TIME: Almanac 1993/TIME Almanac 1993.iso/time/caps/87/87capbus.1

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                                                                                November 2, 1987

THE CRASH

Panic Grips The Globe


A crisis spotlights Washington's failures


First came a vague foreboding, a kind of free-floating anxiety.
The U.S., said worriers, could not go on forever spending more
than it would tax itself to pay for, buying more overseas than
it could earn from foreign sales, and borrowing more abroad than
it could easily repay. There had to be a day of reckoning, and
it could unhinge the whole world economy. But when might it
come?  What form would it take?  How bad might it be?  No one
could say, and so the forebodings could be pushed to the back
of the mind.

But then, slowly at first, the anxiety began to take on a shape
that could be sensed if not exactly foreseen. On all the
world's stock exchanges, prices had leaped up too far, too fast,
to be sustained. The mood in the markets shifted from fantasy
about instant wealth to nervousness about an inevitable
"correction" (a wonderful euphemism). By Monday morning the
concern was no longer vague but had taken on physical
form--piles of papers littering brokers' desks, each
representing a hastily scribbled order to sell stock; rows of
numbers flashing on computer screens, bring news of alarming
price breaks in all the early-opening markets:  Tokyo, Hong
Kong, London, Paris, Zurich...

Then trading began in New York, and the unimaginable happened:
a collapse on a scale never before--no, not even in 1929.
Prices went down, down, down, swiftly wiping out an entire
year's spectacular gains. "I just can't believe that this is
happening," moaned one trader, as he took nonstop sell orders
at Donaldson, Lufkin & Jenrette. At lunchtime, brokers across
the U.S. went hungry or ate sandwiches at their desks while
trying to keep phone receivers pressed to both ears. "This is
going to make '29 look like a kiddie party," shouted a trader
on the Los Angeles floor of the Pacific Stock Exchange.

Almost an entire nation become paralyzed with curiosity and
concern. Crowds gathered to watch the electronic tickers in
brokers' offices or stare at television monitors through
plate-glass windows. In downtown Boston, police ordered a
Fidelity Investments branch to turn off its ticker because a
throng of nervous investors had spilled out onto Congress Street
and was blocking traffic. George Finch, 66, a retired
businessman in San Francisco, summed up the bewilderment:  "I
don't know what the hell is going on."

By the time the 4 p.m. closing bell rang at the New York Stock
Exchange on what instantly became known as Black Monday, the
Dow Jones industrial average had plunged 508 points, or an
incredible 22.6%, to close for the day at 1738.74. Some $500
billion in paper value, a sum equal to the entire gross national
product of France, vanished into thin air. Volume on the New
York exchange topped 600 million shares, nearly doubling the
all-time record. Brokers could find only one word to describe
the rout, an old word long gone out of fashion but resurrected
because no other would do:  panic. The frenzy rose as it spread
once again around the globe. On Tuesday stock prices fell by
12.2% in London, 15% in Tokyo, 6% in Paris and 6.7% in Toronto,
on top of huge losses Monday.

Then, since blind panic is no more sustainable than unthinking
euphoria, came a crazy whipsawing that continued virtually all
week and in markets all around the world. Up, down, up, down,
with trends reversing in hours, and then reversing again. And
always the questions:  Would the stock crisis cause a recession?
Or even a global depression like the one ushered in by the 1929
Crash?  What would happen to the dollar, to interest rates, to
world trade?  What might Ronald Reagan do to calm the markets?
Could a President who was so weakened by the Iran-contra affair
and the impending defeat on the Bork nomination, and who was
distracted by war in the Persian Gulf and his wife's cancer
operation, possibly quell the financial turmoil?  Did he even
understand that he faced a first-class crisis of confidence in
his leadership?

At first the President gave no sign that he did. He spoke only
in comments shouted to reporters over the roar of helicopter
rotors on the White House lawn and in brief formal remarks
issued through his spokesman, marlin Fitzwater. On Black
Monday, he blithely attributed the crash to "some people
grabbing profits" accumulated during the market's long rise.
In a statement after the close of trading, he said that "the
underlying economy remains sound"--unwittingly drawing another
parallel to 1929, when Herbert Hoover said almost exactly the
same thing. On Wednesday, Reagan remarked that the midweek
rally indicated the Monday collapse had been "some kind of a
correction"--a statement that would have been reassuring only
if he had intended it ironically, as he obviously had not. Some
critics began speaking of the President in tones of contempt.
Said a Wall Street money manager during the midst of the crash:
"You sell and get what you can and never again listen to Ronald
Reagan."  M.I.T. Professor Robert Solow, who was awarded the
Nobel Prize for Economics last week, took the occasion to
criticize Reagan's long, obstinate resistance to tax increases
thought necessary by many to trim the budget deficit and thus
restore confidence. The President, said Solow, "is holding the
Congress back from slow access of intelligence."

