This article is an excerpt from the Shortform book guide to "Liar's Poker" by Michael Lewis. Shortform has the world's best summaries and analyses of books you should be reading.
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What was the Black Monday stock market crash? How did the market suffer from this day?
In Liar’s Poker, Michael Lewis writes about the day the financial world felt a shock unmatched since the Great Depression. On Monday, October 19, 1987, the global stock market crashed, wiping out trillions of dollars in investments.
Learn more about Black Monday and how the investment bank Salomon Brothers and Lewis attempted to recover from the crash.
The 1987 “Black Monday” Crash
Lewis writes that the Black Monday stock market crash occurred at a particularly bad time for Salomon Brothers, how the firm missed its chance to turn losses into gains because of some questionable business decisions, and how some individuals did well in the misfortune.
(Shortform note: In the stock market crash that Lewis got to witness, the Dow Jones Industrial Average dropped over 20% in one day. Because of how the world’s stock exchanges were now tightly linked through computerization, falling prices swept around the world more quickly than in any previous downturn. While there had been warning signs during the previous week that stock prices were entering a difficult time, a combination of computer selling algorithms and investor panic exacerbated the market’s problems, triggering a cascade of stock liquidation that formed the Wall Street equivalent of a “run on the bank.”)
Lewis writes that in the week before what would become known as the “Black Monday” stock market crash, Salomon chose to leap into junk bonds while simultaneously laying off 1,000 employees. Some entire departments were let go, including those in charge of money markets and municipal bonds, with no apparent rhyme or reason. Distrust within the company was at an all-time high, especially since the rank-and-file workers knew that the executives sitting on the board wouldn’t feel any negative effects from the layoffs.
(Shortform note: Distrust between employees and employers is hardly restricted to investment firms, but it was certainly on the rise during the time in which Lewis was writing. Economic historians mark the 1980s as a time when the social contract between companies and their workers went through a dramatic shift. Previously, companies provided high wages and benefits to cultivate loyalty in their workforce, but due to the pressures of global competition, many companies laid off workers to cut costs and replaced them with cheaper sources of labor.)
Before Salomon had a chance to find its new footing, the stock market crash hit like a tsunami. Here, Lewis mentions a curious fact about stocks—when the stock market goes down, the bond market goes up. By firing so many of its bond trading experts, Salomon was left with very few people in a position to take advantage of this flip. One Salomon trader had happened to short the S&P index just before the crash, which luckily recovered a big chunk of wealth, but otherwise Salomon and most of its clients lost entire fortunes in the debacle.
(Shortform note: Lewis doesn’t explain the reason why stocks and bonds rise and fall against each other, but the main driving force is investor emotion. Stocks are seen as a way to make money, whereas bonds are seen as a way to keep money safe. Therefore, when stocks are on the rise, investors sell their bonds to raise capital, driving overall bond prices down. Conversely, when stocks suddenly plummet, investors rush to put their money into bonds, making bond prices go up. That’s not the same as shorting a stock, in which an investor borrows shares in a business whose price he thinks will go down. The investor quickly sells his borrowed stock and then, after it drops, buys it back at a lower price and pockets the difference as a profit.)
There was one silver lining as Salomon Brothers’ stock dropped. Gutfreund, Lewis, and many other staff recognized that their stock was deeply undervalued (just as Milken had known the month before) and took the opportunity to buy their own company’s stock when it was selling at an all-time low. Lewis says that for him, his investment didn’t represent any faith or goodwill toward Salomon Brothers. It was simply a cold calculation toward wealth, which would surely follow when the stock price rebounded. In his heart, Lewis was ready to leave, and though he’d wonder if quitting was a wise decision, he had faith (as of his writing) that the business would do well and continue to make money for years to come.
| The Downfall of Salomon Brothers The future wasn’t as bright for Salomon as Michael Lewis predicted. In 1991, the firm was caught violating US Treasury Department rules for bidding on government bonds. Because Gutfreund had known and hadn’t reported the misdealings to the Federal Reserve or to the company’s board, the Treasury threatened to ban Salomon Brothers from dealing in government bonds, effectively killing the firm. Gutfreund and other executives resigned, and Warren Buffett was thrust into the role of temporary chairman of Salomon’s board. According to Alice Schroeder in The Snowball, Buffett feared that if Salomon Brothers defaulted on its debts, a global financial crisis would ensue. He begged the government to let the firm continue trading bonds, and in return, he instituted a policy of absolute transparency toward the regulators investigating Salomon’s wrongdoing. When Buffett testified about the scandal before Congress, he took a hardline stance in favor of total honesty and corporate accountability. Salomon’s fortunes briefly rallied in the years immediately after the crisis, but it never regained its prominent position and was later absorbed into Citigroup. |
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Here's what you'll find in our full Liar's Poker summary:
- A first-hand account of the pursuit of ill-gotten riches at the Salomon Brothers
- The boom and burst of the mortgage bond market
- Where there is room for ethics and level-headed investing
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