8 ATaleofTwoMarkets
- On September 4, 1987, the Federal Reserve Board raised the dis-
count rate. - On October 13, 1987, the House Ways and Means Committee
voted to approve income tax legislation that would disallow interest
deductions on debt used to finance business acquisitions. - On October 18, 1987, Treasury Secretary James Baker publicly an-
nounced an intention to reduce the value of the dollar. - Market prices were already high by historical standards.^4
Some experts attributed the 1987 crash to various institutional
factors, including program trading and portfolio insurance that were
set to sell off big chunks of the portfolios of large investors as prices
fell. When prices fell, these program sales pushed them down even
harder. Other experts pointed to derivative securities, often exotic
instruments whose value fluctuates with changes in the value of
benchmarks such as interest and exchange rates. These derivatives
are usually intended to reduce ris kand volatility in such bench-
marks, though if poorly designed can exacerbate the volatility in
stoc kmar ket pricing.
But given the international nature of the crash and its depth,
hardly anyone accepts these explanations. Most people also agree
that it is impossible to explain rationally the radical price changes
that have occurred at other times—whether the 1929 crash, the 1989
break, or the general 1990s and 2000s volatility. Market frenzy simply
cannot be explained using EMT but is a product of a complex of
forces in addition to actual changes in information about funda-
mental business values.
Market frenzies like these are not isolated and certainly not
unique episodes in financial history. On the contrary, market bub-
bles—situations in which prices are way higher than values—happen
all too often. There was a technology stoc kbubble from 1959 to 1961;
a bubble in the so-called ‘Nifty Fifty’ stocks in the late 1960s and
early 1970s; a gambling stoc kbubble in 1978; a bubble in oil and
energy stocks in the late 1970s; a home shopping bubble in 1986 and
1987; and a biotechnology bubble in the early 1990s (with a resur-
gence in the early 2000s), and all of these resemble the Internet or
dot-com bubble of the late 1990s and early 2000s.
The market capitalization (price times shares outstanding) of the
Internet sector was about $1 trillion at the beginning of 2000, with
sales of $30 billion and losses of $3 billion.^5 In 1999, scores of initial