Tuesday, September 30, 2008

Financial Markets, Part 1

The Dow Jones Industrial Average fell 777 points yesterday, the largest one-day point drop in history. Is it time to worry yet?

Let's review some recent events:

Weekend of Sept. 6-7: The government took over Fannie Mae and Freddie Mac.

Weekend of Sept. 13-14: The government allowed Lehman Brothers to fail. Bank of America bought Merrill Lynch in a fire sale. At the beginning of the year there were five investment banks on Wall Street: Bear Stearns (acquired by J.P. Morgan Chase in March in a forced sale), Lehman Brothers, Merrill Lynch, Morgan Stanley and Goldman Sachs. Only two were left after this weekend.

Week of Sept. 15-19: The government took over AIG. One institutional money money fund "broke the buck." Another institutional money market fund closed and started to liquidate itself. The government announced that it was working on a plan, of a size not yet determined, and subject to Congressional negotiation and approval, to shore up financial markets.

Weekend of Sept. 20-21: The size of the government bailout plan was announced at $700 billion. Negotiations began with Congress. The last two investment banks on Wall Street (Goldman Sachs and Morgan Stanley) agreed to become commercial banks, subject to regulation by the Federal Reserve. The investment banking model died.

Week of Sept. 22-26: Washington Mutual (WaMu) failed in the largest bank failure in U.S. history (assets of about $300 billion). Its assets were sold to J.P. Morgan Chase. Negotiations continued on the $700 billion plan.

Weekend of Sept. 27-28: Citigroup bought Wachovia in a forced transaction. Negotiations were finalized on the $700 billion plan.

Monday, Sept. 29: The U.S. House of Representatives voted down the $700 billion plan by a vote of 205-228. The DJIA dropped 777 points (7%).

While yesterday's decline was the largest one-day point decline in history, it was not the largest one-day percentage decline. I think that record goes back to 1914 [see correction below], but to keep to more recent times, on Oct. 19, 1987, Black Monday, the DJIA dropped 23%. I remember that day and week. I had been controller of Champlain Valley Farm Credit for a little over a year. Both the economy and Farm Credit survived that crisis just fine.

What about time periods longer than one day? On Friday, Sept. 5, just before the timeline above, the DJIA closed at 11,221. It closed yesterday at 10,365. So although the DJIA dropped 7% yesterday, it is down only slightly more (856 points or 8%) for the tumultuous period described above.

The DJIA is now 27% below its all-time high of 14,165 reached just under a year ago on 10/09/07. It may fall further. We are certainly in a bear market (generally defined as a decline of 20% or more). We have survived bear markets before. In the stock market downturn of 2002, the DJIA fell 31%. In the stock market crash of 1973-4 the DJIA fell 45%. We are a long ways from the Great Depression, when the DJIA fell 89% from 1929 to 1932.

This post is part 1 of 2. Click here for part 2.

CORRECTION 10/01/08: The worst one-day percentage decline for the DJIA was not in 1914 as stated above. It was 10/19/87. Clarification here.

UPDATE 10/03/08: Wachovia is now being acquired by Wells Fargo instead of Citigroup. WSJ article. Wells Fargo news release. Federal Reserve news release. Citigroup news release.