New ‘trading toys’ no doubt played a role in Black Monday’s market collapse in 1987. But were there sound financial reasons as well?

See Anatomy of a Stock-Market Crash by Burton G. Malkiel. Excerpt:

"After the crash, commissions were formed to examine the causes of the meltdown and offer recommendations. Ms. Henriques cites approvingly the Brady Commission Report, which emphasized the role played by the financial instruments and trading techniques she has described. The commission called for increased margin requirements, on the theory that, if investors had been required to put up more of their own money for securities or future contracts, the market would have been less volatile. It also called for putting financial markets under the scrutiny of a single regulator.

But the Brady Report should not be taken as holy writ. A Chicago Mercantile Exchange study, for example, concluded that the futures market was a net absorber of selling pressure and that increased margin requirements would have restricted buying and made the decline even worse. A single regulator, it was noted, might also limit financial innovation and the development of helpful hedging techniques.

Ms. Henriques dismisses the idea that there were rational causes—as opposed to structural or technical ones—for a dramatic revision of valuation levels on Black Monday. But such causes are worth considering. The market had rallied sharply during the preceding five years: Valuations were stretched. Price-earnings multiples were over 20 at the same time that interest rates were unusually high, having just risen to over 10%. In addition, Congress had threatened to impose a “merger tax” that would have made merger activity prohibitively expensive and could well have ended the merger boom that had inflated stock prices. What is more, James Baker, the Treasury secretary, had recently threatened to encourage a further fall in the price of the dollar, increasing risks for foreign investors and frightening domestic investors as well.

To be sure, portfolio-insurance trades magnified the decline on Black Monday. But markets all over the world declined just as sharply as the U.S. market, and they didn’t have similar futures markets. Moreover, markets remained below their 1987 summer peak for the next two years. It is unsupportable to claim that the institutional structure of the U.S. market and a lack of unified regulation were responsible for the crash."