BUFFETT - Aug 22,08 with CNBC (3 hrs)

TRANSCRIPT/VIDEO PART ONE: Three Hours With Warren Buffett - Live From Omaha - Courtsey CNBC.com
Posted By:Alex Crippen
Topics:Warren Buffett
Companies:Berkshire Hathaway Inc.

THIS IS PART ONE OF "THREE HOURS WITH WARREN BUFFETT - LIVE FROM OMAHA" ON CNBC'S SQUAWK BOX WITH BECKY QUICK, FRIDAY, AUGUST 22, 2008.
IT IS AN UNEDITED TRANSCRIPT AS PROVIDED BY BURRELLESLUCE.
BECKY QUICK: Good morning, everybody and welcome to SQUAWK BOX right here on CNBC. This morning we have quite a show in store for you coming up today. As you probably know, our special guest for the next three hours is a man who needs no introduction. We are talking about Warren Buffett. And, Warren, good morning. Thank you for joining us this morning.
WARREN BUFFETT (Berkshire Hathaway Chairman & CEO): Yeah, early morning, right.
QUICK: Very early morning. You've only had a couple of complaints about that, right?
BUFFETT: No, I try not to complain too much.
QUICK: Well, good morning. Thank you for joining us today. We have an awful lot to talk about this morning. Also, this is a worldwide, around-the-world show this morning. From the world's most famous investor, we're being--going to be going to the world's most celebrated athletes. Carl, you know, the Summer Games are coming to a close. You've been there covering the whole thing and what are your feelings as we get to this final end of the entire Olympic Games?
CARL QUINTANILLA, co-anchor (Beijing): I was just going to say, Becky, this has got to be the first ever broadcast of split anchor Beijing-Omaha show in the history of television. We've got a lot going on here. We've had--we've had pretty good success, the Americans winning gold in soccer, beach volleyball, going for the gold in volleyball. We'll bring you up to speed on all the Olympic action. But as we're closing down here, into the closing ceremony on Sunday night, we're just beginning an amazing three hours with Warren. Warren, it's great to have you.
BUFFETT: Nice to be here.
QUICK: You know, we were--we were joking about that this morning with Ross that we are now trying to make SQUAWK look just like "World Wide Exchange." We're going to be picking new places around the globe and doing this from time to time. Right, Carl?
QUINTANILLA: That's--exactly. And if the satellite delay gets any worse, we could have entire blocks of the show in which we're just waiting for the other to respond.
QUICK: All right. That sounds perfect. You know, Carl, we're going to check back in with you in just a few minutes because we have a lot of things about the Olympics to talk about with Warren Buffett as well, everything from Coca-Cola to sponsorships. But, folks, we are in Omaha today because last night there was a groundbreaking event in the world of finance and politics that took place right here. It was the world premiere of a documentary called "I.O.U.S.A." Now, the film takes a look at what it says are America's four key deficits. It explores the risks to the future of this country and of its citizens. And, Warren, you were in the documentary, so let's take a look at one of the clips from that right now.
BUFFETT: Yes.
(Clip of "I.O.U.S.A." courtesy Roadside Attractions)
QUICK: The film premiered on hundreds of movie screens across the country last night, including right here in Omaha. After the debut, I got the chance to moderate a town hall meeting with the men who were behind the movie, Blackstone's Pete Peterson and former US Comptroller General David Walker. Warren, this was a discussion with five of the brightest minds of people who are looking out there at the economy, and there is some debate as to how big of a problem this is.
BUFFETT: Yeah. There was a debate last night as a matter of fact.
QUICK: Right.
BUFFETT: And the film takes the position pretty universally throughout the film that it's an enormous problem, and I probably represented the group that thinks this is quite a bit less of a problem than the film portrayed. But I admire the people that did it in that there's so little thinking done beyond the next electoral event that there are important policy matters that do extend way out into the future and--whether it's energy, whether it's the question of weapons of mass destruction, certainly in terms of fiscal policies. So I admire the fact they tackled the subject. I don't--I don't agree with many of the conclusions in the movie.
QUICK: But we did have a huge discussion on this last night. And, in fact, we'll be joined by both Pete Peterson and Dave Walker a little later this morning to talk more about what they see happening in the economy, and it's something we're going to be talking about throughout the morning. So again, Warren, we're thrilled to have you here this morning for three hours, and we do have a lot to talk about today. One of the things we'd like to get straight to, though, is what you see happening in the economy right now. We've been talking to you for some time about what you see as some significant problems in the economy. And, from your perspective, have things gotten any better? Have they gotten any worse?
BUFFETT: No, they've rippled out some, and that's what you'd expect. So the excesses in credit, the deleveraging that was required, the weak credits that are exposed, all that is--we're seeing manifestations out as the ripples go out, and I think I said one time that, you know, you only find out who's been swimming naked when the tide goes out. Well, we found out that Wall Street has been kind of a nudist beach. There's--it's just one discovery after another of firms that either didn't know what they were doing or that did things that they shouldn't have knowingly. And all of the troubles have not been revealed the first time around, usually, so there's considerable disillusionment that's set in in terms of are these guys telling us the truth now or maybe they just don't know what the truth is. So all of that's having an effect, and what we're seeing in business, in our retail businesses...
QUICK: Mm-hmm.
BUFFETT: ...certainly, anything to do with housing is even a further slowing down. I mean, June and July, both in terms of credit experience with people that first got into trouble of house payments and now on credit card payments and so on. And retail trade, it's not over by a long shot.
QUICK: Does that make you think that things are going to continue to decline over the next, let's say, six months?
BUFFETT: Oh, I think they could easily go beyond that, yeah.
QUICK: What's your prognosis, or what's your best guess or your best estimate of what...
BUFFETT: You never know. I've said in the past it ought to be longer and deeper, and I think it is going to be longer and deeper, but no one knows when--what you do know is that it will turn around. I mean, the country will be doing far better five years from now than it is now, but it won't be, in my judgment, it probably won't be doing better five months from now.
QUICK: You talk about how this has rippled out and it's affecting the consumer at this point. Have the credit markets themselves gotten any better?
BUFFETT: Well, the credit markets have had this situation where periodically it's seemed like they were getting better and then something else comes along. So the bankers feel a little bit better for a while and then something comes along and then they want to deleverage further. They find out they've got more trouble. Right now, for example, they're taking back all these auction rate securities. Well, they don't want to take things out of their balance sheet. So it's just one more problem for them, and you've seen these waves of problems and sometimes they create their own momentum. I mean, if the stock prices go down enough of the banks, then they feel like they can't sell securities. Of course, the extreme example was Freddie Mac was--has sort of been chasing a rabbit down the hill...
QUICK: Right.
BUFFETT: ...and promised they would raise additional money and of course the price of the stock got to the point where it became ridiculous. So troubles feed on themselves.
QUICK: Let's talk about Fannie Mae and Freddie Mac, specifically. These are two stocks that it seems like every time you turn around are touching new low levels. There's a lot of concern out there on the market about these two stocks right now. What's your general take on how they got here and what you think's going to happen next?
BUFFETT: Well, how they got here was they had two businesses, basically.
QUICK: Mm-hmm.
BUFFETT: They insured mortgages on a huge scale, trillions, and then they ran sort of a hedge fund, a carry trade where they bought mortgages and borrowed extensively against them. And because they had really the backing of the United States government--and everybody assumed they had the backing. I assumed it. And the truth is they do have the backing of the United States government in terms of their debt, not in terms of their equity--they were able to borrow without any normal restraints in terms of capital or margin requirements or anything of the sort. They had a by-check from the federal government.
QUICK: Mm-hmm.

