Chicago’s Decade of innovation: 1972-1982
“The Chicago system was so dynamic. There were days when there’d be guys fighting – fistfights. It was just great drama. It was wonderful. It made for an aura that said: ‘We’re going to trade these things; we’re going to price these things; and I’m going to do better than you’. That’s the Chicago story.”
- Wayne Luthringshausen,
Options Clearing Corporation chief executive since 1975
If anyone in Chicago in the 1960s had suggested that within a few decades the city would establish itself as an international financial centre, they would have been laughed out of town. To be sure, Chicago was to some degree a centre of money management, a banking hub for the US Midwest. It was also a town whose biggest markets had international significance: the settlement prices for corn, oats, wheat and soybean futures at the Chicago Board of Trade, the world’s biggest futures market, set prices for the whole world. But agricultural commodities were simply not part of mainstream finance. Wall Street was largely indifferent to futures trading, which was looked at as an exclusive domain of farmers and industrial food producers.
Yet between 1972 and 1982, Chicago’s futures exchanges effectively created modern financial derivatives markets. In a decade-long burst of radical innovation, the Chicago Board of Trade and the Chicago Mercantile Exchange – its younger and smaller rival –introduced a string of new financial derivatives that completely transformed the city, its exchanges and the entire world of finance. Beginning with the creation of the International Monetary Market in 1972, followed by the birth of the Chicago Board Options Exchange in 1973, through the introduction of Government National Mortgage Association (“Ginnie Mae”) Mae futures in 1975, futures on US Treasury bills in 1976, US Treasury bond futures in 1977, Eurodollar futures in 1981 and capped by the creation of index-based derivatives and options on futures in 1982, this decade of innovation laid the foundation of modern finance. It marked a critical paradigm shift, opening up the world of derivatives to the power of trading financial instruments and making the broader financial world aware of the importance of derivatives.
The new products the exchanges introduced in those ten richly creative years would help establish Chicago in the subsequent decades as America’s – some would say the world’s – capital of risk management. They would come to form the backbone of today’s markets. Derivatives markets, which four decades ago were purely agricultural in nature, are now dominated by the trading of financial products. More fundamentally, the very contracts launched between 1972 and 1982 continue to make up the bulk of today’s futures markets. Volumes may have grown exponentially, trading may have become speed-of-light fast, open outcry may be breathing its last gasps, but the most traded derivatives in the world remain products such as interest-rate futures, index-based contracts and exchange-traded options. Not only did Chicago attract the world to its markets, it also exported its methods internationally: today, scores of exchanges around the world trade futures and options on the Chicago model.
Why Chicago? How did this city on the edge of the Midwestern prairie make the leap from trading corn and soybean oil, cattle and pork bellies to international currencies and equity options, interest rates and Eurodollars? What enabled Chicago to transform itself into an international financial centre and, in turn, to change the way the entire world traded? And why did the basis for this transformation occur in one explosive, decade-long burst of innovation? Another question lurks implicitly beneath all these: what did Chicago have that New York – the undisputed capital of American finance – lacked?
With hindsight, Chicago’s advantages over its eastern counterpart are clear: its experience of creating new products and the liquidity to trade them; the vitality and dynamism of its trading floors; its culture of hedging and risk-taking; its political savvy; its evangelism for derivatives markets. But at the time, there was little sense in New York that Chicago was a potential competitor. If anything important were to happen in finance, New Yorkers simply assumed it would happen in New York. Within the city’s financial community, the products traded in Chicago were even not referred to as ‘futures’, but more derisorily as simply ‘commodities’. “They thought of them as something farmers played around with,” recalls Bill Brodsky, the WFE chairman and CBOE chairman and chief executive, who was working at the time for Model, Roland and Co., a New York securities firm that became a charter member of the CBOE.
This snootiness only aided Chicago’s efforts. For one thing, it obscured the marked difference between New York and Chicago at the level of the exchanges themselves. Creativity was at the heart of the Chicago exchanges. Over the years they had learned not only how to create new products, but also how to create the liquidity needed to make them successful.
Such creativity was alien to mainstream New York finance. Product innovation was simply not part of operating a stock exchange. Rather than actively seeking business, the large New York stock exchanges operated in a world in which they were used to being approached by companies seeking to secure a share listing. Historically, the route to success for a stock in New York usually progressed through a predictable sequence. When a company first went public, it would trade on the “pink sheets”. When it achieved more volume, it graduated to the American Stock Exchange. The pinnacle of success was a listing on the New York Stock Exchange. The system worked, and the exchanges themselves had little need for innovation or the creation of liquidity.
