their ten-dollar bills. So it was with the stock market in 1987, after five continuous years of giddy ascent. John Kenneth Galbraith, the grand old man of American Keynesianism, can probably claim the credit for being the first observer to state what should have been obvious: that Wall Street prices no longer had any relation to actual economic conditions. Writing in the January 1987 issue of the Atlantic Monthly, he argued that the market was now driven solely by ‘a speculative dynamic – of people and institutions drawn by the market rise to the thought that it would go up more, that they could rise up and get out in time’. It had happened before, in the months preceding the Great Crash of 1929, and as the historian of that disaster Galbraith was struck by several other parallels – most notably the faith in seemingly imaginative, currently lucrative but ultimately disastrous innovations in financial structures. ‘In the months and years prior to the 1929 crash there was a wondrous proliferation of holding companies and investment trusts. The common feature of both the holding companies and the trusts was that they conducted no practical operations; they existed to hold stock in other companies, and these companies frequently existed to hold stock in yet other companies.’ The beauty of this exaggerated leverage was that any increase in the earnings of the ultimate company would flow back with geometric force to the originating company, because along the way the debt and preferred stock in the intermediate companies held by the public extracted only their fixed contractual share. The problem, however, was that any fall in earnings and values would work just as powerfully in reverse, as it duly did in October 1929. Nearly sixty years on, Galbraith wrote, leverage had been rediscovered and was again working its magic in a wave of corporate mergers and acquisitions, and in the bank loans and bond issues arranged to finance these operations.
The Atlantic magazine was the perfect pulpit from which to deliver such a sermon. Three years after the 1929 débâcle it had published the following mea culpa, written by an anonymous denizen of Wall Street, which now reads like a pretty accurate history of the 1980s as well:
In these latter days, since the downfall, I know that there will be much talk of corruption and dishonesty. But I can testify that our trouble was not that. Rather, we were undone by our own extravagant folly, and our delusions of grandeur. The gods were waiting to destroy us, and first they infected us with a peculiar and virulent sort of madness.
Already, as I try to recall those times, I cannot quite shake off the feel that they were pages torn from the Arabian Nights. But they were not. The tinseled scenes through which I moved were real. The madcap events actually happened – not once, but every day. And at the moment nobody thought them in the least extraordinary. For that was the New Era. In it we felt ourselves the gods and the demigods. The old laws of economics were for mortals, but not for us. With us, anything was possible. The sky was the limit.
It is a familiar delusion, the conviction that one has repealed the laws of financial gravity. (Even Isaac Newton, the man who discovered physical gravity, succumbed. ‘I can calculate the motions of the heavenly bodies, but not the madness of people,’ he said, selling his South Sea Company stock for a handsome profit in April 1720 before the bubble burst; but a few months later he re-entered the market at the top and lost £20,000.) Writing of a Wall Street boom at the very beginning of the twentieth century, Alexander Dana Noyes recalled that the market ‘based its ideas and conduct on the assumption that we were living in a New Era; that old rules and principles and precedents of finance were obsolete; that things could safely be done today which had been dangerous or impossible in the past’. Days before the crash of October 1929, the Yale economist Irving Fisher (himself an active share-buyer) pronounced that ‘stock prices have reached what looks like a permanently high plateau’.
All the familiar portents of disaster – swaggering hubris, speculative dementia, insupportable debt – were evident by 1987. ‘At some point something – no one can ever know when or quite what – will trigger a decision by some to get out,’ Galbraith predicted. ‘The initial fall will persuade others that the time has come, and then yet others, and then the greater fall will come. Once the purely speculative element has been built into the structure, the eventual result is, to repeat, inevitable.’ He added, however, that there was a compelling vested interest in prolonging financial insanity, and anyone who questioned its rationale could expect rough treatment from the spivs organising the three-card trick, just as the eminent banker Paul Warburg had been accused of ‘sandbagging American prosperity’ when he suggested in March 1929 that the orgy of ‘unrestrained speculation’ would soon end in tears. Galbraith’s own article in the Atlantic had originally been commissioned by the New York Times but was spiked because the editors found it ‘too alarming’.
Its eventual publication did nothing to puncture Wall Street’s exuberance, at least for a while. (‘Galbraith doesn’t like to see people making money’ was a typical reaction.) On 8 January 1987, a few days after the professor’s gloomy New Year message, traders on the floor of the stock exchange were cheering and hurling confetti in the air as the Dow Jones industrial average broke through the 2,000 level for the first time. ‘Why is the market so high when the economy continues to be so lacklustre?’ Time magazine wondered. ‘Considering such questions mere quibbles, many optimistic analysts are convinced that the crashing of the 2000 barrier is the start of another major market upsurge that might last anywhere from two to five years.’ By the end of August the Dow had climbed to 2,722.42, the fifty-fifth record high achieved that year. Employing a system known as Elliott Wave Theory, the Wall Street guru Robert Prechter calculated that it would gain another thousand points in the next twelve months. Others put their trust in the so-called Super Bowl Theory, which held that the stock market always rose when a team from the original National Football League won the championship. And why not? The theory had been vindicated in eighteen of the previous twenty years, a more impressive success rate than conventional forecasting methods.
Against the madness of crowds, Friedrich von Schiller once wrote, the very gods themselves contend in vain. What hope was there for mere mortals wishing to understand the logic of a bull market that seemed unaffected by sluggish economic growth and a decline in business earnings? To quote Galbraith again:
Ever since the Compagnie d’Occident of John Law (which was formed to search for the highly exiguous gold deposits of Louisiana); since the wonderful exfoliation of enterprises of the South Sea Bubble; since the outbreak of investment enthusiasm in Britain in the 1820s (a company ‘to drain the Red Sea with a view to recovering the treasure abandoned by the Egyptians after the crossing of the Jews’); and on down to the 1929 investment trusts, the offshore funds and Bernard Cornfeld, and yet on to Penn Square and the Latin American loans – nothing has been more remarkable than the susceptibility of the investing public to financial illusion and the like-mindedness of the most reputable of bankers, investment bankers, brokers, and free-lance financial geniuses. Nor is the reason far to seek. Nothing so gives the illusion of intelligence as personal association with large sums of money.
It is, alas, an illusion.
During the South Sea Bubble of 1720 investors hurled their money into any new venture, however weird its prospectus: ‘For extracting of Silver from Lead’; ‘For trading in Human Hair’; ‘For a Wheel of Perpetual Motion’; and, most gloriously, ‘a Company for carrying on an Undertaking of Great Advantage, but Nobody to know what it is’. Similarly, some of Wall Street’s best-performing stocks in 1987 were enterprises that had neither profits nor products – obscure drug firms which were rumoured to have a cure for AIDS, or AT&E Corp, which claimed to be developing a wristwatch-based paging system. ‘The thing could trade anywhere – up to 30 times earnings,’ a leading analyst, Evelyn Geller, said of AT&E. ‘So you’re talking about $1,000 a share. You can’t put a price on this – you can’t. You don’t know where it is going to go. You are buying a dream, a dream that is being realised.’ AT&E soon went out of business, its dream still unrealised, but Geller’s rapturous illusion shows how the market was kept afloat at a time when any rational passenger should have been racing for the lifeboats.
By the second week in October, a few dents were appearing in the hitherto impregnable dreadnought. Some blamed a spate of investigations by the Securities and Exchange Commission into Wall Street’s biggest names – Drexel Burnham Lambert, Goldman Sachs, Kidder Peabody – following the arrest of Ivan Boesky. Others