BUFFETT: And they also had an added problem in that they had a dual mission. The government expected them to promote housing and the stockholders expected them to raise the earnings substantially every year. And as the years went by, they emphasized the latter more and more. They started talking about "steady Freddie," and Fannie Mae said, `We're going to increase the earnings at 15 percent a year.' Any large financial institution that tells you that sort of thing is giving you a line of baloney. I mean, they may do it for a while, but when they can't do it with operations, they do it with accounting and they cheat. And that's what happened at both those places on a huge, huge scale. And we have this--they're so wound up with national housing policy, that they're a national problem and, with this dual situation, you know, Lincoln said a house divided against itself, you know, must fall. And they existed half-slave, half-free for a long time, and then the motivations became in conflict, and when they got on the 15 percent a year merry-go-round and said, you know, `We're going to deliver earnings up every quarter, and we'll meet them to the penny,' when they can't do it operationally, they do it with accounting.
QUICK: So what happens now? You mentioned that this is all tied up with the national housing situation now. Are they two big to fail, and what does that mean?
BUFFETT: Yeah, they're too big to fail.
QUICK: Yeah.
BUFFETT: So that doesn't mean that the equity can't get wiped out, and it almost has in the stock market, and in practical sense as institutions, they don't have any net worth. I mean, if you look at their obligations and look at the fact they have big deferred tax assets as assets. They would've been gone in any market where the government wasn't behind them long, long ago. But the government is behind them, and they will stay behind them, and people that own insured mortgages or who own their debt, I think--nothing's going to happen to them. The equity and the preferred stock is another question and I think you'll see some action fairly soon. You've already seen it in the fact that the Treasury has made pretty much explicit what was formerly implicit.
QUICK: Do you say that knowing anything? Do you know there's a behind-the-scenes plan?
BUFFETT: No. I don't know. No. They--I'm not getting called on it.
QUICK: OK. You're not getting called on this, but you do...(unintelligible).
BUFFETT: I'm not getting called on that specific aspect of it.
QUICK: All right. Now you're telling me we're warm.
BUFFETT: They're looking--they're looking for help, obviously.
QUICK: Right.
BUFFETT: And the scale of help needed is such that I don't think it can come from the private sector.
QUICK: So there could have been a situation where you've been called in the past and you passed on any involvement?
BUFFETT: Yes. They were looking for--they, obviously, had been looking for money. They say that.
QUICK: Mm-hmm.
BUFFETT: And they were told to look for money and--but even the amount of money they were told to look for would be inadequate. I mean, 5 1/2 billion at Freddie would be, you know, that'd be like taking a spoonful out of the Atlantic to try and save the Titanic.
QUICK: How much to you think they need?
BUFFETT: They need a lot. But to get back to the confidence that they had and all of that, it takes far more now. I mean, an ounce of prevention really is worth a pound of cure.
QUICK: If you imagine where things will go with Fannie and Freddie, and you think about the regulators, where were the regulators for what was happening, and can something like this be prevented from happening again?
BUFFETT: Well, it's really an incredible case study in regulation because something called OFHEO was set up in 1992 by Congress, and the sole job of OFHEO was to watch over Fannie and Freddie, someone to watch over them. And they were there to evaluate the soundness and the accounting and all of that. Two companies were all they had to regulate. OFHEO has over 200 employees now. They have a budget now that's $65 million a year, and all they have to do is look at two companies. I mean, you know, I look at more than two companies.
QUICK: Mm-hmm.
BUFFETT: And they sat there, made reports to the Congress, you can get them on the Internet, every year. And, in fact, they reported to Sarbanes and Oxley every year. And they went--wrote 100 page reports, and they said, `We've looked at these people and their standards are fine and their directors are fine and everything was fine.' And then all of a sudden you had two of the greatest accounting misstatements in history. You had all kinds of management malfeasance, and it all came out. And, of course, the classic thing was that after it all came out, OFHEO wrote a 350--340 page report examining what went wrong, and they blamed the management, they blamed the directors, they blamed the audit committee. They didn't have a word in there about themselves, and they're the ones that 200 people were going to work every day with just two companies to think about. It just shows the problems of regulation.
QUICK: That sounds like an argument against regulation, though. Is that what you're saying?
BUFFETT: It's an argument explaining--it's an argument that managing complex financial institutions where the management wants to deceive you can be very, very difficult. Or even when the management doesn't know what's going on, and--just take Bear Stearns. Bear Stearns had--I read it, anyway--750,000 derivative contracts. Now, you know, I could clone Albert Einstein, you know, and--many, many times and have him work 12-hour days for me and he would not be able to keep track of what's going on in an institution like that. It's--the ones that are too big to fail may be too big to manage, in some cases. And they're particularly difficult to manage if they're promising Wall Street and their investors that they're going to do things that can't be done.
QUICK: You've come out and said derivatives are the weapons of financial mass destruction before. But you use derivatives, too.
BUFFETT: That's right. I don't say they're evil, per se.
QUICK: Yeah.
BUFFETT: I just say that once the genie opened the bottle on those many years ago, that their proliferation, their variation, their inability to be valued and their ability to allow institutions to pile up leverage like the world has never seen can cause great systemic problems. And that doesn't mean, you know--it's like gun powder or water. You can do damage with a lot of things, but these have systemic--they pose systemic risks. And incidentally, the government recognizes this. I mean, you've had a task force working on, you know, what do we do to prevent these things from causing a real problems? But they have caused problems so far. I don't think they're going to cause problems at Berkshire Hathaway. I know every single derivative contract we have. Now, when we bought Gen Re, they had 23,000 plus contracts.
QUICK: Mm-hmm.
BUFFETT: There was no way in the world I can get my mind around that. I mean, if I--if I had spent full time and had all kinds of assistants and everything, I never would've known what was in those contracts. We had one contract that was due in 100 years, so that meant that for 100 years some guy at our place put a mark on it every day and some guy at another place put a mark and they got their bonuses based on it. I mean, that is a system that is guaranteed to cause trouble. And so I got out of the business. It took me four years under benign market conditions, and we lost $400 some million in the process. So they are dangerous things. The ones we put on may be dangerous things, too, but I do know every contract, and I know what my gain-loss arrangement is and nobody else marks them. I mean, I keep track of it.
QUICK: You do it yourself on every one. OK. Warren, we have a lot more to talk about with you this morning. We'd like to get to some of your holdings, more on the economy, but we also are going to take a very quick pause right now for a quick break. When we come back, Carl's going to be joining us again from China and Carl, what's on your mind?
QUINTANILLA: Becky, if that's the A-block, I cannot wait to see the rest of the show. Wow. What--that's great insight from Mr. Buffett from OFHEO to derivatives, you name it. We'll get more from the world's most successful investor and an Olympic update as we head into closing ceremony on Sunday night. Becky's in Omaha, I'm in Beijing. This very special edition of SQUAWK BOX continues in just a moment.
(Announcements)
CONTINUED: WAS THAT BUFFETT IN BEIJING?