This difference was to prove critical to the transformation of the Chicago trading world. Necessity had often been the mother of innovation in Chicago: in the face of falling trading volumes in existing contracts, the exchanges frequently turned to new contracts, with varying degrees of success. In response to slumping trade in its traditional contracts, the Board of Trade looked to soybean futures in 1936, soybean oil contracts in 1950 and soymeal futures the following year. The Merc, meanwhile, tried to diversify during the Great Depression with cheese futures and potato contracts. In 1942, when the Second World War put a low limit on trading volumes, the Merc launched onion futures and an experimental contract in hides. In 1949, when trading volumes in egg futures slumped, the Merc had introduced apple, dressed poultry and frozen egg contracts.
A similar motivation gripped the Chicago exchanges in the late 1960s. The catalyst that led to the creation of financial derivatives was really the search for diversification. Trading volumes had slumped at the Board of Trade as government-controlled agricultural surpluses drove down grain prices. The soybean market, which had become one of the exchange’s most promising growth areas, went through a series of short periods in which markets went very quiet, prompting the senior of Chicago’s two main trading venues to start to look once again for new contracts to trade. “People were sitting on the edge of the bean pit reading the newspaper, for lack of anything else to do,” remembers Joe Sullivan, CBOE’s first president, who was then director of the Board of Trade’s planning and market development department and who – along with Eddie O’Connor, the exchange’s vice-chairman and a member of the new products committee – would lead the effort to develop the new options market.
Meanwhile, although the recently introduced cattle and pork belly contracts had really taken off at the Merc, many at that exchange remained somewhat shell-shocked from the Congressional ban on onion futures in 1958, the first time a futures market had been closed by fiat from Washington. Moreover, the markets for butter and eggs had been transformed by new technology, effectively making obsolete the corresponding futures contracts. These developments reinforced the notion that contracts could both be killed and die naturally. On one hand, this legacy spurred an even greater desire to diversify. On the other, the success of the new contracts – which were growing much faster than the Board of Trade’s grain futures – put a spring in the step of the Merc, with the idea that the younger exchange might finally challenge its big brother on LaSalle Street for the limelight.
Financial futures were not the first or the last contracts that were tried out in the energetic pursuit of diversification. The Board of Trade launched beef futures in 1965 and followed the Merc in introducing live cattle futures in 1966 (the Merc had introduced them in 1964). In 1968, the exchange launched futures on iced broilers (processed chickens packed in ice), followed by plywood futures and silver futures in 1969. Throughout the 1960s, as well as live cattle, live hogs and pork bellies, the Merc had launched a host of new contracts – futures on apples, potatoes, shrimp and turkeys – none of which really took off. The Merc also launched lumber futures in 1969. There was much that was innovative in these new products. Live hog and cattle contracts for the first time eliminated the problem of storage, while plywood, lumber and silver futures took the exchanges away from their dependence on agricultural products. However, the aim was not necessarily to develop a novel breed of futures so much as to create a successful new trading vehicle that would extend the exchanges beyond their traditional products. “Basically we were looking for another pit, another contract,” recalls Corky Eisen, by then a senior and active member of the Board of Trade. “We weren’t thinking in terms of a new exchange. We weren’t out to create a whole new world. We just wanted a little pit in the corner of the trading room.”
It was in this context that financial futures emerged – as yet another possible route to diversifying the range of contracts being traded. The idea did not pop up in Chicago out of thin air. For some years, there had been discussions among traders, lawyers and academics about how to craft financial derivative contracts. There was talk about the possibility of futures on bankers’ acceptance notes, a type of commercial paper. Milton Friedman, the University of Chicago economist, had publicly complained about retail investors being shut out of trading currency forwards after a series of US banks blocked him from selling short $300,000-worth of British pounds in 1967. As a graduate student, Mark Powers, who went on to become the first economist at the Merc in 1969, had heard Friedman discuss foreign exchange futures in a public debate. In 1968, Murray Borowitz, a former trucker and a member of the New York Produce Exchange, had proposed to launch futures on the Dow Jones Industrial Average on the newly formed National Product Exchange – a plan vetoed by the SEC. That same year, senior members of the Board of Trade discussed and rejected the idea of a cash-settled futures contract on the Dow. In 1970, Richard Sandor – then a professor at Berkeley and later the Board of Trade’s chief economist – wrote a paper about futures on catastrophe risk for the Journal of British Finance.
Even such talk may not have been as novel as it seemed. Several years earlier, Elmer Falker, a spats-wearing, cigar-chomping, oyster-eating diminutive floor trader, had talked on the floor of the Merc about stock-index futures being the “ultimate” futures contract, but had lamented that “it will never happen ‘cause you can’t take delivery”. Falker’s comment suggests that such ideas had for some time been the subject of casual conversations in the futures world.
