Book Review: A First-Class Catastrophe

Black Monday (October 19, 1987), when the Dow Jones Industrial Average fell over 22%, was not a black swan event. Although it occurred in the context of heightened geopolitical risk, with Iran hitting two American-owned ships with Silkworm missiles and the United States retaliating by shelling an Iranian oil platform in the Persian Gulf, the potential for a huge market sell-off had been telegraphed day after day in 1987.

Diana B. Henriques, an award-winning financial journalist writing for The New York Times, is the author of The Wizard of Lies (the best-selling book about Bernie Madoff, subsequently made into an HBO movie), Fidelity’s World, The Machinery of Greed, and The White Sharks of Wall Street. In A First-Class Catastrophe: The Road to Black Monday, the Worst Day in Wall Street History (Henry Holt, 2017) she once again lives up to her reputation for careful, exhaustive research and engaging prose.

People (I among them) have often claimed that the financial market is a complex adaptive system. Henriques convincingly shows that, in the run-up to Black Monday, it was complex but not reliably adaptive and certainly not a system. Moreover, she claims, “we are still living in the world revealed to us on Black Monday.” In fact, the factors that led to the 1987 crisis “have become even more deeply embedded in Wall Street’s genetic code.”

Henriques explores multiple areas in which the financial market (and here I include equities, bonds, and derivatives) exhibited the potential for cracks in the 1970s and 1980s, starting with the fractured regulatory agencies. Also contributing to the crisis was the introduction of indexing, initially for pension funds, would give rise to herding; these huge funds were “all likely to shift their assets in the same direction at the same time.” Portfolio insurance, often incorrectly cited as the cause of Black Monday, relied on index arbitrageurs (and there had to be enough of them) to zig when it zagged. Computerization sped up trading and the back office processing of orders but brought with it the inevitable glitches.

Populating these potentially problematic areas were people who were protective of their turf, powerful, and creative—regulators and heads of exchanges, agents for financial behemoths, and innovators. As a result of the extensive interviews the author did with the primary players, we get a sense of how they understood their roles in this calamity.

A First-Class Catastrophe is a first-class book. Perhaps through it we will learn some lessons that were ignored in the wake of Black Monday.