RUSSIAN MONEY FRAUDS

This article below is reproduction of investor letters written by a Hedge Fund to its investors. It shows height of corporate raiding which can take place because of government inaction. THANK GOD INDIA is still safer in some sense.

 

 

 

Hermitage Capital Management Limited 

 

Hermitage Capital Management Limited 

Registered Office: St. Martin's House, Le Bordage, St. Peter Port, Guernsey  GY1 4AU, Channel Islands 

Tel +44 (0)20 7440 1777; Fax +44 (0)20 7440 1778 

 

July 23, 2008 

 

 

Dear Hermitage Fund Investor, 

 

We are writing to keep you updated on the administrative harassment we have been 

experiencing in Russia over the last year.  We recently learned a number of new things that 

fully explain what was behind the issues we have been facing.  Sometimes the truth is 

stranger than fiction and the story we tell below will probably be as shocking to you as it was 

to us. 

 

As you may recall from our last letter on April 3rd, an unsuccessful attempt was made to steal 

assets from our three Russian investment vehicles through a sophisticated “corporate identity 

theft.”  The whole story began in June 2007 when our offices (and those of our lawyers) were 

raided by the Moscow Interior Ministry, who seized all the original corporate documents of 

our Russian investment holding companies.  This was done under the guise of a tax 

investigation into withholding tax payments from a managed account belonging to one of our 

clients.  Even though it was confirmed by the Russian Tax Ministry that there were no taxes 

owed, the Moscow Interior Ministry used the spurious tax case as a cover to go on a wide- 

ranging search for assets held in Russia by these three Hermitage investment vehicles. 

  

Simultaneous to the asset search, HSBC (as trustee for the Hermitage Fund) was fraudulently 

wiped off the share registry of our three vehicles and was replaced with a new and unknown 

company called Pluton from Tatarstan.  When we investigated who was behind Pluton, we 

discovered it was 100%-owned by a man named Victor Markelov, who further investigations 

revealed is a 41-year-old convicted murderer from Saratov, Russia.  In order to change 

ownership of a Russian company, one needs to have the original charter, corporate seal and 

certificate of registration of that company.  All of these documents and seals had been taken 

by the Moscow Interior Ministry during the raid on our lawyers’ offices and were in the 

Interior Ministry’s possession when this fraudulent ownership transfer and identity theft took 

place.  

 

At the same time, a number of lawsuits were filed by a tiny shell company called Logos Plus 

in St. Petersburg using forged contracts, which appeared to have been created using the same 

documents that were in the hands of the Moscow Interior Ministry.  The perpetrators then 

sent lawyers that we didn’t appoint and never heard of to the St. Petersburg court to “defend” 

our companies, but instead of defending them, they “fully admitted liability and accepted all 

the claims.”  As a result, the judges in St. Petersburg awarded Logos Plus $376 million of 

damages against our three stolen vehicles. 

 

At first, the perpetrators’ plan appeared to be to get bogus court judgments and then use these 

judgments to seize any assets they found.  Their hope was that the asset searches at HSBC, 

Citigroup, ING and Credit Suisse between June and August 2007 would yield a jackpot of 

assets for the perpetrators to seize.  Unfortunately for them, all our assets had been moved out 

of Russia into safe and lawful jurisdictions a long time before and the perpetrators got 

nothing from us.  After we learned about the whole scheme, we filed a number of criminal 

complaints, and went to court with the proof of the fraudulent claims and were ultimately 

successful in invalidating the St. Petersburg court decisions. 

 

That seemed like it should have been the end of our troubles in Russia, but it wasn’t.  In early 

April we discovered that two new cases identical to those in St. Petersburg had been filed 

against our vehicles late last year in Moscow and Kazan for an additional $903 million.  

Again, lawyers who we had never appointed and never heard of showed up to “defend” our 

companies, and again they admitted full liability and the courts awarded the plaintiffs $903 

million.  What was particularly disturbing about this new discovery were the dates when the 

cases were filed.  They had been filed on October 19th, 2007 in Moscow and October 22nd, 

2007 in Kazan.  This was more than a month after the asset search had yielded no results.  It 

seemed strange and worrying that the perpetrators would continue to be so active filing fake 

cases against our companies when it was clear at this point that they would not be able to 

seize any assets since these companies were empty.  We did further investigations to try to 

understand what their motivation was. 

 

The whole story started to make sense in June this year when we requested information on 

our three stolen companies from the Russian company registration database.  We learned that 

the perpetrators had opened new bank accounts for the three companies in December 2007.  

Two of the vehicles set up accounts at the Universal Savings Bank (“USB”), and the third 

vehicle opened an account at Intercommerz Bank.  Both banks were tiny by any measure. 

USB had total capital of $1.5 million, and Intercommerz had capital of $12 million.  Looking 

more closely at the banks’ disclosure statements on the Russian Central Bank’s website, we 

learned that the aggregate customer deposits increased by 623% at USB and 273% at 

Intercommerz shortly after our stolen companies had opened their accounts.  What was truly 

chilling were the amounts by which the banks’ deposits had increased.  USB’s deposits had 

grown by $97 million and Intercommerz’s by $143 million – roughly the same amounts that 

our vehicles paid in capital gains tax to the Russian government in 2006.  

 

In light of this disturbing coincidence, we dug deeper to see if there was any more detailed 

information about the spike in deposits at the two banks.  Under Russian regulations, all 

banks have to report their top ten borrowers and depositors to the Central Bank on a monthly 

basis, and this information is widely available in Moscow.  We were able to see the reports 

for the two banks and learned that two of our stolen investment vehicles were the largest and 

second largest depositors at USB with a combined $91 million in their accounts, and our 

other stolen vehicle was the largest depositor at Intercommerz with $139 million in its 

account.  The size of each of our stolen vehicles’ deposits was exactly equal to the amount of 

tax it had paid in 2006 to the Russian budget.  

 

The whole story now fell into place.  In short, after the straightforward asset seizure failed 

because our vehicles were empty, the perpetrators set out to steal the taxes that Hermitage 

vehicles had paid in 2006.  How did they do this?  They filed bogus court claims that were 

exactly equal to the 2006 profits of each of the Hermitage vehicles.  Our three companies had 

combined profits of $972 million that year, and the fake court claims from Moscow, Kazan 

and St. Petersburg totaled $972 million.  By burdening our vehicles with these new “claims,” 

we believe the perpetrators went back to the tax authorities and filed amended tax returns 

with additional “losses” that reduced the companies’ profits to zero.  On the basis of the  

restated results, the perpetrators appear to have filed for a refund of all the taxes that the 

Hermitage Fund paid in 2006 ($230 million) and directed it to the newly opened accounts in 

these tiny banks.  With the refund money deposited in the banks, the perpetrators could wire 

it wherever needed, complete the fraud and then cover their tracks.  Indeed, as of the time of 

writing of this letter, USB has filed a liquidation request with the Russian Central Bank and 

once the waiting period is over, it will cease to exist. 