The hunt for new products took the two exchanges in different directions. Although the Board of Trade considered stock futures, the exchange ultimately decided to use its licence with the Securities and Exchange Commission – the only one of its kind among the US commodities exchanges, it had been acquired in 1929 in order to trade stocks but had lain dormant since 1939 – to trade equity options. The Merc decided to develop currency futures. Markets for both already existed – in the case of options, an over-the-counter business run by put-and-call dealers in New York; while an inter-bank market operated for currency trading. Rather than reinventing the wheel, the Chicago exchanges were aiming to put their floor-trading expertise to work on bringing transparency, price discovery and openness to markets that were hitherto deeply inefficient (options) or highly restricted (currencies).
The lack of openness in the currency market had been exposed by Milton Friedman’s repeated public expressions of frustration at having been locked out of trading in 1967. Another economist with a growing interest in derivatives – Myron Scholes – recalls being similarly irritated when trying to trade the over-the-counter put and call options whose prices were advertised in Sunday editions of the New York Times. “I would price them all and call a dealer on Monday morning to make a trade,” says Scholes. “He would tell me they were sold out and try to offer me something else. That’s when I learned about ‘bait and switch’.” The market was informal, inefficient and unorganised. Put and call dealers would gather in Michael’s, a New York restaurant, working at the tables and the telephone booths.
Chicago was not alone in recognising there was an opportunity in introducing exchange-trading to these markets. In April 1970 – several years before financial futures traded in Chicago – the International Commercial Exchange, another project spearheaded by Murray Borowitz at the New York Produce Exchange, launched futures trading on nine currencies. The ICE’s efforts would seem to have justified the paranoia of Leo Melamed, the Merc Chairman at the time, who spearheaded the effort to establish the IMM. “I thought it was such a good idea that someone would steal it – the Board of Trade, or if not them, those bastards in New York,” he recalls.
However, Melamed and other Merc officials were calmed on a two-day visit to the ICE shortly after its launch. “It was like being in a library,” he says. “There was no sound.” The contracts he saw were quite unlike those he had in mind – sized at $10,000-worth lots, they were more aimed at small businessmen traveling to Europe than at tapping into the inter-bank market. “They had it all wrong,” he says. “If this was a good idea, it was a big idea and you needed the dealers to be involved, so the size of the contracts had to make sense.” More critically, the ICE effort was introduced while the Bretton Woods system was still in place, denying the new market the volatility it needed to flourish.
Within two years, Bretton Woods had collapsed and the Merc launched the International Monetary Market, whose success in the wake of the ICE’s failure suggested an instructive lesson – to succeed, Chicago did not have to be the first; it had to be the best. First-mover advantage was obviously important, but it did not guarantee success. Ultimately, it did not matter where the idea for financial futures originally came from. As Murray Borowitz had demonstrated, there was no profit per se in dreaming up the idea. What mattered was if the idea could successfully be put into practice. First-mover advantage only applied if the move itself was viable. Financial futures may not have been born in Chicago, but they certainly grew up there.
That lesson was reinforced at the tail-end of Chicago’s “decade of innovation”, when the Chicago exchanges were beaten by the Kansas City Board of Trade in the race to introduce index-based futures. The KCBT launched Value Line stock index futures in February 1982 (it had first proposed them in 1977), two months before the Merc introduced S&P futures. Two years earlier, the world’s first cash-settled futures contract had been launched not in the US but at the Sydney Futures Exchange – a US dollar currency future. In the US, Kansas City received first approval in 1982 from the Commodity Futures Trading Commission for the first cash-settled index futures contract. Nevertheless, ultimately the contracts thrived not in Kansas or in New York – where the New York Futures Exchange also launched a cash-settled index-based futures contract – but in Chicago, which contained by far the biggest pool of experienced futures traders. Within five months of being launched, the Merc’s S&P contract had overtaken the combined trading activity of its rival products in New York and Kansas City. To be sure, New York had a futures-trading community – particularly at the New York Produce Exchange, which had also spotted the opportunity offered by expanding into financial contracts – but it was not in the mainstream of Wall Street. The New York Produce Exchange had also been severely weakened by the $150m DeAngelis salad oil scandal of 1966. The result was that while the brightest and best minds in Chicago were completely focused on futures, their counterparts in New York were concentrated on equities.
With the IMM, the Merc had launched the first viable market for financial derivatives, a record that might have gone the way of the Board of Trade were it not for the SEC’s tortuous approval process. In fact, the Board of Trade’s board first discussed the idea of an options exchange in 1969 – a year before the Merc’s board began considering currency futures, but securing the regulatory go-ahead proved a long road. The SEC’s opposition to the proposal was embodied in Irving Pollack, then director of the agency’s division of trading and markets (and subsequently an SEC commissioner), who Sullivan remembers as “an old-guard, throw-back regulator, bound and determined to stop us in our tracks”. Pollack’s attitude to the plan was encapsulated in a remark he made to Sullivan, in which he told the Board of Trade employee he had “never seen a market manipulation in which options weren’t involved”. When the exchange first met the SEC staff to discuss the idea, Pollack told them “not to waste a nickel on this. There are absolutely insurmountable obstacles to doing what you’re proposing, so forget it.” At times, SEC staff seemed willfully ignorant that what was being proposed was quite different to an equity exchange, insisting that exchange-created options have an “issuer”, that margins be set at the same level as equities, that investors should receive prospectuses and that options should be traded through specialists rather than open outcry.
