The most remarkable thing about the spectacular sharemarket crash of 1987 was how little actually broke. The economic impact of the colossal 25 per cent one-day fall in the sharemarket — much bigger than the 1929 crash, which wreaked havoc — had little impact on the Australian economy.
“With benefit of hindsight it was a much smaller event than it appeared at the time,” says former Reserve Bank governor Ian Macfarlane. “The Reserve Bank didn’t react much at all,” he adds, dispelling the misconception the economy powered on because of RBA interest rate cuts.
In the space of a few weeks in late 1987 the benchmark All Ordinaries index collapsed 50 per cent — almost unimaginable now, when a 3 per cent drop is front page news — reversing the surge earlier in the year.
“The market has gone beyond all reason,” said the flamboyant late stock picker Rene Rivkin in March 1987.
Yet the economy grew a whopping 2 per cent in the final three months of that year, slowing a little into the bicentennial year before accelerating in 1989.
The crash was the end, or at least the beginning of the end, for a colourful array of entrepreneurs like Bond and Skase, but more Australians got jobs: between October and February 1988 the unemployment rate steadily fell from 8.1 per cent to 7.4 per cent.
Why? The 1987 crash, unlike those in 1929 and 2008, didn’t implicate or reflect problems in the banking system, which is typically exposed to real estate, not corporations.
The real economy was insulated. “No one was forced to sell to repay loans; forced selling is the problem,” Macfarlane says. “If we had a big fall today, which could easily happen, say 5 per cent or 10 per cent, investors would just grin and bear it.”
The hankering for “financial stability” that has motivated officials in the wake of the global financial crisis — a strange goal for a supposedly capitalist society? — is at odds with the main lesson of the 1987 crash. That is, financial volatility is tolerable, even beneficial, as long as it’s animated by individuals using their own money. Few people or institutions borrow to buy shares; so when they lose money, others aren’t potentially sent broke too.
Financial deregulation in the 1980s fuelled irrational exuberance in Australia’s boardrooms late in the decade. Loans to businesses as a share of GDP surged from a little over 30 per cent in 1983 to more than 55 per cent by 1987. Corporate gearing, the ratio of debt to equity of non-financial firms, roughly doubled to 100 per cent by 1988.
But even that level of gearing — about $1 of debt for every $1 of equity — still provided a buffer to absorb losses and insulate lenders, apart from a few spectacular examples. As for the shareholders, they were typically better off and could afford to lose without cutting their spending.
The 87 crash also maimed the so-called “efficient markets hypothesis”, the then-new idea that markets only respond to new information and then incorporate it rationally into prices.
“The EMH says asset prices only move in receipt of new info, but here we had possibly the biggest single movement ever that occurred absent of any obvious event,” Macfarlane says.
To keen contemporary observers, the 1987 crash revealed the fundamental reason for the much larger GFC 25 years later. (Curiously, the West Australian government sought to rescue the relatively small investment bank, Rothwells — a curious use of public funds.) The readiness of governments to bail out financial institutions was the fundamental reason why the financial crisis occurred.
A 1987-style crash is less likely today. The worst one-day drop in the ASX 200 was about 8 per cent in late 2008. The market has become broader, bigger and more stable. “In parts of the 1980s, over half of the market by value was resources, compared to less than a fifth now,” says Tim Baker, an equity analyst at Deutsche Bank. Share prices, at about 15 times earnings, aren’t too stretched either, based on traditional ratios of price to earnings, he says.
Resources stocks swing wildly with commodity prices and discoveries. The portion of the market owned by households has halved to about 12 per cent. Meanwhile the share owned by super funds, which hold shares for the long term, has doubled to 27 per cent.
Listed companies’ gearing ratios are about 50 per cent today on average, while their debt servicing costs have fallen to about 8 per cent, down from above 30 per cent in the late 1980s.
While the sharemarket crash itself was relatively harmless, the collapse in commercial property prices a few years later — values in Sydney, Melbourne and Perth roughly halved — was devastating, almost causing the collapse of one of Australia’s largest banks and culminating in the 1991 recession.
An economic crisis today is more likely to be precipitated by a slump in housing, not share prices. Australian households, and through them the banks, are very exposed to property values. Home owners and (especially) banks are highly leveraged, too, which makes any fall in prices potentially more damaging.
Scott Morrison is confident the fundamentals are strong. “While Australia’s housing markets, especially in our largest cities, have experienced strong growth over the past decade, this of itself is not evidence of an underlying weakness in housing asset values nor that a hard landing for our housing markets is ahead,” the Treasurer said this week. “On average, Australian households have five times assets coverage over the value of their debts.”
We have to hope he’s right.