 

So the two-pronged scam worked in one area and failed in another.  The perpetrators weren’t 

able to steal the assets from us based on the fake court claims, but they were able to steal 

$230 million from the Russian government by filing amended tax returns on behalf of our 

stolen companies.  What makes this story even more shocking is that we filed six 255-page 

criminal complaints with the Russian authorities in December last year, one month before the 

tax fraud took place, and they did nothing to stop it.  Two complaints were sent to the 

Russian General Prosecutor, two to the Russian State Investigative Committee and two to the 

Internal Affairs Department of the Interior Ministry.  There was enough information to 

prevent the fraud and indict a number of people behind it if the government had acted.  

 

Instead of doing anything to save the Russian state from this highly sophisticated and 

organized looting, two of our complaints were thrown out immediately; two were returned to 

the same Interior Ministry official we were complaining about (essentially, he was being 

asked to “investigate himself”); and one was thrown out for “lack of any crime committed.”  

Only one complaint was taken seriously.  It was taken up by the Russian State Investigative 

Committee in early February, but before it could get any traction, the case was lowered to the 

South region of the Moscow district of the State Investigative Committee (the lowest level of 

the Committee) and by June, another senior Interior Ministry official whom we had named in 

our complaint had joined the “investigation” team (again, to “investigate himself”).  To this 

day there has been no serious response by the Russian authorities to this massive fraud 

against the Russian state.  

 

As we described in our April letter, the problem of corporate “raiding” is now so endemic in 

Russia that President Medvedev speaks about it as one of the biggest problems faced by 

Russian businesses.  In this case, raiders have taken this problem to a new and absurd 

extreme by “raiding” the Russian state itself and so far getting away with it.  Together with 

HSBC, we will shortly be filing new criminal complaints with the Russian General 

Prosecutor and Russian State Investigative Committee as well as with many law enforcement 

authorities outside of Russia.  It is hard to predict what will happen next in this unfolding and 

unbelievable saga, but as always we will keep you updated on any further developments as 

they arise. 

 

Sincerely, 

 

Hermitage Capital Management  

CROOKS OF AMERICA

ALL HIGH & MIGHTY -- CROOKED

The lords of Enron cooked their books. They overstated their profits by hiding a billion dollars in losses, thus driving up the price of their stock. Their accountants winked at the subterfuge, then shredded the documents. Before it all came crashing down in the largest bankruptcy in history, the executives got rich while their employees and stockholders got screwed.

It's an outrage! It's a scandal! And it is, of course, a time-honored American tradition.

America has a grand and glorious history of stock chicanery. In the early days of our history, stock market skulduggery was a perfectly respectable way to achieve wealth, although not quite as respectable as slave trading or stealing land from the Indians.

Much of America's awesome industrial colossus was built on financial scams. The 19th-century railroad barons considered stock fraud an indispensable business tool, as much a part of their working lives as bribing legislators or hiring Pinkertons to beat the bejesus out of union organizers.

Stock scamming is the kind of crime that attracts people who are well-bred, well-dressed, well-mannered. Financial crooks tend to be respectable, patriotic folks who demonstrate their patriotism by giving large sums of money to America's hardworking politicians, asking nothing in return except perhaps the teensy tiniest little amendment to the tax code.

Some of the greatest names in American history made their fortunes through shameless chicanery—Vanderbilt, Morgan, Rockefeller, Stanford, Gould, Kennedy. But you don't have to be a blue blood to succeed at financial swindling. America is the land of opportunity, a place where a poor Italian immigrant named Charles Ponzi could rise from rags to riches by inventing a scam so beautiful that it still bears his name.

"Really, there is no limit to the cons and swindles that have been seen over the years," says former labor secretary Robert Reich, a connoisseur of big-money scams. "The human mind is capable of inventing very innovative products and services—and also extraordinarily innovative swindles."

The Enron scandal brings back fond memories of the great American scams of yore. Here is a rogue's gallery of America's financial crooks, a small sampling of the scalawags, schemers and scoundrels who have bilked and swindled Americans over the centuries:

Wall Street's First Scandal

In the 1790s, when stocks were sold outdoors on Wall Street, speculator William Duer nearly destroyed the fledgling market.

British-born, Eton-educated, a former member of the Continental Congress and a New York judge, Duer had made his fortune selling supplies to George Washington's army. After the Revolution, Alexander Hamilton appointed him assistant secretary of the treasury, but Duer quit the job when he learned that federal law prohibited Treasury officials from speculating in federal securities.

Free of this inconvenient rule, Duer promptly began using his inside knowledge of the Treasury Department to speculate in bank stocks, using large sums of money borrowed from banks and his rich friends. Meanwhile, an audit of Duer's books at the Treasury Department found $238,000 missing. Hamilton ordered the Treasury to sue Duer for the money.

That caused Duer's financial empire to collapse, which bankrupted many of his creditors, bankers and brokers, which in turn caused a financial panic on Wall Street. While Duer went to debtors' prison, 24 Wall Street brokers met under a buttonwood tree in 1792 to draw up the first rules to regulate trading.

" 'Tis time," Hamilton wrote, "there should be a separation between honest Men & knaves, between respectable Stockbrokers . . . and mere unprincipled gamblers."

"Finding that line of separation," wrote John Steele Gordon in "The Great Game," a history of Wall Street, "has occupied the finest minds of Wall Street and the government ever since, with mixed results at best."

Robber Barons

The Civil War was quite unpleasant for many Americans but it was great for Wall Street.

Many of the era's foremost robber barons—J.P. Morgan, John D. Rockefeller, Andrew Carnegie, Jay Gould—dodged the draft by paying $300 to hire a substitute. This modest investment left them free to spend the war years getting rich instead of getting shot. Many on Wall Street, including Morgan, made a fortune speculating in gold, the price of which rose against the dollar with each defeat of the Union Army. Appalled, President Lincoln announced that he hoped every gold speculator "had his devilish head shot off."

Meanwhile, Morgan was financing a deal to buy 5,000 rifles from an Union Army arsenal in New York for $3.50 apiece, then sell them to the Union Army in Virginia for $22 each. The rifles were defective—causing soldiers to shoot their thumbs off—but a judge ruled the deal legal. Morgan earned a 25 percent commission, plus interest.

But those profits were peanuts compared with the money made in the railroad business after the war.