By the early 1970s, attitudes in Washington began to change, as a more business-friendly tone filtered down through the agencies of the federal government following Richard Nixon becoming president in 1969. William Casey, who became SEC chairman in 1971 (and subsequently went on to run the CIA under Ronald Reagan), was much more sympathetic to the Board of Trade’s proposal and helped overcome the resistance of SEC staff. By October 1971, Pollack himself gave the go-ahead in a letter written in fluent legalese. “Based on the material presented to date, the Commission finds that in principle the proposed options exchange does not appear to be inconsistent with relevant statutory requirements and standards,” he wrote.
Although this marked a severe about-face for the SEC official, Joe Sullivan recalls that perhaps the only part of the CBOE proposal Pollack favoured from the start was the plan to separate brokers and dealers and to give priority to public orders. In Pollack’s view, this was far superior to the trading system at the New York equity exchanges, whose specialists the SEC staffer regarded as “a bunch of thieves”, Sullivan recalls.
This difference was another critical reason why the IMM and the CBOE succeeded – the dynamism, camaraderie and meritocracy of the trading floors of the Chicago exchanges stood in sharp contrast to their counterparts in New York. At the New York Stock Exchange and the Amex, liquidity was based on the specialist system. The specialists effectively had a monopoly on making markets in individual shares, while the rest of the market was made up by traders employed by brokerages. As Myron Scholes remembers: “The specialists had the keys to the city, they had the mantra, they had fixed commissions. They didn’t have to innovate. They were selling securities in a securities-based world.”
The Chicago system of trading had evolved very differently. Members of the exchange could trade in the pit either on their own account, as a broker for others, or both. This system had inherent conflicts of interest, but in Chicago no one had the “right” to be the market-maker in a particular product. There was no concept of monopoly or franchise. Traders were not limited to any one pit, and often went from one to another, creating both genuine competition and a thirst for new trading opportunities. That made the Chicago exchanges the most vibrant, lively, competitive and aggressive in the world, with the biggest pool of independent professional risk-bearers anywhere.
The distinction made a tangible difference to the market. For example, when the Amex launched options trading in 1975 and started to compete with the CBOE, the spreads were tighter in Chicago. In 1977, The Economist noted that the CBOE “has a superior form of market mechanism to conventional American stock exchanges; instead of one, occasionally two, ‘specialists’ who trade both as agents and as principals, there are several designated market-makers who trade only for their own account. The competing market-makers account for the higher volume of trading and for the finer spreads on CBOE.”
If the New York financial community tended to look down its nose at the Chicago trading style, the traders on the floors of the Merc and the Board of Trade reciprocated the sentiment, plus interest. “We thought New York was stodgy,” recalls Charlie Carey, who began trading in the 1970s and went on to become chairman of the Board of Trade in 2003. “We thought it was run by brokers and specialists. We thought that’s what led to their inability to capture new ideas like the CBOE. It was run by the large New York firms. In Chicago, we were proud that what we did was open and honest. Anyone who wanted to had an equal chance of making money. You didn’t feel that way about New York. It was a closed game, rigged against the customer.”
There was also a strong sense of community among the Chicago traders. Many had little or no formal education, and the pit was their classroom. In Chicago, futures trading was a way for those with limited opportunities elsewhere to become wealthy and successful. Typically, people often began their lives at the exchanges as clerks before moving on to the trading pit. They grew up on the trading floor, both personally and professionally, with cohorts maturing under the watchful eyes of senior traders. They were often loud and brash, dressed sharply, used colourful language and socialised together after trading hours. “There was a very clubby atmosphere,” recalls Charlie Carey. “It was a small grain-trading club. There were 1,400 members but only about 600 or 800 came to work every day – you’d be surprised how many of the guys down there you’d end up knowing. It was kind of clubby by pit.”
Younger traders were often mentored by older patrons who gave or lent them the start-up money they needed for membership or trading. Corky Eisen recalls a conversation with his mentor in 1950. “He said: ‘You’ve been given an opportunity here. You owe the same opportunity to those who come behind you.’ That was the difference between Chicago and New York. There, you were born to it, here you aspired to it and you worked your way up.”