By Thursday night, however, Reagan at last showed that he
recognized the seriousness of the situation--and the need for
action. "We shouldn't assume that the stock market's excess
volatility is over," he asserted at a White House press
conference, and he acknowledged that public fear spread by those
gyrations "could possibly bring about a recession."  More
important, he announced that he was summoning the leaders of
Congress to a bipartisan deficit-cutting conference at which,
through his top aides, he was "putting everything on the table
with the exception of Social Security, with no other
preconditions."  Including a tax increase?  Though he could not
quite bring himself to pronounce those words, Reagan clearly
indicated that, well, yes, he would at least discuss the
subject. Reminded again and again by reporters of his many
previous pledges to veto anything resembling a tax increase, he
refused to repeat any such pledge; he merely said both spending
and taxes should be kept "as low as possible."

It was, however, anything but an inspiring performance. The
President repeatedly stumbled and seemed unsure of just what he
wanted to say. Several times he slipped into well-worn
denunciations of congressional Democrats before remembering that
this time he was supposed to sound conciliatory. In his
Saturday radio speech, Reagan once again called on Democrats to
"remember that lower taxes mean higher growth," even while
acknowledging that "all sides must contribute" to a
budget-cutting package. The net impression was that in
countenancing discussion of a tax increase he was doing
something he felt he must, without an conviction.

The impact of the President's words was hard to gauge.
Exchanges in Asia and Europe suffered additional heavy losses
Friday, but that might have been more a response to a bad
Thursday on Wall Street. Despite a lukewarm reaction in the New
York financial community to the President's statements, prices
on the Big Board steadied, perhaps from exhaustion. The Dow
average eked out a .33 gain to close the week at 1950.76. Tow
bits of news helped:  the Consumer PRice Index rose at an annual
rate of only 2.1% in September, less than half the 5.8% pace in
August; the GNP grew at an annual rate of 3.8%, after adjustment
for inflation, in the third quarter, up from 2.5% in the second
quarter. Those figures seemed to indicate that the American
economy, if not exactly sound in its fundamentals, was at least
not deteriorating as drastically as the Black Monday stock-price
collapse might have led an unsophisticated observer to believe.

Nonetheless, the week as a whole will go down as the worst in
financial history. The Dow's Black Monday plunge of 22.6% was
almost double the record 12.8% fall on Oct. 28, 1929. Despite
a spirited rally on Tuesday and Wednesday, the DOw was still
down an unprecedented 295.98 points, or 13.2%, for the week.
That immediately eclipsed the record 235.48-point decline the
market had suffered the previous week. From its peak of 2722
in August to its Friday close, the average has fallen 28.3%,
burning up an estimated $870 billion in equity values. Volume
for the week was inconceivably greater than ever before,
totaling 2.3 billion shares on the Big Board; the four heaviest
trading days in New York exchange history all occurred last
week. The turnover strained the exchange's computer network to
the limit, and the Big Board decided to knock off trading two
hours early on Friday and this Monday and Tuesday to allow
exhausted brokers time to catch up on their paperwork.

At best, the President may have bought some time for the WHite
House and Congress to come up with a program to convince
investors that something worthwhile will be done to bring budget
and trade deficits under control. Probably not much time,
either Wildly gyrating markets are better than those that plunge
straight down, but they are hard on the nerves of stockholders
who have already proved they are ready to jump at the first sign
of trouble. The continued drop on the foreign exchanges Friday
cannot be brushed off. If the wild week proved anything, it was
that in an era when the U.S. is dependent on foreign goods and
capital, no exchange is an island. Price breaks overseas can
tough off panic in the U.S., which can then hammer prices down
further abroad; that, in fact, is roughly what happened Monday
and Tuesday.

