Luskin: I Caused the ‘87 Crash

Here’s a fascinating ‘Whodunit?’ from SmartMoney columnist and financial commentator Don Luskin:

Now it can be told! Twenty years after the great stock market crash of October 19, 1987, when the Dow Jones Industrial Average fell by more than 22% in a single day, the truth about why it happened can now be revealed.

And believe me, I know what really happened. Because I caused the crash myself. Yep, it was me. With a little help from my some bad judgment, some colossal mistakes, and some outright criminality.

Back then I ran portfolio management and trading for Wells Fargo Investment Advisors. With $69 billion under management, we were then the world’s largest institutional investment manager. The company is now called Barclays Global Investors, and with almost $2 trillion under management, it’s still the world’s largest.

In 1987 Wells Fargo was by far the largest player in the two strategies that caused the crash. One was "program trading," the simultaneous execution of hundreds of stock trades with a single electronic order. The other was "portfolio insurance," a hedging strategy that used program trading and stock index futures to hedge the downside risk in institutional stock portfolios.

According to official government reports issued in the aftermath of the crash, program trading and portfolio insurance combined to cause the crash. The portfolio insurance strategy required that Wells Fargo execute program trades, selling all 500 stocks in the S&P 500, over and over as the market declined. With every execution, the market declined even more. And that triggered the next execution.

…On the day of the crash, we were executing plenty of sell programs for our own portfolio insurance strategies all day. At the same time, clients called to say, "Sell a billion S&P, right now" — and we did. Then they called again. And we sold again. And again.

That’s why I say I caused the crash. It was my team’s finger that was on the sell button. It was our job to push it, and we pushed it.

Our execution of portfolio insurance and program trading strategies were blamed for the crash in the official government reports. But here’s what got left out…

You’ll have to read on for the detective element of the story. It will be posted on his SmartMoney column later today, and is available at his personal blog this morning.