The mentor gave Eisen $15,000 to help him become a clearing member at the Board of Trade. “He said: ‘here’s how you get started’,” Eisen says. “I said: ‘how do I thank you?’. He said: ‘you don’t. You owe somebody else a chance’. That was the culture here. Years later, after he retired to Florida, he came to visit Chicago and I took him to the market-makers’ lounge and introduced him to a young trader sitting there. The young guy threw his arms around him and hugged him. ‘I owe my start to you,’ he said. ‘Corky told me you wrote him a cheque to get him started, and he in turn has got me started. I owe my career to you’.”
Chicago was not entirely meritocratic, however. As in New York, where specialist positions often passed from father to son, having a relative on the floor was a big help, particularly at the Board of Trade. “It was difficult to break in to the Board of Trade unless you knew somebody, you had an entrée or someone shepherded you along,” says Les Rosenthal. “I was lucky. The person who sponsored me didn’t have a family of his own and he took me under his wing and sort of adopted me. Were it not for someone who was willing to sponsor me through the membership process, I wouldn’t have been able to join.” Ethnic ties also helped. Within Chicago, the Board of Trade was often known as “the Irish exchange” and the Merc “the Jewish exchange” – a caricature, albeit one with a grain of truth.
The sense of community reflected the fact that there was an enormous amount of member control in Chicago, a structure that made members very interested in the institution of the exchange itself. Member control was reflected in their attitude to even the most senior exchange employees, who the traders regarded as their employees. The members had in mind not only what the exchange presented them in terms of opportunities to trade but also what was “best” for the institution. Corky Eisen and other traders of longstanding at the Board of Trade would deliberately trade newly launched contracts to try to ensure they would be a success. He recalls a colleague’s reaction when Eisen rushed to participate in trading a new futures contract for live chickens. “He said to me: ‘what do you know about trading chickens?’ I said: ‘Absolutely nothing, but I don’t care if it’s horseshit or hay – it’s a contract and I’ll trade it’.” Soon after Eddie O’Connor had helped establish the CBOE, he returned full-time to the soybean pit. “I got involved in the options only because we were in expansion mode,” he says. “I was doing it for the exchange, but my livelihood was trading soybeans.”
Member control could also be a burden – particularly when it came to trying to secure internal approval for launching financial futures. The Board of Trade faced a more serious hurdle in this regard. As the more established exchange, it had a more conservative culture. Even after the SEC gave the CBOE proposal the initial nod, Sullivan and O’Connor still faced considerable opposition among the members. Some of the naysayers were motivated by business considerations. The membership of the Board of Trade could be broadly divided into “locals” – independent traders – and “commercials” working for the big food-processing companies. The locals were more keen on the idea, while the commercials, in general, were not. “The Board of Trade was an agricultural exchange,” recalls Corky Eisen.” It was run by the Cargills, the Continental Grains and the Bunges, and that was their world. It was very difficult to sell them on the concept of coming up with a new trading vehicle. They liked it just the way it was.” These companies with long institutional memories were also aware of the part options – in their former guise as “privileges” – had played their part in the Great Wheat Collapse of 1932, when speculators tried to corner the wheat market using calls and futures, a scandal that led to commodity options trading to be banned under the 1936 Commodity Exchange Act. Equity options had almost been banned as well two years earlier.
Other opposition was more down to internal politics, led by a trader named Ford Ferguson, whose faction had not only backed the idea of trading Dow Jones futures but also strongly disliked the leaders of the CBOE effort. “Whatever O’Connor tried to do, Ferguson was against it,” Eddie O’Connor recalls. Another problem was that by early 1970s, the commodity markets had taken off again, and the need for diversification seemed less urgent. The interminable dealings with the SEC meant most Board of Trade members saw no progress for at least two years. On a few occasions, only the chairman’s casting vote kept the project alive. At times, Sullivan and O’Connor pulled the wool over the members’ eyes in order to hide the spiralling costs.
As the up-and-coming exchange, the Merc was more open to new ideas. In the late 1960s, a group of “young Turks” had seized control of the Board. However, Leo Melamed recalls that there was some initial opposition to the plans for the IMM. “There were former egg traders, agricultural traders who opposed the move into financial futures,” he says. “Cattle and pork bellies were doing well and hogs were coming up. The cost of membership had gone up from $3,000 to $100,000. They thought it would be a risk, that it would blow up and destroy the exchange or make us a laughing stock.”
Even in the mid-1970s, when the CBOE had demonstrated success, the Board of Trade membership was far from convinced about Ginnie Mae futures. “Whatever programme you came up with, there was always 49 per cent of the group that was against it,” says Les Rosenthal. When it came to the proposal to issue special-purpose seats to trade the new contracts, the member ballot was only won by two votes – one of whom had to be dragged back from O’Hare Airport to participate in the vote. One recurring argument was that new contracts would take away business from established ones, recalls Richard Sandor. “First they argued the bonds would take liquidity from the Ginnie Maes. Then they argued the 10-year T-notes would take liquidity from the bonds. Then they argued the bond options would take liquidity from the bonds. None of it was true. In fact, they created liquidity because people wanted to speculate on the yield curve,” Sandor says.
