Surviving Black Monday

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To subdue inflationary pressures, we were trying to slow the economy by making money more expensive to borrow. There’s no way to predict how severely the markets will respond to such a move, especially when investors are gripped with speculative fervor. I couldn’t help but remember accounts I’d read of the physicists at Alamogordo the first time they detonated an atom bomb: Would the bomb fizzle? Would it work the way they hoped? Or would the chain reaction somehow go out of control and set the earth’s atmosphere on fire? After the meeting ended, I had to fly to New York; from there I was scheduled to leave that weekend for Switzerland, where I was attending my first meeting of the central bankers of the ten leading industrialized nations. The Fed’s hope was that the key markets—stocks, futures, currency, bonds—would take the change in stride, maybe with stocks cooling off slightly and the dollar strengthening. I kept calling back to the office to check how the markets were responding.

The sky did not catch fire that day. Stocks dipped, banks upped their prime lending rates in line with our move, and the financial world, as we’d hoped, noted that the Fed had begun acting to quell inflation. I was finally allowing myself to breathe a sigh of relief when a message reached me from Paul Volcker, the former Chairman of the Federal Reserve. He knew exactly what I’d been going through. “Congratulations,” it read. “You are now a central banker.”

I did not for a minute think we were out of the woods. Signs of trouble in the economy continued to mount. Slowing growth and a further weakening of the dollar put Wall Street on edge, as investors and institutions began confronting the likelihood that billions of dollars in speculative bets would never pay off. In early October, that fear turned to near panic. The stock market skidded, by 6 percent the first week, then another 12 percent the second week. The worst loss was on Friday, October 16, when the Dow Jones average dropped by 108 points. Since the end of September nearly half a trillion dollars of paper wealth had evaporated in the stock market alone—not to mention the losses in currency and other markets. The decline was so stunning that Time magazine devoted two full pages to the stock market that week under the headline “Wall Street’s October Massacre.”

I knew that from a historical perspective this “correction” was not nearly the most severe. The market slump in 1970 had been proportionally twice as large, and the Great Depression had wiped out fully 80 percent of the market’s value. But given how poorly the week had ended, everyone was worried about what might happen when the markets opened again on Monday.

I was supposed to fly on Monday afternoon to Dallas, where on Tuesday I was to speak at the American Bankers’ Association convention—my first major speech as chairman. Monday morning I conferred with the Board of Governors, and we agreed that I should make the trip, lest it seem that the Fed was in a panic. The market that morning opened weakly, and by the time I had to leave it looked awful—down by more than 200 points. There was no telephone on the airplane. So the first thing I did when I arrived was to ask one of the people who greeted me from the Federal Reserve Bank of Dallas, “How did the stock market finally go?”

He said, “It was down five oh eight.”

Usually when someone says “five oh eight,” he means 5.08. So the market had dropped only 5 points. “Great,” I said, “what a terrific rally.” But as I said it, I saw that the expression on his face was not shared relief. In fact, the market had crashed by 508 points—a 22.5 percent drop, the biggest one-day loss in history, bigger even than the one on the day that started the Great Depression, Black Friday 1929.  

I went straight to the hotel, where I stayed on the phone into the night. Manley Johnson, the vice chairman of the Fed’s Board, had set up a crisis desk in my office in Washington, and we held a series of calls and teleconferences to map out plans. Gerry Corrigan filled me in on conversations he’d had in New York with Wall Street executives and officials at the stock exchange; Si Keehn had talked to the heads of the Chicago commodities futures exchanges and trading firms; Bob Parry in San Francisco reported what he was hearing from the chiefs of the savings and loan industry, who were mainly based on the West Coast.

The Fed’s job during a stock-market panic is to ward off financial paralysis—a chaotic state in which businesses and banks stop making the payments they owe each other and the economy grinds to a halt. To the senior people on the phone with me that night, the urgency and gravity of the situation was apparent—even if the markets got no worse, the system would be reeling for weeks. We started exploring ways we might have to supply liquidity if major institutions ran short of cash. Not all of our younger people understood the seriousness of the crisis, however. As we discussed what public statement the Fed should make, one of them suggested, “Maybe we’re overreacting. Why not wait a few days and see what happens?”

Though I was new at this job, I’d been a student of financial history for too long to think that made any sense. It was the one moment I spoke sharply to anybody that night. “We don’t need to wait to see what happens,” I told him. “We know what’s going to happen.” Then I backed up a little and explained. “You know what people say about getting shot? You feel like you’ve been punched, but the trauma is such that you don’t feel the pain right away? In twenty-four or forty-eight hours, we’re going to be feeling a lot of pain.”