Speech by SEC Chairman:
Remarks at the SEC Historical Society Symposium, ‘Keeping the Markets Open – Lessons Learned From the 1987 Market Break'

by

Chairman Christopher Cox

U.S. Securities and Exchange Commission

SEC Headquarters Office Main Auditorium
Washington, D.C.
November 1, 2007

Thank you, Brandon [Becker, former Director of the Division of Market Regulation; now partner at Wilmer Cutler Pickering Hale & Dorr]. Nineteen eighty-seven was a long time ago. But in the case of my involvement in these events, the final chapter — at least, the epilogue — wasn't written until earlier this year, when a writer of financial fiction named Paul Erdmann died in the wine country of northern California, to little public notice. He'd started his first book from a Swiss jail cell, where he was locked up on charges of illegal speculation in the futures markets. As a novelist, he eventually became one of the great doomsday forecasters — and in one of those quirks of history that turn out to be consequential, his bestseller "The Crash of '79" became vacation reading for the then-recently retired Senate Majority Leader, Howard Baker.

Just over two years into retirement, Senator Baker got an unexpected call from President Reagan, asking him to replace Don Regan as Chief of Staff. As you know, he said yes — and as part of the package, he brought with him his trusted lawyer, A.B. Culvahouse, who would become the new Counsel to the President and my new boss. Shortly after Senator Baker came aboard, he met with me in the West Wing to talk about what I was working on, and some of the issues he'd like me to address. In particular, he mentioned that he'd recently read a novel on vacation in which the President used a variety of emergency powers to try to stave off global financial collapse. He wanted to know whether, in real life, the President had powers such as those described in "The Crash of '79", and whether a White House contingency plan existed for dealing with a meltdown in the markets. Out of that conversation grew a project. I was asked to write a detailed memo describing the various emergency powers the President might exercise in a market crisis.

This was in February of 1987. Fast forward to October of that year, when the stock market began what would become the largest one-day percentage drop in history. And the problems didn't end on Monday. The following day, when the market dropped again, there was an emergency meeting in the Chief of Staff's office. I was summoned there because of the memo I'd written. The meeting was notable not only for its urgency and importance, but also for who wasn't there. There were only about a half dozen of us, including the new Press Secretary, Marlin Fitzwater, but we were missing some of the obvious financial heavyweights that you'd expect to see at a time like this — for example, Beryl Sprinkel, who was President Reagan's chief economist. As is always the case in real-life emergencies, people aren't always where you would like them to be. And of course, 20 years ago, being physically present was far more important than it is today, when we all carry sophisticated telecommunications equipment in our pockets.

In the midst of this White House strategy session in the Chief of Staff's office, the phone rang. Senator Baker got up from the table and answered it, but he said so little that one couldn't infer from the White House end of the phone conversation to whom he was speaking, or what had been discussed.

When he came back to the table, he announced that he had just spoken with John Phelan, the head of the New York Stock Exchange. Phelan was simply making a courtesy call to inform us that he had decided to close the New York Stock Exchange. That news hung over the table like a clammy fog, but no one said anything. By that point in my career, I'd been a lawyer for 10 years and a securities partner with a major law firm, and I was used to giving advice. But this seemed like it should be someone else's portfolio. Nonetheless, the silence continued, and so even though I was the lawyer in the group, I could no longer contain myself and asked of Senator Baker, "You're not going to let them do that, are you?"

He asked me what I thought would go wrong if the NYSE closed, and I ticked off the most important things I could think of on the fly: that closing the market would be seen as a threat to the liquidity of equities, and would cause even more panic selling in other markets; that it would eliminate the opportunity for the market to self-correct, and for bargain hunters to move in to buy stocks on the cheap; and that it would raise dicey and novel questions, such as at what price trading in a particular security should reopen.

He asked me on what authority he could insist that the market stay open. I answered that he should simply tell the exchange that the President of the United States didn't want the market to close.

So Senator Baker got back on the phone, and obviously, the message had an impact. We now also know that the White House wasn't the only source dispensing this advice.

There's a further ironic connection between Senator Baker's coming aboard in 1987 and the events that we're recounting today. A.B. Culvahouse, the lawyer that Senator Baker brought with him to the White House, was a securities practitioner like me. (Today he's the Chair of O'Melveny & Myers.) Shortly after the two of them came aboard, there was a vacancy in the chairmanship of the SEC. Senator Baker naturally looked to A.B. for advice, and in turn A.B. assigned me to work on the project, because I had the finance portfolio in the Counsel's Office. I offered up a suggestion of a securities law scholar whose work had very much impressed me when years earlier as a law review editor I was writing on Rule 10b-5 — and that was of course Professor David Ruder, who was not only selected by President Reagan to be Chairman, but also was in the captain's chair for the market collapse of '87. The nation couldn't have had a finer leader during that time of crisis.

Just as was the case for many of today's panelists, October 19 was a beginning, not an end, for me. President Reagan decided to create a task force to investigate the causes of the market collapse, and make recommendations. He decided upon former Senator Nick Brady as chairman, and selected an executive director whom I'd known previously because he was my Department Chairman when I was on the faculty at Harvard Business School, Bob Glauber. And Bob chose for his deputy another of my finance colleagues from the HBS faculty, David Mullins. When I brought the task force members along with Bob and David in to meet the President, I started on a new project of serving as lawyer to the Brady Commission — beginning with writing Executive Order 12614 for the President's signature.

The Presidential Task Force on Market Mechanisms commenced work on November 5, 1987, and spent two months studying what went wrong. Their recommendations led to, among other things, the now-familiar circuit breakers. Their autopsy also included some valuable information that I took with me to Congress. It highlighted index arbitrage and other structural flaws and anomalies as the real culprits, but in the same way that the Great Chicago Fire is blamed on Mrs. O'Leary's cow, the Brady Commission ultimately traced the events of Black Monday to selling pressure that started during the period from October 14 to 16, when the Dow fell by over 250 points. The selling, they said, was triggered primarily by two proximate causes: disappointingly poor merchandise trade figures, and the filing of anti-takeover tax legislation, which caused risk arbitragers to sell stocks of takeover candidates, resulting in their precipitate decline and a general ripple effect throughout the market. In later years, whenever my colleagues in Congress would tell me — as Dan Rostenkowski once did — that the market doesn't pay any attention to the bills we introduce, I'd remind them of this story.

http://www.sec.gov/news/speech/2007/spch110107cc.htm