Listener: 18 October, 1997.
Keywords: Business & Finance;
In the weekend after the sharemarket crash of October 1987 I read every book on financial crashes I could find. Unlike too many advisers and commentators I knew this was “it”. Earlier I had written how the relationship between share prices and company earnings (profits), “the P/E ratio”, was well above historical trends. That meant that the return from investing in shares was from capital gains, not from their earning real income from productive assets. (But it was only afterwards I realized that the earnings being reported by many companies was based on the capital gains they were making out of their share trading, so a true P/E ratio was even more exaggerated than I thought.) The market was being driven by blind greed, feeding the fickle bubble of speculation. When the bubble bursts, prices crash. If history warns that collapses followed such booms, reviewing past experiences might tell about the economic fallout, and even how to avoid future disasters.
There are lots of good descriptions of crashes: tulip speculation, the South Seas Bubble, property, and so on. One of the best accounts is John Kenneth Galbraith’s The Great Crash about the 1929 New York crash, as vivid a piece of economic writing as there is, supported by a stylish pen and dry wit. (Another good read is Robert Beckman’s Crashes.)
Galbraith recalls how in an effort to shore up an alarmingly collapsing market on Black Thursday (24 October, 1929), the US bankers put up an enormous fund to purchase stocks (what the Americans call shares) at above the going rate, thereby give investors confidence. The president of the New York Stock Exchange, Richard Whitney, jauntily appeared on the trading floor, gave orders to buy huge amounts of key stock on behalf of the bankers. The market steadied, but only temporarily, for prices collapsed again on the Monday, and this time there was no bankers’ fund to shore them up, for even the wealthiest bankers are but Canutes when the tide turns on an overvalued share market with ridiculous P/E ratios. Ten years later, Whitney who the bankers had used as a symbol of confidence and integrity, the man who a few years after the crash was the uncompromising defender of the integrity of his stock exchange in a congressional investigation, was jailed for larceny and fraud. He had used other people’s assets to cover his borrowings caused by falling share prices.
That story prepared me for the various jailing which followed our (and the Australian) crash of 1987. (It would appear that nowhere else were there convictions to the same extent). It is sometimes said their jailings prove all the main financiers behaved criminally, even if only some get caught. Well, no. It is true that generally the wrongdoing of the incarcerated were found out after their firms crashed, so we might infer there were probably successful firms in which similar misdemeanours occurred. On the other hand, there were firms which fell, led by executives of great integrity, in which no misdeeds were identified. Moreover some of the fraud occurred in an attempt to shore up increasingly impossible positions, so it was not needed for sound companies.
The history of our crash is yet to be written. I can understand a certain reluctance in the business community to support such a venture, and yet we desperately need to understand what happened – partly to avoid another bout of speculative stupidity (although that may not be possible), but also to understand the impact of the 1987 crash on subsequent economic performance.
It is no good Rogernomes lauding business, privatization, and a couple of years of economic expansion, while the ignore they devastation of the 1987 crash to which they contributed. Ignoring uncomfortable facts tells the unprejudiced that the account is not complete – and probably not true. (It is the same problem we get with a recent Employers Federation report which mentions the decline of the unemployment rate from “10.9 percent in 1992 to 6.4 currently” with nary a word of how it got so high in the first place.)
What happened in 1987? First it was a global financial crash, not confined to New Zealand. However our share market crash seems to have been the worst. On top of the world boom and bust, we had the consequences of the financial market liberalization of the mid 1980s. There had been a debate over the degree of government regulation of financial markets. between Colin Patterson of the Securities Commission who wanted stronger controls, and the Treasury, who were laissez faire in the best Chicago economics tradition. With the dispute unresolved, the financial sector bolted through rules designed for a different era, fuelled by our cupidity (because we invested in the speculative ventures which could not have proceeded without our contribution). They behaved like repressed kids released in a china shop. The reform’s prospects of economic prosperity was the excuse for the promises of returns on the share market for if the economy were to grow so should share prices. The prospects and promises are still unrealised.