In the 1860s, the federal government subsidized the building of a transcontinental railroad by granting millions of acres of free land to two railroad companies, the Union Pacific and the Southern Pacific. Eager to line their pockets at the expense of their stockholders, Union Pacific management formed a dummy construction company with an impressive-sounding French name, Credit Mobilier, and hired Rep. Oakes Ames as president. Credit Mobilier charged Union Pacific about $100 million to build the railroad—nearly twice what the job actually cost. The rest of the money went to Credit Mobilier's stockholders, a group that included many of Ames's congressional cronies and Vice President Schuyler Colfax, who had been bribed with cheap stock to look the other way.

There were congressional hearings and angry editorials and a federal lawsuit, but ultimately the scammers of Credit Mobilier went free, considerably richer for their very modest labors.

Fleecing the Commodore

The most colorful stock swindle in American history came in 1868, when Commodore Cornelius Vanderbilt, proprietor of the New York Central Railroad, attempted to take over the rival Erie Railroad, which was controlled by three of the most crooked rascals ever to sell stock—Daniel Drew, Jay Gould and Jim Fisk.

Vanderbilt, one of America's richest men, instructed his brokers to buy every Erie share they could find. Drew, who was Erie's treasurer, responded by printing up more Erie shares—tens of thousands more. Peeved, Vanderbilt prevailed upon a judge he had on his payroll to issue an injunction forbidding Erie to issue any more stock. Drew responded by getting a judge who was on hispayroll to order Erie to keep printing stock.

"If this printing press don't break down," said the flamboyant Fisk, "I'll be damned if I don't give the old hog all he wants of Erie."

When Vanderbilt's judge issued a warrant for the arrest of Drew, Fisk and Gould, the trio fled across the Hudson River to New Jersey with $7 million of Vanderbilt's money. They took up residence in a Jersey City hotel and hired cops armed with cannons to protect them from arrest.

Next, the battle shifted to the legislatures of New York and New Jersey, where agents for each side generously spread around bribe money, hoping for favorable legislation. Gould himself appeared in Albany, carrying a trunk that was, the New York Herald reported, "stuffed with thousand-dollar bills which are to be used for some mysterious purpose in connection with legislation."

Ultimately, Vanderbilt failed to take over the Erie. But he wasn't hurt too badly: He managed to unload his 100,000 Erie shares in London. The real losers in the affair were Erie's other stockholders, who saw the value of their shares diluted by nearly half.

Ponzi's Scheme

Charles Ponzi came to America around the turn of the 20th century, a poor Italian lad armed with nothing but a dream and a devious mind.

He started out with small swindles that didn't always pay off—he was jailed in Atlanta and Montreal—but he refused to give up his dream.

In Boston in 1919, Ponzi founded the presciently named Securities and Exchange Co. and guaranteed investors a 50 percent profit in 45 days. And he kept that promise—for a while. The first investors were paid with money obtained from later investors. Thrilled, they touted Ponzi's magic to their friends. By the summer of 1920, Ponzi was taking in $250,000 a day—so much cash that he was stashing it in desk drawers, file cabinets, even wastepaper baskets.

He bought hundreds of suits, a dozen gold-handled canes, a limousine and a 20-room mansion in the tony Boston suburb of Lexington. He should have taken the money and run. He couldn't keep paying early investors with the money from later investors, particularly since he wasn't actually investing the money. The Boston Post unmasked his scam and he spent a decade in jail.

On his way to prison, a reporter asked him to explain his actions, saying that the public deserved an explanation.

"The public deserves exactly what it gets," Ponzi replied. "No more, no less."

Master of Hounds

After the stock market crashed in 1929, Congress investigated Wall Street, exposing countless instances of chicanery, skulduggery and plain old fraud. Liberals called for the creation of a federal agency—the Securities and Exchange Commission—to regulate and police the market.

Richard Whitney, president of the New York Stock Exchange, disagreed. Whitney told Congress that the stock exchange could police itself without any interference from meddlesome bureaucrats.

Alas, Whitney proved to be an imperfect spokesman for his message. Despite his impressive Establishment credentials—Groton, Harvard, master of hounds at the prestigious Essex fox hunt—Whitney was as crooked as a pretzel. He formed a company to produce an apple liquor called Jersey Lightning but the hooch didn't sell and the company's stock tanked. So Whitney started stealing. First he stole $150,200 worth of bonds belonging to the New York Yacht Club. Then he stole $667,000 from the Stock Exchange Gratuity Fund, which had been set up to aid the widows and orphans of brokers.

Caught by stock exchange officials in 1937, Whitney demanded that they cover up his crimes. "After all, I'm Richard Whitney," he said. "I mean the stock market to millions of people."

When he was sentenced to five to 10 years in Sing Sing, cynics chortled as they recalled the title of his much-quoted speech to the Philadelphia Chamber of Commerce: "Business Honesty."

Slippery as Oil

At first, Anthony "Tino" De Angelis was known as "the salad oil king." Later, he became known as "the great salad oil swindler."

A former Bronx butcher, De Angelis was the president of Allied Crude Vegetable Oil, a major player in the commodities markets of the 1950s and '60s. Allied borrowed millions of dollars to speculate in vegetable oil futures. The loans were secured by warehouse receipts for millions of pounds of salad oil that Allied stored in huge petroleum tanks in Bayonne, N.J.

But the tanks were not full of salad oil. They were full of water, with just enough oil floating on top to fool the inspectors. De Angelis had conned some of America's biggest banks and investment firms out of $175 million. When the scandal broke in 1963, it nearly bankrupted two large brokerage houses.

De Angelis spent seven years in federal prison—years he later described as among the best of his life. "There you had peace. It was tranquil," he said. "You come outside and try to make a living and all the big guys try to shoot you down."

Phony, Phony, Phony

"It was like fixing a horse race," recalled one of the masterminds of the Equity Funding swindle of the 1960s and '70s. "We were always rigged to win."

Equity Funding sold an investment package that was a combination of mutual funds and life insurance. Customers bought a mutual fund whose dividends paid the premiums on the insurance policy. Equity then sold the insurance policies to reinsurance companies. This was profitable but not profitable enough for Equity's officials. They decided they could make more money by creating fake insurance policies, selling them to the reinsurance companies and pocketing the money.

This fraud worked well for nearly a decade. Equity officials made millions and Equity's stock rose from $6 to $90. But in 1973, says Charles R. Geisst, author of "Wall Street: A History," the scam collapsed when an Equity employee, dissatisfied with the size of his Christmas bonus, blew the whistle. After that, Equity went bankrupt, investors lost $300 million and a dozen Equity honchos went to prison.

The Wall Street Journal explained the scam to its readers in one of the most delightfully surreal paragraphs ever to grace its august pages:

"The customers didn't exist. Their mutual fund shares didn't exist. The funded loans didn't exist. The phony customers' phony pledges of their phony fund shares to buy phony insurance ultimately became numbers on a computer tape, which then printed out phony assets for Equity Funding Corp.'s phony books."

Greed Is Good

"Greed is all right, by the way—I want you to know that," Ivan Boesky told an audience of business students in 1985. "I think greed is healthy. You can be greedy and still feel good about yourself."

