Friday, October 19, 2007

Happy? Crash Day!

Twenty years ago today was "Black Monday."

As a student who was there, I can tell you that it was a very strange day at NYU GBA (the acronym for what is now the MBA program at Stern Business School).

Students actually called in to see if classes were closed!

Throughout the day, as I got on and off the elevator to attend classes, meetings, etc. I heard classmates saying the market was down 100 points, then 200 points, all the way to the close of 508.32 points below Friday's close of 2,246.72 - down 22.62%.

It was surreal.

We didn't have access to the Internet. There weren't tickers everywhere. People got the news from the radio or if they went to a broker's office to use the publicly available Quotron (Bloomberg, before Bloomberg became robust).

Because of the lack of immediacy and the unprecedented nature of the crash; those of us at school that day were fairly confused since we could hear old information after new information, without knowing which was correct.

It had a significant impact on the career paths of graduates of all business schools that year, and for some years thereafter.

It's hard to tell for certain if the impact on me was positive, negative or neutral, but it was a wild week (and an interesting few years after that).

Being a student that term (located at Trinity Place, next to the American Stock Exchange and a five minute walk to the NYSE), we were constantly hearing news of insider trading allegations, mass dismissals at Wall Street firms, and a general anxiety.

The market was right back at the same level the following year, but businesses became more cautious (until a quick LBO bubble in 1989 that was pricked by the refusal by Japanese banks to fund a $300 per share offer for United Airlines).

Those of us who lived through it, whether in the pits, the floor, the trading desks, or preparing for those careers, have learned to be more skeptical of market moves (at least those of us who allow ourselves to remember 1987).

Wall Street humor was up to the challenge and the jokes were uncomfortably close to the truth. Some examples:

  • What's the difference between an investment banker and a pigeon?
    A pigeon can still make a deposit on a Porsche!

  • How do you attract the attention of an investment banker?
    Call out "hey waiter!"

  • The last one plays on a Dean Witter commercial that was running at the time:

  • A banker comes home after the crash and drops into a chair in the living room with his head in his hands.

    His wife asks where they stood financially.

    He replied that they had lost everything!

    She asked "the jewelry?"; "the co-op?"; "the summer house?"; "the club membership?"

    The husband, shell shocked and absent-mindedly nodded his head and said yes.

    His wife screamed, ran out on their high-rise balcony and jumped to her death.

    The husband looked up and said "thank you Dean Witter!"

Sound harsh? Well that was Wall Street in the 80s.

Some things have changed. Things are more PC, but some of the old culture remains.

The most remarkable thing to me, looking back, is how what was old is new again.

  • We had "toggle" bonds. We just called them PIK (the ability to pay interest in cash was understood).

  • Junk bonds (excuse me, "high yield bonds") were issued with and without covenants (depending on the market environment).

  • LBOs made sense just from a financial engineering standpoint. Debt was cheap relative to equity (tax rates were a little higher, making the incentive slightly greater) and Drexel was a junk bond powerhouse. Now, for many reasons including lower absolute interest rates, financial engineering adds very little value. But LBOs are still done (albeit by "Private Equity Firms").

  • Strange structures were invented. One of my favorites was the Zero/Coupon bond, which paid no interest for the first few years and then paid a cash coupon (although there might have been a PIK provision). At least the market didn't get the opportunity to get involved in that this time; but we did have CDOs, CLOs, SIVs, etc.

  • Things were SO crazy that James Grant did an April Fools edition of the Grant Interest Rate Observer with the description of an LBO of IBM. My personal favorite from that farce was the idea of a "zero coupon annuity." A construct that would pay no interest, forever.

Since then we've had bubbles in tech, bio-tech, the Internet, and, most recently, in real estate.

Our markets have become more complex, with more options than ever for investors that want to hedge risks or speculate on them.

Personally, I think we have to let people make mistakes - even if that means bankruptcy. I believe that we need an effective social net that allows those who fall down to pick themselves up. It shouldn't, in my opinion, be an attractive proposition, but we have to help our citizens survive and learn new skills. The complexity of designing an effective plan is a significant challenge, but it's one we face in the 21st Century, as we encourage more countries and people to participate in the world economy and allow free trade.

We need regulation, but things that are against the law now are already against the law. We don't, in my opinion, need to say the same thing a different way.

The Treasury's role in M-LEC and the Fed's role in Long Term Capital were, in my opinion, absolutely correct and necessary. The financial firms need to work together to clean up their messes - they just need the support and assistance of appropriate government or regulatory entities to ensure that the dealings are supported by those entities; and to make joining an easier decision for these firms that must answer to shareholders/partners why they took a particular action.

Monologue over.

It's the anniversary of a pivotal event. Hopefully we learn from our mistakes.

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