Moreover, even if prices stabilize--a gargantuan if, given the
extreme jumpiness of the markets--the bust that has already
occurred darkens prospects for business. Even in an economy the
size of the U.S.'s, the nearly $385 billion in asset values that
vanished last week alone is a sum large enough to have a strong
impact. Not all those losses are theoretical; for many people
who sold on Monday, the damage is painfully real. And investors
who sat tight and saw the value of their stocks recover a bit
at midweek have had an unforgettable demonstration that they
cannot count on eventually being as rich in reality as they once
looked on paper.

To be sure, hardly anyone expects a rerun of the Great
Depression that followed the 1929 Crash. Main reasons:  the
economy has developed many safeguards, and the Government, if
it cannot yet be trusted to resolve the nation's fundamental
financial problems, at least knows enough to avoid making the
situation drastically worse. The banking system collapsed in the
wake of the 1929 debacle, but it is much sounder today, shored
up by federal deposit insurance, among other things. Says James
Wilcox, an economist at the University of California, Berkeley:
"In the 1930s when things looked bad, people ran from the banks
out of fear. In 1987 people run to the banks to put their money
in, because this time the banks are among the safest things
around."

The Federal Reserve Board, in hindsight, is widely considered
to have played a role in converting the 1929 Crash into the
1930s Depression by allowing the U.S. supply of money and credit
to shrink substantially at the worst possible time. Last week
the Fed took exactly the opposite tack. Chairman Alan Greenspan
on Monday was denounced by some critics for having inadvertently
helped trigger the stock-market break by pushing up interest
rates in early September. But on Tuesday morning he became
something of an instant hero by reversing policy:  just before
the markets opened, he announced that the Federal Reserve,
"consistent with its responsibilities as a central bank," would
make as much money available as might be needed- -for example,
to banks that might be hurt by suddenly uncollectible loans to
stockbrokers. Greenspan seemed to be as good as his word; by
week's end the Fed was apparently pumping enough money into
banks to bring interest rates down again slightly. Led by
Citicorp, the major U.S. banks dropped the benchmark prime rate
that they charge corporate customers from 9.25% to 9%. The move
came only two weeks after the banks had boosted the prime from
8.75% to 9.25%.

But if no depression is in the cards, the market crack could
cause a recession all by itself. Economists last week were
quoting odds like so many Las Vegas bookies. Some guessed the
chances of a recession had gone from 1 in 4 to 1 in 2, others
from 15% to 35%, but few doubted that the odds had increased.
If a recession does not come, most agreed, the economy probably
is in for at least a slowdown that might knock a percentage
point or two off its growth rate.

Frank Korth, senior vice president of Shearson Lehman, explains
the mechanism by which market cracks get translated into
slowdowns or recessions:  "If you lose $4,000 in the stock
market, you don't go out and spend $1,200 on a new color TV or
$4,000 on a new motorboat. As a result, the man on the street
whose job is in the boat plant is out of a job because there is
no market for his company's product. Boatbuilders don't want to
build inventory, so they close down their plants. Everybody
loses:  the plant workers, the suppliers, the corner grocer, the
shoe store."

This is, of course, a highly simplified scheme, and there is
nothing inevitable about it; it could be averted by Government
action that would restore confidence. But what kind of action?
An answer must begin with an analysis of what trigger the
market crash.

Superficially, the bust might seem, to put it bluntly, insane.
By no rational calculation could the asset value and earning
power of American corporations be 22.6% less on Monday night
than they had been the previous Friday. But that statement
assumes that their values on Friday were realistic, and in
hindsight there is widespread agreement that they were not. In
other words, the crash to some extent really was--ho, all
right--a correction, though one on a scale to make that word
seem ludicrously inadequate.

Says Korth of Shearson Lehman:  "The market should not have
reached 2700 [on the Dow Jones average] in the first place. We
probably should have been trading around 1900 or 2100; maybe
2000 would have been the right number based on interest rates,
corporate earnings and other fundamentals. We were 700 points
ahead on sheer greed."  As early as August, when the American
bull market celebrated its fifth birthday, some investing pros
were noting apprehensively that stock prices were getting out
of line with expected corporate earnings, and dividend yields
had fallen well below the interest return on bonds, making the
fixed-income securities potentially a better investment. But the
general feeling then was that the Dow might go as high as 3000,
on pure momentum if nothing else, so why not stick around for
the end of the ride?  A similar psychology ruled
overseas,according to Nils Lundgren, chief economist of Sweden's
PK banken. Says he: "The market was really overspeculated, with
people saying to themselves, 'I won't get out now, but as soon
as stocks start to fall, I will sell.'  When you have that
mentality operating, you are ready for a big fall."