Boesky lived those words. He made hundreds of millions of dollars trading in stocks and bonds but he always wanted more. In an interview, he admitted that he fantasized about climbing atop a huge pile of silver dollars: "Imagine—wouldn't that be an aphrodisiac experience?"

Seeking ever more wealth, Boesky paid Dennis Levine, an investment banker with Drexel Burnham Lambert, millions of dollars for inside information on corporate takeover bids. Boesky then used the information to speculate in the companies' stocks, making tens of millions more. It was insider trading at its most lucrative.

When Levine was caught by the SEC, he ratted on Boesky. When Boesky was caught, he ratted on several other Wall Street wheeler-dealers—including Michael Milken, Drexel's legendary "junk bond king." Boesky even lured Milken to a hotel room, where they discussed their illicit deals in a conversation recorded using a microphone hidden in Boesky's clothes.

When the smoke cleared, Boesky served about 18 months in prison and paid a $100 million fine. Milken did three years and paid $200 million. Drexel went bankrupt.

Boesky's story inspired the 1987 movie "Wall Street," with Michael Douglas playing a reptilian character named Gordon Gekko—who recited, nearly word for word, Boesky's now-legendary "greed is good" speech.

Wall Street's Next Scandal

The list of financial scandals goes on and on: Ivar "The Match King" Kreuger, Bernie Cornfeld, Robert "Fugitive Financier" Vesco, the savings and loan crooks of the '80s. Now, as congressional committees, investigative reporters and the SEC struggle to unravel the Enron scandal, concerned Americans might be forgiven for wondering:

Given the history of wheeling, dealing, scheming and scamming in the world of high finance, can we expect to see more of these scandals in the future?

"It's never going to change," says Gordon, the Wall Street historian. "As long as there's a great deal of money to be made on Wall Street, there will always be people of dubious morals coming up with new ways to fleece the sheep. Welcome to capitalism."

Reprinted without permission 

1987 WALL STREET CRASH - FULL YEAR TIMELINE

1987 Timeline

Many people remember the events leading up to October 19, 1987. Unfortunately, very few of them recall the specifics. When many people talk about the dramatic drop in the overall stock market, they either blame a single cause (portfolio insurance) or treat the market fall as if it were something that came from out of the blue. Far from being a lightning strike or an act of God, the crash was a single event caused by a complex series of interconnected events. Hopefully after perusing the timeline we have constructed to review the events leading up to the crash, you will come to the same conclusion.

January 1, 1987

The year opens with bond yields near their lowest levels in nine years. Corporate treasurers have been issuing debt like it is going out of style, coining more than $200 billion in notes during all of 1986 -- two times the level of debt issued in 1985. A healthy market for junk bonds -- bonds issued that are considered below "investment grade" -- has helped tremendously. "With bond rates expected to remain at low levels, investment bankers predict that corporations will continue to flock." (New York Times, Jan. 2, 1987)

January 8, 1987

The Dow Jones Industrial Average closes at 2,002.25, breaking the 2,000 level for the first time. Trading volume swells to 194.5 million shares and most other stock indices set records as well. Optimism abounds that the string of records will bolster investor confidence and bring new investors into the market.

January 22-23, 1987

The Dow Jones Industrial Average leaps 51.60 points to 2145.67 on January 22, making its largest one-day point rise ever. Although well below any record for a percentage gain, the news is taken as another indicator that demand for stocks remains strong. The euphoria is slightly eroded the next day when the Dow plunges 114 points in 71 minutes on January 23. Program trading based on the difference between the value of stock futures and the cash market is blamed for the swing. Treasury Secretary James Baker expresses concern about the "excess" volatility.

February 5, 1987

The Securities Exchange Commission (SEC) announces that it is moving well beyond its initial focus in its investigation of Ivan Boesky. This case, coupled with half-a-dozen others that will break over the next few months, will make insider trading household words. Boesky's investigation hinges on a $5.3 million invoice to Boesky from Drexel Burnham Lambert, the firm that made junk bonds popular. The SEC wants to know why Drexel sent one of its major customers a bill for that amount. The SEC further subpoenas Guy O. Dove, another large junk bond customer of Drexel and continues to gather records on other Drexel customers.

February 9, 1987

Former Lazard Freres & Co. investment banker Robert M. Wilkis is sentenced to two concurrent prison terms for participating in an insider trading scheme with Dennis B. Levine. Wilkis allegedly earned $4 million in two offshore accounts as a result of trading based on inside information. Randall D. Cecola receives a five-year suspended sentence for his role in the scheme.

February 12, 1987

The next round of insider trading allegations taints Goldman, Sachs and Kidder, Peabody. Robert Freeman, Richard Wigton, and Timothy Tabor are all arrested and charged with insider trading violations. Federal prosecutors allege that the three have made millions of dollars based on insider information.

February 13, 1987

Prominent investment banker Martin Siegel pleads guilty to a number of tax and securities charges. Siegel coughs up $9 million in fines, faces up to ten years in prison, and admits that he was the informant who fingered Freeman, Wigton, and Tabor. Siegel also narcs on Boesky, stating he got $700,000 after he supplied information about ongoing corporate takeovers he was privy to as a result of his job at Kidder, Peabody. Siegel worked at Kidder, Peabody for 15 years before moving to Drexel Burnham in February of 1986. Some pundits question whether or not the takeover boom can continue due to the investment banking profession being tainted by these alleged improprieties.

February 17, 1987

A Virginia grand jury indicts 16 followers of paranoid politico Lyndon LaRouche on charges of securities fraud and a host of other felonies. As a result of these charges, the LaRouche organization is almost completely shut down.

February 18, 1987

Robert Prechter, an Elliott Wave guru who is currently peddling a book forecasting a crash, states that he thinks the Dow Jones Industrial Average will hit somewhere between 3,600 and 3,700 in 1988. The actual high for the year is 2193.75 in December.

February 21, 1987

The ever-controversial Andy Warhol dies of complications relating to a surgery he was undergoing. Famous for popularizing Pop Art, Warhol is probably best known for his offhand quip that in the future, everyone will enjoy 15 minutes of fame.

March 5, 1987

The investigation into Drexel Burham Lambert heats up after the government subpoenas more than a dozen of its clients. The probe has obviously expanded beyond Boesky and Drexel's basic practices in the junk bond and investment banking arena. Based on interviews, journalists conclude the government is looking for systematic violations in insider trading laws. Drexel is now officially under siege by U.S. prosecutors.

March 11, 1987

The ever-vigilant SEC snares Merrill Lynch's Nahum Vaskevitch in its growing inside trading web. The agency alleges that Vaskevitch fed information to Israel-based David Sofer about as many as twelve mergers or acquisitions that he was privy to in his role as head of international mergers and acquisitions.

March 12, 1987

PaineWebber broker Gary Eder and a number of other PaineWebber employees are indicted for tax evasion. Although unrelated to the flurry of insider trading allegations, the fact that they were helping clients to filter money out of their accounts in ways that avoided reporting gains to the IRS does nothing to help Wall Street's increasingly tarnished image.