The ability to overcome such opposition was another aspect that set Chicago apart. The city’s exchanges were blessed with extraordinary leaders – both political leaders and thought leaders – who collaborated to bring new ideas to fruition in the face of internal and external obstacles. Leo Melamed, Joe Sullivan, Eddie O’Connor, Richard Sandor, Les Rosenthal – these men were extraordinary visionaries, risk-takers, unafraid to use their intellectual imagination, determined to bring their ideas to fruition and devout believers in the future of their industry. The Merc – which was to overtake the Board of Trade in size and eventually to acquire it – also had tremendous continuity of leadership, which saw Leo Melamed and Jack Sandner in powerful positions for decade after decade. That continuity provided a long-term vision that enabled the exchange to flourish.
In spite of this leadership, the opposition to the IMM and CBOE suggested that even though Chicago had established liquidity and dominance in futures trading, it would not necessarily be a straightforward task to transfer it over to the newly listed products. The exchanges responded ingeniously. At the Merc, rather than depending on the existing members to move from their established pits over to the untested markets, the exchange created a new institution with its own membership. Every full Merc member received an IMM seat, but the exchange also created 150 new memberships, which went on sale to the public at the relatively low level of $10,000. This innovation overcame both the problem of depending on veterans to provide the bulk of liquidity and – because membership was very affordable – tapped the pool of young would-be futures traders for whom the cost of a full membership was prohibitive. As a result, the exchange attracted young blood – a tranche of new, youthful traders, including professionals attracted by the prospect of making serious money; fresh college graduates; sons, relatives and friends of Merc members; and “runners” or others in low-level positions at the Merc. “They were different because they were hungry, they were in their twenties and thirties and they had something to prove,” recalls Leo Melamed.
The CBOE was also established as a separate entity. In part, this was because opponents at the Board of Trade took the view that it should shoulder its own debts rather than foist them on its parent. Moreover, for regulatory reasons it also made sense not to make equity options simply another pit on the established trading floor. As its own exchange, the CBOE also had its own sale of seats – which, like those at the IMM, were priced at $10,000. However, in order to ensure liquidity, the CBOT, as the founder exchange, gave all of its 1302 members a perpetual right to trade at the CBOE, inadvertently creating a problem that would later came back to haunt the options exchange in a series of lawsuits that delayed its demutualisation and were only resolved in 2009. The CBOE’s trading hours were longer than those of the grain pits, staying open until 3pm to allow them to cross over to the options floor when trading finished at 1.15pm on the main exchange. (When it came to launching financial futures, the Board of Trade similarly stratified the trading hours to accommodate grain traders who wished to cross over after the main pits had closed for the day.) In line with the collegial sentiment of helping new contracts along, a group of senior traders also created “the lunch bunch” – up to 40 people who would move over to trade options when the grain pits were quiet between 11am and 12.30pm. Both the longer hours and the “lunch bunch” helped create instant liquidity at the CBOE and added to its success.
Chicago’s other great built-in advantage over New York was in clearing. The weakness of the settlement process in New York was exposed in the late 1960s and early 1970s in the paperwork crisis, which overwhelmed back offices and forced the New York Stock Exchange to reduce trading hours, extend the settlement cycle by one day and shut its doors every Wednesday. Rather than genuine clearing houses, New York had mechanisms for physically delivering stocks after each transaction. By contrast, the nature of a future or option was different, so clearing was more efficient in Chicago, where futures trading and clearing functioned effectively throughout the paperwork crisis (albeit on lower volumes). When New York subsequently succeeded in immobilising stock certificates by creating the Depository Trust Company and the National Securities Clearing Corporation, “they recreated the Chicago system,” says Wayne Luthringshausen, who was put in charge of the CBOE’s clearing house at its inception.
The CBOE’s clearing house – modelled on that of the Board of Trade’s Clearing Corp – began as a wholly-owned subsidiary of the CBOE. However, in 1975, when the Amex was seeking to launch options trading, negotiations at the SEC between the exchanges produced two possible solutions: interfaced clearing houses – essentially recreating the stock model – or one common clearing house. Luthringshausen convinced Sullivan to push for the latter option. “If Amex came in with its own clearing, it wouldn’t be long before the New Yorkers moved all their business there,” he recalls. “So I said: ‘Let’s control clearing as much as we can’. I convinced him we needed to fight to keep it in Chicago. If we hadn’t, the New Yorkers would’ve overwhelmed it.” What emerged was the Options Clearing Corporation, still based in Chicago and now the world’s biggest derivatives clearing house.
