Greenspan's Litmus Test - Black Monday

 re: "Moreover, the '87 crash had no specific news catalyst, but was more of an emotional event based on the desire among investors to "sell everything" without knowing exactly why"

1987 was the litmus test for Central Bank stupidity (no black swan). Even Robert Prechter’s Elliott Wave International got it exactly right.

Monetary flows (volume times transaction's velocity), fell from 16 in AUG, to 4 in NOV (See G.6 release – debit and demand deposit turnover). [ Δ, not Δ Δ ] Note, money flows, bank debits (money actually exchanging counter-parties), turned negative during the S&L crisis.

https://monetaryflows.blogspot.com/2010/07/monetary-flows-mvt-1921-1950.html

Conterminously (3 months prior to the crash), the rate-of-change in RRs (the proxy for R-gDp), was surgically sharp, decelerating faster than in any prior period since the series was first published in January 1918. The proxy declined from 11 in JUL to (-)4 in OCT. [ Δ, not Δ Δ ]

Accompanying this sharp deceleration in the RoC for M*Vt (proxy for all transactions in American Yale Professor Irving Fisher’s truistic: “equation of exchange”, the monetary authority mis-judged macro-economic strength (like the last half of 2008), and on Sept. 4 the FOMC raised (1) the discount rate, which was not yet a penalty rate, 1/2 percent to 6%, & (2) the policy FFR 1/2 percent to 7.25% (up from 5.875% in Jan).

Black Monday began when the target FFR was increased to 6.5% on 9/4/1987. The effective FFR began to trade above the policy rate c. 9/22/1987 (constrained by reserve demand). The effective FFR spiked on Thursday (the very first day of the reserve maintenance period).

On Sept. 30 the effective FFR spiked at 8.38%; fell to 7.30% by Oct. 7; then rose to back to 7.61% Oct 19 (Black Monday). Thus, the effective FFR spiked 36 basis points higher than the FOMC’s official target, it’s policy rate on “Black Monday”.

The shortfall in the quantity of legal reserves supplied by the FRB-NY’s trading desk (which had already dropped at a rate not exceeded at any time since the Great Depression) bottomed with the bi-weekly period ending 10/21/87. This was the trigger. However, the Fed covers: The Nattering Naybob’s “Elephant Tracks”. So you can't run a regression against the historical time series.

At the same time, the 30 year conventional mortgage yielded 11.26%, up from 8.49% in Jan. 87, & Moody’s 30 year AAA corporate bonds yielded 11.06% on 10/19/87, up from 9.37% in Jan. 87.

The preceding tight monetary policy (monetary policy blunder), i.e., the sharp reduction in legal reserves (mirroring the absolute decline in our means-of-payment money), had effectively forced all rates up along the yield curve in the short-run (when inflation and R-gDp were already markedly subsiding). I.e., interest is the price of loan funds, the price of money is the reciprocal of the price level.

Note: interest rates may either rise or fall during the short-run, in response to the FOMC tightening policy, depending upon the “arrow of time”, and the monetary fulcrum (the thrust of inflation).

On 10/19/87 the CBs had to scramble for reserves (too stringently supplied relative to demand) at the end of their maintenance period (bank squaring day), to support their loans-deposits (it is noteworthy that contemporaneous reserve requirements were then in effect exacerbating the shortfall & response time).

A significant number of banks, with large reserve deficiencies, tried to settle their legal reserve maintenance contractual obligations at the last moment. But the FRB-NY’s “trading desk” failed to accommodate the liquidity needs in the money market – until it was already way too late (i.e., ignored their perversely coveted interest rate transmission mechanism).

I.e., it was a major monetary policy blunder by the Maestro, Chairman Alan Greenspan. And economists don’t talk about what the ABA doesn’t want them to. See - Sent: Thu 11/16/06 9:55 AM “Spencer, this in an interesting idea. Since no one in the Fed tracks reserves (because the ABA and stupid economists want to eliminate them)…” and “Today, with bank reserves largely driven by bank payments (debits), your views on bank debits and legal reserves sound right!” – Dr. Richard G. Anderson

Oh wait, wasn’t the crash blamed on programmed trading (reflecting academic censorship and fake news). Rewriting history, the Fed covers its “elephant tracks”.