March 16, 1987

No one is safe from the long arm of the SEC. Takeover master Carl Icahn announces that he is under investigation for possible violations of securities laws. Although the specific takeover under scrutiny was not specified, the Chairman of TransWorld Airlines appears unperturbed by the news.

March 19, 1987

The Boesky probe brings down West Coast broker Boyd Jefferies. Jefferies agrees to plead guilty to two felony charges related to manipulating stock prices. Jefferies is forced to resign as president of Jeffries & Co. and is barred from the securities business for at least five years. The firm agrees to a permanent injunction against breaches of securities law and to censure.

March 21, 1987

The fall of Jefferies & Co. quickly sucks American Express Shearson Lehman Brothers and Salomon Brothers into the inquiry. Both firms are subpoenaed as part of the investigation of stock manipulation, focusing on the firms underwriting practices, as well as those of the American Express majority-owned Fireman's Fund unit.

March 30, 1987

Wall Street's first quarter ends with a bang. Stock prices worldwide have surged 22% after netting out the dollar's decline. Companies took advantage of this by issuing more stock and bonds. IDD Information Services estimated that companies issued $87.7 billion in the first quarter alone, up 27% year-over-year. Unfortunately for stockholders, it is here at the end of the first quarter that the dollar's continued decline started to hurt stock and bond holders. The Dow Jones Industrial Average slumps 57.39 to 2,278.41 and bond prices fall to their lowest levels since last fall.

March 31, 1997

Leslie Roberts gets 15 years in prison for ripping off his uncle Robert Gory. Roberts allegedly ported millions of dollars from Gory's brokerage account at EF Hutton & Co., where Roberts was employed as a broker.

April 9, 1987

A former director of a Federal Reserve bank becomes embroiled in the insider trading mess. Robert Rough is accused by a number of witnesses of leaking market-sensitive information to Bevill, Bresler & Schulman. In an unrelated charge, the former president of the brokerage, Gilbert Schulman, is accused of participating in a scam involving Treasury bonds to cover up the firm's losses. Against this backdrop, Treasury bonds rise to above 8.0% for the first time in 13 months.

April 16, 1987

As if the opinion of Wall Street could not get lower, 15 employees of various Wall Street firms are arrested by Federal agents and charged with selling cocaine. Furthermore, they are charged with trading drugs for information, stock, and lists of preferred clients. To emphasize the amount of drugs flowing to Wall Street, the New York City Police Department states that 114 people were arrested for buying and selling cocaine on the streets and in parks around the financial district so far in 1987. Two undercover agents who were part of the Federal bust state that cocaine is either used or accepted by 90% of the people on Wall Street.

April 23, 1987

Bond fund redemptions accelerate as the prices of bonds continue to plunge. Many are concerned that the falling dollar could revive inflation. Prices of bonds are off as much as 10% since the end of March after rising nearly 100 basis points. Ivan Boesky pleads guilty to conspiracy to lie to the government. Boesky is released without bail and his sentencing is scheduled for August 21. The same day, Guinness PLC takes a $206 million charge partially related to the firm's relationship with Boesky.

April 26, 1987

Wall Street law firm Davis, Polk & Wardwell reveals that it has discovered a cocaine ring operating in its office. One of the principals was tipped off by a custodian with a beeper who offered to help him sell drugs.

April 27, 1987

The Drexel Burnham Lambert probe is now focusing on the Beverly Hills office of Michael Milken, the man behind the company's high-yield bond operation. The government is being helped along by Charles Thurnher, a Drexel executive with intimate knowledge of the company's operations.

April 29, 1987

The dollar and bond prices both plummet after the House of Representatives passes an amendment to take measures to reduce the trade surpluses held by many Asian nations. Many fear that foreign investors, particularly the Japanese, now will not participate in the Treasury's quarterly funding auction. Representative Dick Gephardt is behind the legislation.

May 6, 1987

The Assemblies of God votes to strip the Reverend Jim Bakker of his ordination. Bakker has been embroiled in a sex and money scandal since last year, when he admitted that he had a "sexual encounter" in 1980 and has been blackmailed ever since. Jerry Falwell takes over Bakker's PTL ministry.

May 16, 1987

Speculative companies with little more to offer than interesting stories account for many of the year's best performing stocks. Among them are: AT&E Corp.,a company developing a wristwatch-based paging system; Copytele, a company that makes flat-panel video display products; Carrington Labs, up on speculation that a drug it has can reduce AIDS symptoms. Analyst Evelyn Geller of Blair & Co. says of AT&E, "The thing could trade anywhere -- up to 30 times earnings. So you're talking about $1,000 a share.... You can't put a price on this -- you can't. You don't know where it is going to go. You are buying a dream, a dream that is being realized." Although Geller speaks specifically of AT&E, her comments can be taken as a general indicator of the type of analysis that has caused these price eruptions. AT&E, for its part, no longer trades.

May 17, 1987

An article in the New York Times discusses the many investment banks that are considering cutting personnel due to impending bad times. Rising inflation, a widening insider trading scandal, and rising bond yields are blamed for the pessimistic outlook.

May 19, 1987

Besieged Drexel Burnham Lambert publishes a study it conducted of 23,000 U.S.-based companies with sales of at least $25 million and pointed out that less than 800 qualified for investment grade bond ratings. This is a transparent attempt to shore up public opinion regarding the company's junk bond operations, which have come under scrutiny due to the expanding insider trading investigations.

June 4, 1987

Kidder Peabody pays a record $25.3 million to settle outstanding insider trading charges against the firm. One of the charges settled was that the 80% General Electric-owned brokerage conspired with a small firm led by Ivan Boesky to illegally trade stocks.

June 20, 1987

A 17-year-old high school student named Daniel Stein becomes the youngest broker in the United States. Despite the mounting insider trading charges, young Stein's enthusiasm for Wall Street has not been dampened one bit. With the markets racing ever higher, the public's enthusiasm has not waned either. Four days later, U.S. Attorney Rudolph Guliani tries to expand the number of lawyers assigned to investigate Wall Street.

July 1987

Lieutenant Colonel Oliver North achieves notoriety as he tells his version of the Iran-Contra story to a spellbound Congressional investigating committee. North's testimony is broadcast on live television and is seen by millions of Americans. A Time magazine poll finds that 60% of Americans sympathized with the Marine, while on 51% found him to be "truthful." The hearings mark the most significant investigation into activities in the Executive branch since the Watergate investigation in 1973.

July 17, 1987

Crude oil prices hit $22.39 per barrel, up from only $16.40 in March and the high $17 range at the beginning of the year. Although prices would fall back to the $20 range in August and stick there until the crash, the 11% increase in crude oil prices from the beginning of the year created a lot of anxiety over inflation. It was inflation anxiety in part that drove yields on the 30-year government bonds higher and higher.

July 22, 1987

Treasury bond markets stand in disarray as government bond yields continue to climb. The 30-year bond touches 8.79%, its highest level since early June and well up from 8.5% on July 14. This jump marks the beginning of a massive bond swoon that will carry the yield as high as 10.22% on August 15.