With the creation of the IMM and the CBOE, the dawn of financial derivatives had arrived. Both of the Chicago exchanges had established separate trading institutions dedicated exclusively to the buying and selling of financial products, the first time such a thing had happened outside New York. Building on its long history of futures trading, the city had moved beyond agricultural products and into a new era. A few big names on Wall Street came to Chicago to trade for the first time. The dawn of a new era was not immediately evident, however. The general attitude in New York to the IMM was one of dismissive indifference or incredulity, although some of the more progressive thinkers on Wall Street showed more interest initially in the CBOE – including Robert Rubin, then a partner at Goldman Sachs, who was a founding director of the exchange. The transformation of Chicago into an important financial hub was not truly recognised until after the “decade of innovation”. Some in Chicago would say today that the leaders of Wall Street have still yet to recognise the city’s status. Nevertheless, within a few years of the launch of the IMM and the CBOE, financial derivatives seemed to be on the verge of fulfilling Leo Melamed’s uncharacteristically modest boast to Richard J. Daley, the legendary mayor of Chicago, that they would “move the centre of gravity of finance in the country a couple of feet west of New York”.
Having created new memberships through the creation of the IMM and CBOE, the Chicago exchanges repeated the trick throughout the decade. When the Board of Trade launched interest rate futures, it created another class of memberships to trade the new contracts. In 1976, the Merc further expanded its membership by offering 300 seats at the relatively cheap price of $30,000 each to non-livestock traders in what was to become the Associate Mercantile Market Division. In 1982, the Merc did the same when it secured a licence to trade Standard and Poor’s index futures, creating 1,300 new seats in its Index and Options Market (IOM) for all members (at a cost of $30,000 each) and sold more seats to the public (for $60,000 each). The Board of Trade did the same with the Index, Debt and Energy Market (IDEM) and the Commodities Options Market (COM) in 1982. Each new development became an opportunity to create more memberships, tied to trading particular new products. The system ensured that the contracts would be successful and freed them from any dependence on veteran traders. As Les Rosenthal puts it, the seat expansions were “designed to do attract ‘cannon fodder’ for the new contracts … It was very difficult to get an established corn trader to trade US government bonds. We designed memberships that could only trade government bonds and couldn’t trade corn, so the corn trader wouldn’t be worried about creating competition for himself.” The result was that from 1972 to 1982, the number of exchange memberships tripled to about 6,000. The net effect was that capital and liquidity poured into the new markets.
Although this was a further step for the exchanges, they had always understood the importance of creating liquidity in new products – something their New York counterparts had never had to deal with. As far back as the 1850s, the Board of Trade had tried luring traders with a free lunch of cheese, crackers and ale when trading was slow.
In the 1930s, the Merc enthusiastically solicited new members with newspaper ads, educational pamphlets and by cold-calling commodity brokers. In the late 1960s, the Merc had hired Martin Cohen, a daring young advertising executive, who had created eye-catching ads that even ran in Playboy magazine. Being naturally more conservative, the Board of Trade was slower to dive in to modern advertising, but by the time Ginnie Mae futures were launched, the exchange made up for it with an ad in Forbes that promoted the new contract by personalising Ginnie as a beautiful young woman, winking one lash-rich eye at the reader with an enticing look.”We’re not plain grain any more,” the ad stated. As an industry with a shady reputation, about which many investors were either ignorant or had a negative opinion, the futures and options industry was forced to market its products in a way that stock markets did not. The Chicago exchanges set out on these campaigns with a missionary zeal. To promote the IMM, the Merc sent its top executives on a European road show to drum up support from investors across the Atlantic. Since volumes at the IMM built up slowly, the exchange was forced to promote it even harder. In 1980, the Merc went on to become the first US exchange to open an office in the City of London. Such efforts not only helped build liquidity for the exchanges themselves, but also had a positive effect on the entire industry. The success of options in the US, for example, in large measure depended on the CBOE’s efforts in direct education to both brokers and customers.
The Chicago exchanges understood, then, that new products had to be explained, that investors and traders needed to be educated. As the “lunch bunch” demonstrated, within the exchanges, a sense had also developed that liquidity had to be created, with exchange leaders and senior members prodding their fellow traders to help provide volume. When the Merc came to launch S&P futures in 1982, Jack Sandner and Leo Melamed ran a highly effective campaign that saw them standing at the door of the exchange and handing out lapel badges to every trader with the motto “Fifteen minutes, please” on them, to try to encourage traders to spend some time each day trading the new contracts. Such efforts came after many contracts over the years had fallen by the wayside. For much of the history of the Chicago exchanges, product development had been akin to throwing mud at a wall and trading whatever stuck, with committees of traders coming up with ideas for new contracts without a great deal of preparatory research.
