economics explain their formula for pricing options. August 15, 1997: Economists explain the day's stock market plunge. June 13, 1997: Newsmaker Alice Rivlin discusses the soaring stock market. March 31, 1997: Paul Solman looks at what makes the stock market move. December 6, 1997: How powerful is Chairman of the Federal Reserve Alan Greenspan? Jim Lehrer discusses. Browse the NewsHour's coverage of business and economy. OUTSIDE LINKS New York Stock Exchange

PAUL SOLMAN: Joining us now Robert Glauber, Undersecretary of the Treasury in the Bush administration. In 1987, he ran the Brady Commission, the federal task force that investigated the market crash. He teaches at Harvard. Paul Erdman is a former investment and commercial banker. He has written several novels about financial markets, including the bestseller The Crash of ‘79. Gentlemen, welcome to you. Dow down 200 or so in two days, is this eerily familiar to the days leading up to the crash of ‘87?

Recent drops: "It is eerie, but I think it's very different."

ROBERT GLAUBER, Former Treasury Official: Well, Paul, it is eerie, but I think it's very different. First of all, this time the market's down about 2 percent on Thursday and Friday. Back in ‘87 it was down about 6 percent on that Thursday and Friday.

PAUL SOLMAN: Explain why is that a difference? I mean, the numbers--a hundred points each time--

ROBERT GLAUBER: But the points count for a lot different, a hundred points when the market's at 8,000 is different than a hundred points when its at 2000. And I think percentages are a better way of looking at it. But I there's a bigger difference. Back in ‘87, when the market fell apart, it really did, as you said in the introductory piece, fall apart, the plumbing, the infrastructure of the market, started to break down.

PAUL SOLMAN: What do you mean by that?

ROBERT GLAUBER: I mean the clearance and settlement system, the way people pay for their stocks, didn't work very well. Communications broke down. People couldn't get through to their broker. Specialists, who make markets on the New York Stock Exchange, some of them ran out of the capital, so the things that make the market work in an orderly way fell apart. It became disorderly, and that was a big difference. That's really what marked ‘87, not that the market went down, because markets are going to go down from time to time for sure, but it went down in a completely chaotic way. This time I think it's less likely and so far certainly it hasn't happened.

PAUL SOLMAN: Paul Erdman, eerily familiar, similar?

PAUL ERDMAN, Writer: Well, it's a little familiar in the sense that I think the best measure of a stock market, where it is, is the price/earnings ratio. And back in the fall of ‘87 it was well over 20. In the fall of 1929 it was well over 20, and today it's well over 20, compared to a historic norm of 14 to 1.

PAUL SOLMAN: Explain what a price/earnings ratio is, if you would, briefly, Mr. Erdman.

PAUL ERDMAN: Well, if a company earns $10, normally it sells for $140.

PAUL SOLMAN: That means 14 times its earnings?

PAUL ERDMAN: Exactly. And now it's 50 percent outside of that normal range. However, I do agree that the technical aspects of the market have changed dramatically after ‘87. We have now two major circuit breakers in place that have never been tested. If the Dow goes down 350 points, there's a timeout, a half hour.

PAUL SOLMAN: When you say circuit breaker and time out, just explain what you mean.

PAUL ERDMAN: Okay. Trading stops for half an hour.

PAUL SOLMAN: Just stops completely.

PAUL ERDMAN: Stops completely. And if then it--the fall resumes after this--the fall in the market and it drops 550 points below where it started--I'm talking about the Dow--then there's an hour of trading stock, another hour time out. Well, I mean, it's very difficult to build up a panic when, you know, every other hour you're out there in the lunch room drinking coffee. So for that reason alone I think we're hardly going to see an eighteen or nineteen hundred point drop, which would be the equivalent of what happened in ‘87.

PAUL SOLMAN: Please go ahead, if you want to respond.

ROBERT GLAUBER: I think Paul's absolutely right. I think circuit breakers are likely to make a big difference, and just the capacity of the exchange. Today the exchange can do, it believes, 2 billion shares of transactions. Back in 1987 to do 600 million almost brought the exchanges to a grind, grinding halt.

The dooms day scenario.

PAUL SOLMAN: So, again, it's these technical factors. Is there no dooms day scenario, Prof. Glauber, and if there is, what is it?

ROBERT GLAUBER: Well, if you want to build one, I think you start building it around the idea that a large number of people run for the exit and try and sell all at the same time.

PAUL SOLMAN: When you say run for the exit, again, for those of us who don't know what that means--

ROBERT GLAUBER: That they try and sell their shares and cash in their equity holdings.

PAUL SOLMAN: Oh, you mean--from the stock market.

ROBERT GLAUBER: From the stock market. And perhaps a large number of financial fund shareholders might do that. Today mutual funds have 12 times as much money in stocks as they did back in ‘87. So there are a lot of new mutual fund shareholders, and if they all decided to panic at the same time, they could drive the market down very, very quickly. So far that hasn't happened.