August 24, 1987

Standard & Poor's reports that 158 companies listed on the New York Stock Exchange have split their stock so far in 1987. Most anticipate the year will be a record for stock splits and Standard & Poor's forecasts a total of 250 by the end of the year. The yield on the 30-year government bond hits 8.98%. The next day, the Dow Jones Industrials hit 2722.4 -- a high that will not be breached until exactly two years later on August 24, 1989.

September 6, 1987

Former professional gambler Jack Keller decides to trade in his poker chips for a seat on the Chicago Board Options Exchange. Keller snagged 25 major poker titles during his stint as a professional gambler, including the winning spot at 1984's "World Series of Poker." Keller states he quit poker "because it had no more to offer me." He cites "regular hours" as one of the principal attractions of the options pit, as he has two sons.

September 11, 1987

Dan Rather walks off the set of the CBS Evening News as a result of a disagreement with management. CBS goes to black for five minutes.

September 29, 1987

The 30-year Treasury hits 9.77%, its highest level since December of 1985. Traders describe a discouraging environment where everyone has Treasuries to sell but no one is buying. The Dow Jones Industrial Average has already fallen to 2590.6, 4.8% below the all-time high hit the month before.

October 1, 1987

Television talk show host Johnny Carson celebrates his 25th anniversary on the air as host of the evergreen Tonight Show.

October 6, 1987

A rally in bond prices since the Sept. 29 fizzles and equity prices begin to feel the downward pull of the long bond's gravity for real. The Dow Jones Industrial Average drops 3.47% to 2548.63 on volume of 175.6 million shares. Waves of computerized selling make it difficult for the market to maintain equilibrium. Many pundits blame portfolio insurancefor the accelerated decline. Two days later long bond yields stand at 9.91%.

October 12, 1987

Confidence among the major investment banks begins to deteriorate. Salomon will dismiss 12% of its municipal bond workforce and will re-examine how much space it needs in New York City. The volatile, downward market in bonds has caused profits at the nation's largest investment bank to plummet. Sources say that 800 employees will get the axe. The next day Kidder Peabody announces that it will cut its municipal bond trading operations by 35%.

October 14, 1987

The Dow Jones Industrial Average drops a record 95.46 points to 2412.70. The Dow will tumble another 58 points the next day, taking the venerable index down more than 12% from its all-time high hit on August 25. Pundits blame a widening foreign trade deficit that is fueling the dollar's descent and consequently weighing on bonds. The Japanese yen and the Swiss franc have both risen substantially in the past two months. Computerized trading, possibly a result of portfolio insurance, has led the downward charge.

October 16, 1987

Iranian missiles hit a U.S.-flagged tanker off of the coast of Kuwait. Only five months before, an Iraqi missile hit the U.S. frigate Stark, killing 37 sailors. Fears of heightened tensions as a result of the inevitable U.S. retaliation drive the Dow Jones Industrial Average down 108.35 points to close at 2246.74 on record volume. The yield on the 30-year bond stands at 10.12%. Treasury Secretary James Baker voices concern about plunging stock prices, although he states that they have dropped "from a very high level." Many economists take the dramatic rise in bond yields that have precipitated the tumble in stocks as a sign that the Federal deficit and the balance of trade both need to be addressed.

October 17-18, 1987

The weekend before the crash, millions brood over what is perceived to be a worsening economic picture and become increasingly concerned about tensions in the Middle East. With the risk-free yield on a 30-year bond at 10.12%, only a hair below the long-term annual return from the stock market of 10.60%, many must be wondering why they are in stocks at all. Government officials decry bond yields as "needlessly high" and based on "exaggerated fears of inflation."

October 19, 1987

In the early morning, two U.S. warships shell an Iranian oil platform in the Persian Gulf. Combined with a myriad of economic factors, this helps to set off an unprecedented 508 point downpour in the Dow Jones Industrial Average, leaving it at 1738.74. The 22.6% deluge is the worst one-day beating the index has taken since hostilities were initiated in World War I and causes the 12.8% decline of October 28, 1929 to pale in comparison. The Dow is down 983.66 points since August 25, a 36.1% decline. Chaos reigns on the trading floor as many specialists simply give up, flooded with orders. Volume hits 604.3 million shares, almost twice the prior record of 338.5 million set on October 16. Many economists cast dire predictions, noting the 1929 crash preceded the Great Depression.

---

Although investors stand about today, white-knuckled and awaiting the next crash, it remains obvious that many of the principal drivers leading to the 1987 crash are not present today. The rise in bond yields, crude oil prices, and the trade deficit combined with the collapse of the dollar and general investor confidence all provided the context for the collapse in stocks. Although valuations were near all-time highs prior to the crash, the valuations themselves did not drive the crash -- it was the exogenous events that muddled economic forecasts and that in the end wrecked havoc with bond prices that provoked the cataclysm. Like a closed room filling with gas from a leaking pipe, it is hard to blame the resulting explosion completely on the poor soul who struck a match.

In 1987, bond yields went from 7.28% to 10.22% in nine months. If a similar move in yields were to begin today, yields on 30-year Treasuries would have to increase to 9.0% by July of 1998. What institutional money manager in late 1987 would think twice about nabbing bonds yielding 10.22%, very close to the historical average return from stocks? Not very many. This swelling in the yield of the average bond was driven by increasing fears of inflation, the falling dollar, the widening trade deficit, and rising oil prices -- all culminating in mid-October when tensions in the Persian Gulf increased after the attack on the U.S. frigate Stark. Volatility in the stock market had been exacerbated for months leading up to October 19th because of all these factors -- the crash was the culmination of all these factors, not some natural disaster or force of God.

Looking over the historical record, the collapse of confidence in Wall Street also appears critical to the collapse in equity prices. With Milken, Boesky, Siegel, and Freeman all were pulled into court, this was a strike at the elite of arbitrage and mergers and acquisitions. The level of corruption and unfair practices that was revealed as routine on Wall Street in the ten months leading up to the crash can compare only with the systematic abuses recorded in the late 1920s that led to the Securities Act of 1933, the Securities Exchange Act of 1934, and formation of the Securities and Exchange Commission. Although it is hard to say with any certainty that this was a crucial pre-existing factor, it seems clear in retrospect that as more saw Wall Street as a rigged game, they were less likely to remain confident in the face of mounting anxiety.

Certainly concrete things like program trading and portfolio insurance also had a role in the sudden, spectacular collapse on October 19th. However, a muddied economic picture that drove bond yields up nearly 3.0% and diminished confidence in Wall Street created a backdrop that made a fall almost inevitable. Perhaps the reason so many can claim they "called" the crash was because even at the time this backdrop of rising yields and increased skepticism was clear. Although over the past few years we have seen short, sharp drops in the market driven by increased uncertainty about the economy or various industries, it seems impossible when one looks at the historical record to come to any other conclusion -- crashes occur after bond yields explode and confidence begins to waver, not before. People who talk of stock market crashes, major drops on the scale of 1987, as if they just happen are ignoring the facts.