When markets get into such a state, almost anything can start
a smashup. In the event, last week's explosion did not lack
for triggers. Interest rates were pushing higher:  the yield
on U.S. Treasury bonds rocketed briefly above 10%. That seemed
likely to pull money out of stocks into the bond market. In
fact, something of the sort seems to have happened. While the
stock market suffered through its collapse Monday, the bond
market began a brisk rally, presumably propelled by money
fleeing the stock exchanges and looking for a safe haven. The
biggest immediate blow of all was a report two weeks ago showing
that the monthly U.S. trade deficit in August had declined only
slightly, to $15.7 billion. Investors who had been hoping for
a large reduction took that as a sign that U.S. finances were
out of control and that the Reagan Administration did not know
how to fix them. They began dumping stocks.

Moneymen in the U.S. and Europe found a personal villain:  U.S.
Secretary of the Treasury James Baker. Some came close to
implying that he turned a serious stock-price decline into an
all-out crash single-handedly. That would be a wild
exaggeration, but he surely did not help.

What Baker did was get into a complicated but unnerving spat
with West German financial authorities, who two weeks ago
permitted the fourth rise in German interest rates in three
months. What was so bad about that?  Washington would like West
Germany, Japan and other major countries to reduce interest
rates for two reasons:  1) to avoid competing against the U.S.
for international capital needed to cover the federal budget
deficit; 2) to stimulate their domestic economies so they will
import more U.S. products and not be so dependent on export
sales that swell the American trade deficit. Baker might have
been justified in criticizing the German interest- rate boost;
he was not the only moneyman to consider it unnecessary as well
as unwise. The boost was supposed to combat inflation, but West
Germany is a country with almost no inflation.

Baker, however, went much further than merely criticizing the
Germans. In a series of statements beginning Thursday, Oct. 15,
and continuing through a TV interview on Sunday, he repeatedly
asserted that the U.S. would not accept the German interest-rate
boost quietly. Moneymen immediately read his comments to mean
that Washington would no longer abide by the February Louvre
accord under which the U.S., West Germany, Japan and four other
nations try to keep the values of their currencies within a
narrow trading range. Indeed, the New York Times quoted an
unnamed "senior Administration official" as announcing an
"abrupt shift in policy," implying the U.S. would seek to
retaliate against the Germans not just by letting the dollar
fall but by actively driving it down. For investors around the
world, many of whom assumed the unnamed official must have been
Baker, that raised horrifying specters:  chaos in the currency
markets and a breakdown of the slender degree of international
financial cooperation achieved under the Louvre agreement
(named after the Paris museum, which also house the French
Finance Ministry offices in which the accord was negotiated).
U.S. Economist Pierre Reinfrew accuses Baker of "initiating
economic warfare against the Germans and then threatening to
bomb his own currency."

Treasury sources vehemently deny that Baker intended any such
thing. All he want to say, they insist, was that Washington
would not let the West Germans push the U.S. into raising its
own interest rates; they point out that his statements never
even mentioned the dollar specifically. And the unnamed senior
official?  It was not Baker, Treasury people insist; in fact,
Baker would like to get his hands on whoever it was. Perhaps,
but such statements cannot inspire confidence in the degree of
policy coordination within the Reagan Administration.

Ironically, Baker in a sense won his campaign. Flying to Europe
for a scheduled visit Monday, he persuaded the West Germans to
roll back the interest-rate increase he had assailed, and they
together specifically reaffirmed the Louvre agreement. But it
was much too late to calm the unrest Baker's previous statements
has intensified. Well before he patched things up with the
Germans, selling on the world's stock exchanges had accelerated
into an all-out crash.

One factor behind the speed of the market's descent was the
almost complete computerization of the New York exchange and
other markets. There is immense dispute, even days after the
fact, as to what part computers that make trades
semiautomatically played in touching off the gigantic volume of
sell orders. Taking no chances, however, the Big Board after
the Monday debacle instituted restrictions on so- called program
trades of large portfolios of stock carried out by computer, in
order to damp down price swings.

In a broader sense, computers unquestionably had an
all-important role. They enable the exchanges to execute trades
swiftly, in volume that would have been inconceivable a few
years ago. So at times of market excitement, the volume that
would once have been stretched over a week or so gets squeezed
into a day. When the orders are predominantly on one side,
prices run up or down violently.