PAUL SOLMAN: Well, what about this cup of coffee that Mr. Erdman says they'll all be taking because the market will close down, that doesn't reassure you?

ROBERT GLAUBER: It does, but if they were really determined to do it, they'd take the hour off at the coffee and then go and continue to sell. I think it's very unlikely. But if you wanted to build a dooms day scenario, I think you'd build it around a lot of new investors in equities through mutual funds all deciding to cash in at the same time.

PAUL SOLMAN: Mr. Erdman, is that the dooms day scenario, if there is one?

PAUL ERDMAN: Well, yes. What's going to be the trigger, I think that's the big question that one asks. In the 1970's what triggered stock market crashes, if you want, were external shocks, two oil shocks. All of a sudden there was a big problem in the Near East and the supply of oil was endangered, and up went prices, up went the potential of inflation, and the stock market began to collapse. You can't predict external shocks obviously. I think one thing maybe to worry about is the last big collapse in the stock market that we've seen after ‘87 happened in ‘89 in Japan.

At that time their equivalent of our Dow, the Nikkei 250, was around 40,000. Today it's about 17,000. And what happened there was that they--the bubble--they called it the bubble burst. And I think if we had a bubble here, which potentially could burst, and it caused the whole market to go down very substantially, we'll probably find it in Silicon Valley. These high tech companies, which prices have been way, way up, and if all of a sudden, as has been happening the last couple of days, earnings do not meet up to expectations, this then could set off a buying spree with high-tech stocks and then could encompass the entire market.

Who gets hurt in a crash?

PAUL SOLMAN: Professor Glauber, what would happen if that or some version of what Mr. Erdman is talking about occurred? I mean, who'd get hurt most? Who'd get hurt least?

ROBERT GLAUBER: A lot depends on how it happens. If it happens in the way that triggers a panic, which was what we had in ‘87, then a lot of people could get hurt because they would get scared; they wouldn't be able to sell their stocks when they wanted to sell their stocks, the market would over-correct, go down too far, and then bounce back later. If it goes down in an orderly way, then it's I think just a market readjusting to people's expectations. If earnings were up double digit this year, they're going to be up single digit next year, the market will probably go down. It really depends how the market reacts to the trigger, whatever that trigger is.

PAUL SOLMAN: And what does it do to the economy? I mean, suppose there is--I don't want to make it up--but suppose there's a significant downturn in the market--what does that do to the economy?

ROBERT GLAUBER: Well, a lot depends on how long it lasts. If you go back to ‘87, when it didn't last very long, as you said in your piece, the market was back up to where it started within six or seven months, probably not a whole lot to the economy. And, in fact, in ‘87, it didn't do a lot to the economy. If it went down and stayed down for a long time, people would feel poorer; they'd have less value in their stocks, in their savings, and they'd probably spend less. And that that could cause a recession.

PAUL SOLMAN: Okay. Mr. Erdman, who gets hurt most and who gets hurt least if there's a fairly dramatic downturn? I don't know how else to characterize it.

PAUL ERDMAN: I would say it's the investor per se. And there's a lot of investors in America today because of this boom in mutual funds. I'd go back to kind of an old hacky saying--do you want to eat well, or sleep well as an investor--and if you want to eat well, what you've been doing, you've been investing in really high flying, high-tech stocks that have been zooming up. If you want to sleep well, you've been going into dreary things like bonds and Treasury bills and money market funds. It would seem to me that when you get the price/earnings ratio, 50 percent above normal, it would be kind of sensible to aim for the middle, not to eat too well, not to sleep too well but have some stocks, some bonds, some money market funds, and so forth.

The lessons of '87...

PAUL SOLMAN: What did we learn from ‘87? Maybe, Prof. Glauber, since you ran that Brady Commission, what did we learn from the last crash that maybe helps us in this?

ROBERT GLAUBER: I think what we learned, it's very, very important that the market be able to operate under a lot of demands of people trying to either buy or sell--in the case of ‘87 sell--and I think we've learned that lesson. I think the market is a great deal stronger. Circuit breakers are in place.

PAUL SOLMAN: Circuit breakers meaning when the market stops.

ROBERT GLAUBER: Stops, as Paul said. That's going to make a difference, I think. So I think we learned how to make the plumbing stronger.

PAUL SOLMAN: And where's your money? This is the last, quick question. Is your money still in the stock market?

ROBERT GLAUBER: Some of it is.

PAUL SOLMAN: Some of it is. Mr. Erdman?

PAUL ERDMAN: I've still have got a lot in the stock market. Yes. I'll tell you why--because the stock market, you know, has been going up, but so has the American economy, and we're in better shape today than we have been in many, many decades, and the future looks great.

PAUL SOLMAN: Well, okay, we'll leave it on that very optimistic note. Thank you, gentlemen, both very much.

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