_{WALL STREET’S WORST DAYS}

The Worst Days on the Street

Keeping with the last issue’s theme of the worst pitch decks ever seen, this week we are covering the worst days on the Street, especially after the bloodbath that has ensued over the past couple of days.

Black Monday (October 19, 1987)

“It was relentless." — Peter Low, NYSE floor trader

He loosened his necktie for the first time in 24 years and hadn’t used a bathroom since before 9:30 a.m.

The Dow Jones dropped 22.6% in a single session on October 19, 1987, the largest one-day percentage decline in stock market history, worse than any single day in the 2008 crisis or the COVID crash. Just one random afternoon in October.

Portfolio insurance was supposed to protect against this kind of shock. Pension funds and institutions had bought automated programs that would sell futures contracts as prices fell, a hedge, as they say.

What nobody modeled was what happened when every program tried to sell at once: the selling triggered more selling, which triggered more programs, which triggered more selling. The automated systems that were supposed to limit losses were accelerating them, with no circuit breaker or pause button. Floor traders like Peter Low ran across the NYSE selling 50,000-share lots and just kept going.

The bigger danger wasn’t the stock prices, it was the plumbing. Every trade needs a clearing firm in the middle, making sure the buyer gets their shares and the seller gets their money. One of the biggest clearing firms for options traders was First Options Corp., a unit of Continental Illinois Bank.

As markets collapsed, the options traders First Options cleared for racked up massive losses they couldn’t cover, which left First Options on the hook. If it failed, those trades wouldn’t settle, other firms wouldn’t get paid, and the whole options market could have frozen. Panic spreads fast when nobody knows who can pay.

So the Fed stepped in. It promised to flood the system with cash and pushed banks to keep lending to Wall Street firms, while regulators let Continental Illinois pump emergency money into First Options. The Dow recovered everything within ~two years. The traders’ hairlines did not.

2010 Flash Crash (May 6, 2010)

~$1 trillion in market value disappeared in 36 minutes.

Accenture traded at one cent per share. Sotheby’s traded at $100,000.

At 2:32 p.m. on May 6, 2010, the Dow fell ~998 points (nearly 9%) in minutes before recovering most of it. About $1 trillion in market value evaporated and then largely reappeared within the half hour. The whole thing lasted 36 minutes, but it felt like a lifetime. Or so I’m told. I’m not a dinosaur…I was in elementary school dreaming of being an investment banker.

What caused it: a mutual fund sold 75,000 E-mini futures contracts worth $4.1 billion through an algorithm programmed to execute based on volume, not price. High-frequency traders picked up the contracts and passed them back and forth in a “hot potato” pattern (buying and immediately reselling). In 14 seconds, between 2:45:13 and 2:45:27 p.m., they traded ~49% of all volume while accumulating almost no net position.

Liquidity collapsed. Market makers had standing “stub quotes” (placeholder bids at a penny, or asks at $100,000) that existed only as technical formalities. When real orders couldn’t find real buyers, they hit the stub quotes. Accenture went from ~$40 to $0.01. Sotheby’s briefly traded at $100,000 a share. Exchanges later cancelled ~20,000 of the most extreme trades, but plenty of investors still got burned.

Trading paused for five seconds at 2:45:28 p.m. when the CME’s automated safeguard kicked in, and that pause was enough: prices snapped back within minutes. In 2015, a British trader named Navinder Singh Sarao was charged with spoofing, placing and canceling large fake orders to move prices. He had been doing it from his parents’ house in Hounslow. He pleaded guilty and was sentenced to one year of home confinement, with no jail time. Stub quotes were eventually banned.

2012 Software Bust

Knight Capital lost $10 million a minute for 45 minutes because someone forgot to update one server.

On August 1, 2012, Knight Capital Group, one of the largest equity market-makers in the U.S., handling roughly 11% of daily NYSE volume, deployed new trading software across its eight SMARS routing servers. A technician failed to copy the new code to one of them.

That server still had an old function called "Power Peg" running, originally built years earlier and never deleted. The new deployment sent orders to all eight servers, including the one running Power Peg, but that function had a bug: it never recorded completed orders, so it never stopped sending them.

In 45 minutes, Knight's system executed 4 million trades across 154 stocks, buying and selling 397 million shares. The firm accumulated a net long position of $3.5 billion in stocks it hadn't intended to buy. The pre-tax loss was $440 million, nearly four times Knight's 2011 net income. The company's stock fell 33% that day and 75% over the next two days.

Knight raised $400 million in emergency financing from a group of investors including Jefferies, which took a convertible stake and became the largest shareholder. A better outcome perhaps than the First Brands deal.

By December, Knight agreed to be acquired by Getco LLC. The combined firm, KCG Holdings, was eventually acquired by Virtu Financial in 2017. Knight Capital had been in business for 17 years. It ceased to exist as an independent company 45 minutes after a deployment checklist had one unchecked box. I wonder if the server guy was liable for any of those issues.

COVID-19 (March 9, 2020):

The market triggered its emergency circuit breaker four times in two weeks, a first.

March 9, 2020: market down 7% at the open and trading halted for 15 minutes. March 12: down 7% at the open again. Halt. March 16: the Dow lost 2,997 points (~12.9%) and triggered a third halt. March 18 triggered a fourth.

The S&P 500 fell 34% in 23 trading days, the fastest bear market in history. The mechanism that stopped trading was put in place after Black Monday in 1987. It had never been used and it was used four times in ten days.

The speed mattered more than the depth. In 2008 markets fell further with the S&P dropping 57% from peak to trough but the decline took 17 months. Investors, lenders, and institutions had time to adjust. In 2020, $11 trillion in U.S. equity value was gone before the end of March.

