The fault, dear market, is close to home
AS the stock market settles down from the panic that seized it on ``Black Monday'' and the days immediately following, it is possible to take a calmer survey of what went wrong and why. Several formal inquiries are already under way, and we will need their reports to reach satisfactory final conclusions. It is already evident, though, that much of the early assessment was wide of the mark. It really isn't surprising that many market analysts, money managers, financial advisers, and brokers whose judgments and actions have such enormous influence on the stock market's behavior would in bad times seek to deflect criticism from themselves. It is at least a bit surprising, however, that such obviously self-serving and inherently implausible efforts were given credence in the press and political circles at the time of the crash. We were told repeatedly that blame rested with President Reagan and Congress, and that ``they had better get down to business and start sending the market the needed signals.'' The market's ``nerves'' were on edge and had to be soothed. Responsibility was attributed to the federal budget deficit, to the international balance-of-payments deficit, to interest rates, and to all of these forces in complex admixtures that finally eroded investors' confidence.
The argument that the federal deficit or some other external political/economic factors were substantially responsible for the stock crash was on its face absurd. Over the two-month span between Aug. 27 and Oct. 27, the Dow Jones industrial average fell about 850 points, losing one-third of its value. From Oct. 14 through Oct. 27 alone, the Dow's drop exceeded 650 points, a free fall that included Black Monday's record decline of 508 points. In the preceding months - the last dash of the Great Bull Market - stock prices had, of course, been moving feverishly upward. No set of economic developments or news during this span could plausibly be construed as an ``objective'' source of such market behavior.
Any $4.5 trillion economy is likely to have some problems. Ours certainly does. But arguing that it was economic performance which includes high job creation, falling unemployment, sustained real GNP growth that reached a 3.8 percent rate in the third quarter of 1987, moderate inflation, high consumer confidence, and budget deficits declining from 6.1 percent of GNP in 1983 to 3.3 percent in FY '87 made the stock market fall like a stone is not helpful. It takes attention away from the actual sources of the market's unsettling volatility.
One of the sources is the judgment of the gaggle of analysts, brokers, and others who shape the stock market. If economic conditions such as the deficit were responsible for the market's crash, why didn't the preponderance of commentary alert investors a year or so ago, before the bull charged to such dizzying heights. Instead, of course, many analysts proclaimed the likelihood of the Dow's reaching 3,000 or even 3,500. ``Caveat emptor'' is always good advice to individual investors. This doesn't remove the bad judgment of the professional traders who, in the words of New York Stock Exchange chairman John J. Phelan Jr., got ``overenthusiastic on the upside and frightened on the downside.''
It is the market professionals, not the public, who have displayed erratic judgment. Polls taken since the unfortunate events of Oct. 16 have without exception shown Americans responding temperately. The public clearly does not believe that the fundamentals of United States economic performance have changed very much over the past year.
Deficiencies in institutional arrangements, as well as of judgment, underlie the market's crash and general erraticism. Attention is now focused on the impact of computerized stock futures trading. Chairman Phelan, who has been far ahead of his colleagues in recognizing the internal problems, also contends that ``the markets were too leveraged, and they are still too leveraged. There's too much credit.'' Heavy leveraging ``works terrific going up, but terrible going down.'' More generally, Mr. Phelan maintains, ``the markets are not [i.e., should not be] for individual professionals to make money in.'' As the markets have become an arena for ever more elaborate short-term trading games by market professionals, with the result of increased interday and even intraday volatility, ``their credibility'' is ruined, Phelan says.
What is worse, market mechanisms and practices that encourage volatility - when very little is changing in the larger economy - needlessly, rashly, discombobulate millions of citizens who must, once again, doubt the wisdom of their institutional leaders. This volatility needs to be minimized through some judicious mix of self-policing and governmental regulation.
Everett Carll Ladd is executive director of the Roper Center for Public Opinion Research and professor of political science at the University of Connecticut.