But never so violently as on Black Monday. Tickers and news
reports flashed the story of huge price declines on heavy
volume. With each sale, more investors became convinced that
a collapse had begun and they had better get out while they
still could. Mutual-fund managers tried to hold on but could
not:  they had to dump stock to get cash to pay off investors
who clamored to redeem their fund shares. Margin calls to
investors who had bought stock on credit aggravated the frenzy.
Some could not put up additional collateral and were sold out.

Why, then, did the rout give way to a rally?  Traditionally,
that happens after every so-called selling climax (even in
1929), because most investors who were thinking of selling have
been cleaned out in one grand sweep and buyers start looking for
newly cheap shares. The rally in the middle of last week was
given particularly powerful support by some 200 major
corporations that started buying up their own stock at bargain
prices, in part of keep it out of the hands of would-be raiders.
The rush put at least a temporary damper on mergers and
acquisitions anyway. Several deals fell through because the
bids made for the target companies suddenly looked
unrealistically high after the general decline in stock prices.

But it is anyone's guess whether the small degree of stability
so painfully achieved on Friday--volume dwindled as the Dow
average stood almost still-will hold even for days or hours.
Alan Meltzer, professor of political economy at Pittsburgh's
Carnegie-Mellon University, thinks the "markets will remain
volatile because there are still too many unanswered questions."

The most fundamental questions, economists agree with the
closest approach to unanimity they ever achieve, are:  How long
will the U.S. try to live it up on borrowed money?  And can it
summon the will to start the painful readjustment necessary to
kick the habit--a readjustment that grows more painful the
longer it is put off?

The problem is hideously complicated in detail but simple enough
in outline. Ever since the giant tax cuts of 1981, the U.S. has
been running deficits on a scale never seen before. True.
Reagan announced at his press conference that the deficit in
fiscal 1987, which ended on Sept. 30, dropped to $148 billion,
from $221 billion the prior fiscal year. But the new figure is
still far too high, and it is likely to rise again soon; much
of the 1987 reduction was due to one-shot effects of the
tax-reform law. Concurrently, the U.S. has swung from a surplus
of exports over imports of $3 billion as recently as 1975 to a
trade deficit of $156 billion last year.

One result is that America has run up a foreign debt of about
$250 billion. Economists across a broad spectrum of ideological
positions warn almost with one voice that this situation is
precarious in the extreme. Foreigners will not continue forever
to finance American profligacy, and the stock-market crash was
a relatively mild foretaste of what could happen if they pull
their money out. The nation would then face a grim choice of
financing the deficit by ruinous printing-press inflation or a
sudden, brutal cutback in spending that might trigger a real
economic bust.

No wonder, then, that stock investors have been nervous.
Whatever the precise ix of emotions and events that triggered
last week's collapse--and to establish that mix would require
probing into millions of minds around the world--its root cause
was a dim but accurate perception that U.S. prosperity was not
sustainable with present policy. And with Congress and the
President perpetually wrangling over the most modest proposals
to reduce the budget deficit, they could see no sign that policy
was about to change.

In truth, even with the most brilliant policy, the passage to
a sounder prosperity is likely to be tricky, dangerous and
painful. Lowering the trade deficit will take years, and will
probably require a cut in American consumption--meaning, in
other words, at least a temporary reduction in the standard of
living. Many economists think the dollar will have to fall
further too, reluctant as both U.S. and foreign moneymen are to
see that happen. The reluctance is understandable. Unless a
decline is carefully managed, it will raise two dangers:  a
renewal of inflation and a panic flight of foreign capital from
the U.S. (since foreigners would not be eager to hold
dollar-denominated investments that shrank in value against
their own currencies).

But there is an impressive consensus, in the U.S. and aborad,
on how to begin to correct the imbalances in the American
economy. The President and the Democratic-controlled Congress
must agree, right away, on a package of measures that hold some
real promise of reducing the budget deficit steadily and
substantially. Certainly these must include painful spending
cuts. But they must also include tax increases, much as Reagan
hates the thought. Not because they are any panacea; indeed
they carry a serious risk. Higher taxes might reduce consumer
spending just when a recession is beginning, and deepen the
slump. But no significant budget cut is possible without at
least some sort of modest tax increase, and no progress toward
solving the nation's fundamental economic problems is possible
without a real deficit reduction.