The Fed announced unlimited bond-buying on March 23 (shout out JP). Congress passed the $2.2 trillion CARES Act on March 27. The S&P 500 bottomed on March 23, the same day the Fed moved, and was back at its February highs by August.

The fastest bear market in history became the fastest recovery. A portfolio that panic-sold at the bottom on March 23 locked in a 34% loss. A portfolio that held recovered it entirely within five months.

_{PRESENTED BY PETRARCH}

Fitch Logged Its Highest Private Credit Default Reading Yet

Fitch reported in May that the US private credit default rate reached 6.0%, the highest reading since the firm began tracking the market. 

Most of those defaults were deferred interest and restructured terms. These keep a struggling borrower upright without fixing what is wrong. Some of those companies will recover. The rest wind down eventually and are forced to search for a buyer.

Inventory, real estate, receivables, and intellectual property all have one. The operational records a company generated every working day for years never have, until now... 

Petrarch has built an infrastructure to anonymize and assetize a company’s operational records. They buy those records, clear the rights, de-identify the material (remove logos, names, faces) on premise, and restructure it into an asset with a defined value.

If you are in private credit or distressed assets, set up some time to learn more about them here.

_{NEAR-DEATH EXPERIENCES}

Companies That Almost Didn’t Exist

There are times when companies make crazy moves in an effort to save themselves. Usually, they fail but sometimes the ideas are so crazy that they actually work. These are those times.

FedEx’s Gamble:

Fred Smith flew to Las Vegas with FedEx's last $5,000 and won $27,000 at blackjack. Then he made payroll.

Smith famously got a mediocre grade on the Yale paper that first laid out the idea (or so the legend goes), and he founded FedEx anyway. By 1973, the company had been operating for less than a year, fuel costs were spiraling, and investors had stopped picking up the phone.

Smith flew to pitch General Dynamics for more capital, but its board passed. On the way home, he stopped in Las Vegas, sat down at a blackjack table with the company’s remaining $5,000, and walked away with $27,000. He wired it back to Memphis.

Smith later said the win “wasn’t decisive,” just an omen that things would get better. What actually saved the company was the ~$11 million he raised shortly after.

But for a week in 1973, the difference between FedEx existing and not existing was a few hands of blackjack. The company went public in 1978 and is now worth ~$72 billion. The General Dynamics board can count this among its biggest misses. Fred Smith should have given his dealer in Vegas a couple of shares for fun.

Disney’s Corporate Raider:

Disney paid a corporate raider $328 million to go away, had $10 million in cash, and still almost lost.

In June 1984, Walt Disney Productions had less than $10 million on hand. Theme park attendance had fallen 19% in the first quarter. The animation studio hadn't released anything in years. Into this walked Saul Steinberg, a corporate raider who quietly built an 11.1% stake and filed with the SEC that he intended to acquire up to 49% of the company. His plan was to buy it and break it up.

Disney paid him $328 million in greenmail to make him go away. $300 million was used to buy back his shares at a premium, plus $28 million in expenses using money it essentially didn't have. The payment bought time but was not a solution.

Roy Disney, Walt's nephew, resigned from the board and used his 36% shareholder bloc to force out CEO Ron Miller. Michael Eisner came in from Paramount. Frank Wells from Warner Bros. Within a decade they had produced The Little Mermaid, Beauty and the Beast, Alion King, and The Lion King.

The studio that had no new animation in 1984 became the most valuable entertainment company in history. Steinberg, who had the whole thing in his hands, walked away with a check. Granted, it was a large one.

Friendly Neighborhood Sony-man:

Marvel offered Sony the rights to almost every superhero they had for $25 million. Sony only wanted Spider-Man.

Marvel offered Sony the rights to almost every superhero it had for $25 million. Sony only wanted Spider-Man.

Marvel filed for bankruptcy in December 1996. It owed money to vendors, had cut staff, and was selling movie rights to survive. In 1998, it offered Sony Pictures the film rights to nearly its entire character library, from Captain America and Thor to Black Panther and more, almost everything Disney churns out today, for $25 million total.

Sony’s response, per an executive in the room: forget the rest, just do a deal for Spider-Man.

Marvel licensed other characters for almost nothing. It got a flat $25,000 for Blade, which went on to gross ~$70 million in the US. The characters Sony didn’t want became the core of the Marvel Cinematic Universe, the highest-grossing film franchise in history.

Disney bought Marvel in 2009 for ~$4 billion, and the package Sony passed on is now worth more than most countries’ film industries. The Spider-Man rights are still at Sony, with Tom Holland getting that bag..

Billy G Bails Out Apple:

Apple had 90 days of cash left. The person who bailed them out was Bill Gates.

By mid-1997, Apple was functionally insolvent. Gil Amelio had been pushed out as CEO, Jobs had just returned, and the company had roughly 90 days of operating cash remaining. Hilarious now for a company that is effectively a mutual fund that sells iPhones and has a war chest rivaled only by Berkshires.

What happened next was the most uncomfortable moment in Silicon Valley history: at Macworld Boston on August 6, 1997, Steve Jobs announced that Microsoft would invest $150 million in Apple and commit to continuing to make Office for the Mac.

Bill Gates appeared on a giant screen behind Jobs via satellite. The crowd booed (obviously).

The deal included a patent cross-license and made Internet Explorer the default Mac browser, both humiliations for a company that had spent years positioning itself against Microsoft.

But without the investment and the Office commitment, Apple's enterprise credibility was gone and the cash was gone with it. Jobs framed it as a partnership of mutual interest but it was a lifeline.

Apple launched the iMac the following year, the iPod in 2001, and the iPhone in 2007. Microsoft sold its Apple stake by 2003 at a significant gain. Apple is now worth $3.5 trillion. The $150 million that saved it is a rounding error on a rounding error, even to Bill.