That was the theme, implicit or explicit, of comments around
the world last week. Foreign government and financial leaders
have an all-important stake in U.s. economic policy. The
worldwide market crack is already hurting their economies; for
example, it has delayed European programs to privatize industry
by selling chunks of government-owned companies to individual
investors. An American recession, should that be the result of
a continued stock slump, could quickly travel abroad.

French President Francois Mitterrand, speaking at a financial
forum Thursday, complained about a "world that constantly moves
the carpet under your feet, pulling it out and threatening to
trip you up."  The market bust, he said, "is the disorder of a
non-system. There is no system. It has been broken."  Others
left no doubt about who must bear responsibility for fixing it.
Says a senior Canadian government economist:  "Everyone, all
around the world, has been keeping an eye on the U.S. economy
and wondering how long it could continue to survive without
dealing with things like its trade imbalance and its huge
federal deficit. When people became convinced that the U.S.
lacked the will (we know it has the ability) to deal with these
problems, they lost confidence in the U.S. market."  Guido
Carli, former head of the Bank of Italy, is specific about what
needs to be done:  "The only way out is to reduce the U.S.
deficit. Otherwise there is a risk of recession."

Does Reagan now understand the necessity?  Just before Black
Monday, Treasury Secretary Baker in a TV interview restated the
President's opposition to any sort of tax boost. But he and
other insiders were already monitoring the stock market
apprehensively. The previously Friday, White House Chief of
Staff Howard Baker had pulled together an informal group
consisting of himself, the Treasury Secretary, Council of
Economic Advisers Chairman Beryl Sprinkel, Federal Reserve
Chairman Greenspan and White House Aide Kenneth Duberstein.
They met with the President after the market had closed with a
then record loss of 108.36 points (shortly to be vastly
eclipsed). Their message:  basic economic indicators were good,
but the markets were very nervous.

On Monday, Howard Baker was on the telephone almost all day
long, keeping in touch with old colleagues on Capitol Hill,
where he had once been Republican Senate leader, and phoning
people on Wall Street, including New York Stock Exchange
Chairman John Phelan, to get market reports. At 3:40 p.m., 20
minutes before the close of trading,the chief of staff and
Duberstein called at the Oval Office to give Reagan a market
status report. But prices were tumbling too rapidly for anyone
to keep track of them. Reagan, as his later statements
indicated, simply did not know what to make of the crash.

The decisive meeting occurred Tuesday after the market close.
James Baker, by then back in his Treasury office after having
cut short his trip to Europe, first called in Howard Baker,
Greenspan and Sprinkel to coordinate what they would tell the
PResident. Then, joined by Duberstein, they went upstairs in
the White House to the brightly colored West Sitting Room, which
the Reagans use as a living room. James Baker opened by telling
Reagan that the world seemed to be looking for some movement on
the President's part, and the quickest way he could display
leadership was by reaching a compromise with Congress on
reducing the budget deficit. Everyone knew that would have to
include a tax increase.

Greenspan, who had been an informal economic adviser to Reagan
before the President chose him to head the Federal Reserve,
voiced a somewhat perverse but effective argument:  in effect,
the only way to keep taxes low was to agree to raise them a bit.
If there was no budget compromise with Congress, he said, the
financial markets might continue to weaken and the economy might
take a real turn for the worse. That, he continued, might give
the Democrats enough political clout to shove through a big
increase severely trimming back Reagan's cherished tax cuts,
either by ramming one through over the President's veto or by
winning the 1988 election and enacting a stiff boost after
Reagan left office. The President showed great reluctance to
accept the advice that he should compromise on a modest boost
now. But, says one participant, eventually the "President
bought the [Greenspan] argument that if the economy goes down
the tubes you lose the whole thing, the whole legacy."

Even so, the two Bakers had to argue further on Thursday to
cement Reagan's agreement to state in his press conference that
night that he would put everything on the table in budget
discussions with congressional leaders. But as the President
began speaking, advisers who had coached him were concerned that
he would take back that pledge almost immediately after making
it. Their fear was that once Reagan got past his prepared
statement and started answering reporters' questions, he would
go on automatic pilot and repeat all his standard denunciations
of taxes. In fact, Reagan once or twice started to do exactly
that but caught himself before going too far. Said an adviser
the next day:  "He almost blew it. He came very close."

But he did not blow it, and the budget negotiations were set to
begin early this week. It should not take long to find out
whether some agreement can be reached. Even if a renewed market
decline does not force a quick resolution--and one very well
might--the talks will be racing a deadline of sorts. if a
budget compromise is not worked out and enacted by Nov. 20, some
$20 billion of automatic spending cuts go into effect under a
modified version of the Gramm-Rudman Act. They would slash away
with idiot impartiality at defense and social spending, at good
programs and bad. And that would just about end any chance that
Washington would give the stock markets the signal they yearn
for.

What if the negotiations break down and the market gets the
opposite signal:  that the U.S. is unable or unwilling even to
start working out some long-range solution to its gargantuan
budget and trade deficits?  As last week's wild price whipsawing
demonstrated, no one can predict stock prices and volume for
even a few hours. But if the U.S. continues to float on a sea
of red ink and foreign debt--well then, many financial experts
suggest, sooner or later the markets can expect the real crash.
How it could be much worse than Black Monday is as difficult
to imagine as was Black Monday itself just days before. But the
world had better hope it never finds out what the ultimate bust
would be like.

--By George J. Church.  Reported by Rosemary Byrnes and Barrett
Seaman/Washington and   Frederick Ungeheuer/New York, with other
bureaus


Greenspan's Big Test

If any one man can decide how last week's market turmoil will
affect the U.S. economy, and indeed that of the entire world,
he is Alan Greenspan, 61. As chairman of the Federal Reserve
Board, the soft-spoken economic forecaster is the ultimate
arbiter of the nation's credit supply and thus of the interest
rates at which money is lent throughout the U.S. banking system.
On the job less than three months, Greenspan is suddenly being
forced to make rapid and delicate decisions to prevent the
market crash from turning into a mushrooming financial collapse
and to stave off a steep recession. Says Charles Schultze, who
was chairman of President Jimmy Carter's council of Economic
Advisers:  "Greenspan is in a very difficult period in which he
is truly being tested."

Following Black Monday, Greenspan moved quickly to avert
further disaster. The day after the market's plunge, the new
Fed chairman cut short a speaking trip to Dallas and hurried
back to his ornate second-floor office in Washington's Eccles
Building. He had already issued a terse announcement that the
nation's central bank would "serve as a source of liquidity to
support the economic and financial system."  That was a signal
that banks would have no difficulty obtaining additional credit
as needed to provide for the huge losses sustained by
shell-shocked brokerages. Greenspan's announcement produced an
immediate decline in interest rates, as the banking system moved
in effect to replace some of the $500 billion in stock values
that vanished on Black Monday.

Greenspan also began moving behind the scenes to bolster the
Reagan Administration's political response to the crash. Within
an hour of Treasury James Baker's return from West Germany to
Washington on Tuesday, Greenspan was huddling with him to plan
the Administration's response to the market crash. Later that
day the Fed chairman helped persuade Reagan to offer Congress
a summit meeting to negotiate a federal-deficit reduction
program.

People like Lyle Gramley, a former Federal Reserve governor who
is now chief economist for the Mortgage Bankers Association,
praised the Fed chairman for his decisive actions. But critics
like Paul Craig Roberts of Washington's Center for Strategic and
International Studies charge that Greenspan also helped cause
last week's market disaster. They note that back on Sept. 4,
Greenspan's first important move as Fed chief was to push
successfully for a hike in the bellwether discount rate, the
interest that the Fed charges on funds lent to financial
institutions, from 5 1/2% to 6%. It was the first such increase
in nearly 3 1/2 years.

Greenspan justified the rate hike as a move against potential
inflationary pressures, which indeed it was. But for investors,
any increase in interest rates makes stocks less attractive,
since higher returns become available for bonds, Treasury bills
and other fixed-income securities. During the two trading days
after the Fed announced its decision, the Dow Jones industrial
average dropped 54 points. Admits Gramley:  "A common problem
is the markets do not understand Alan Greenspan's statements.
He needed to express [the Fed's decision] more clearly."

Greenspan's task is especially difficult because he follows
Paul Volcker, who left the Fed last August after eight years as
chairman. Volcker was legendary for his ability to inspire
confidence at home and abroad. Greenspan's experience is also
grounds for reassurance. In 2 1/2 years as Gerald Ford's chief
economic adviser, he had some success in combatting
inflation,then the nation's main economic woe. But,
unfortunately, the progress was temporary, and inflation was
not decisively licked until a severe credit squeeze was imposed
in the early 1980s by Volcker and the Fed.