In the late 1960s, both the Merc and the Board of Trade started to take a more professional approach, hiring teams of economists to research new products and potential markets. Mark Powers, an agricultural economist at the University of Wisconsin who had written his doctoral dissertation on pork belly futures, went to work for the Merc in 1969, where he played a critical role in the development of the IMM. Richard Sandor, a professor at Berkeley, joined the Board of Trade in 1972, where the departure of Joe Sullivan – not an academic but a former financial journalist – to the CBOE had left a research void. The recruitment of academic economists was another difference between Chicago and New York. Some veteran members did not see the need to recruit academics. “What do we need a doctor for?” Izzy Mulmat, a Jewish émigré who retained a strong central European accent, asked rhetorically when the Merc hired Powers. “Are we a hospital?” But such appointments were a natural corollary to the need of Chicago’s exchanges to create new products to trade. Because the markets were innovative, experimental and valued financial engineering, they were attractive to the top minds in cutting-edge financial research – among them, Nobel laureates Milton Friedman, Myron Scholes (whose collaborator Fischer Black had died by the time Scholes was awarded the Nobel) and Robert Merton. “Here was a live, real market that people came to study,” says Sandor. “It was a laboratory for economists.”
For example, a 1968 study of the options market, led by Burton Malkiel and Richard Quandt at the Financial Research Center at Princeton University, encouraged the Board of Trade to try to bring exchange trading to the options market. (Quandt, Malkiel and their Princeton colleague William Baumol, along with James Lorie and Merton Miller of the University of Chicago and Paul Cootner of MIT, also helped write the Nathan Report, the CBOE feasibility study submitted to the SEC.) Milton Friedman, then a professor at the University of Chicago, wrote the feasibility study for the IMM and teamed up with Melamed to promote the idea.
The academics were not just a source of ideas. The exchanges used the support of Friedman and Malkiel and Quandt to add an air gravitas and respectability to undertakings that met with a great deal of scepticism and deprecation, particularly in New York. When the Black-Scholes formula was published – by happy coincidence, a few months after the CBOE launched – it not only helped traders in the fledgling market to price options accurately, but also added to the status of the new exchange, with the idea that some of the youngest and brightest economists of the day were interested in how the market functioned.
As Sandor was to find out when he made the move from San Francisco to Chicago (a move initially made as a one-year sabbatical) however, having good ideas only got you so far. Together with Warren Lebeck, the Board of Trade’s executive vice-president and secretary, Sandor drafted the first contract for Ginnie Mae futures in April 1972, one month before the launch of the IMM. Although the contract needed to be reshaped no fewer than 23 times before it was ready to trade, the most serious hurdle the Board of Trade faced was regulatory. Under the US regulatory framework of the early 1970s, interest-rate futures would have been viewed as securities and thus subject to the jurisdiction of the SEC. Given the hoops the Board of Trade had been forced to jump through to gain approval for the CBOE, that was not a prospect the exchange relished repeating. At the same time, it became clear that with the futures sector’s expansion into financial contracts, the industry’s continued regulation by the US Department of Agriculture’s flaccid Commodity Exchange Authority was becoming unsustainable. Political action to enhance oversight of the futures industry was also spurred by the widespread outrage in the early 1970s at the rising cost of food – a phenomenon many consumers blamed on the phantom of “speculation” at the Board of Trade and the Merc. In response, Congress recommended a new watchdog designed specifically for futures markets, including financial futures. The Board of Trade – which had spent a considerable amount of time developing ties and educating staff at the Agriculture department – initially balked at the idea, but quickly came to see that it could shape the new agency to its benefit. The Merc was also enthusiastic.
Chicago’s main point man in the negotiations in Washington over the new agency was Philip McBride Johnson, the Board of Trade’s outside counsel. During two years of hearings, Johnson practically lived in the capital, explaining time and time again the role of the futures markets and rebutting accusations of excessive speculation. The Board of Trade had sent Johnson to Washington to secure two main objectives. First, to ensure the new agency would have sole and exclusive authority over the futures markets. Secondly, the young lawyer was tasked with the aim of making sure “that the definition of a commodity would get broadened out to include just about anything that the mind could imagine,” Johnson recalls. This broadening out had to be done without using the word ‘security’. There was a concern that the interest-rate futures the Board of Trade was developing would be deemed in Washington as instruments on securities, raising the prospect that the exchange would once again become entangled in a drawn-out approval process at the SEC. To Johnson’s credit, he fulfilled his mission on both counts, in spite of the efforts of some at the SEC – who feared the erosion of the distinction between securities and commodities – to thwart the Chicago lobby.
The creation of the CFTC in 1975 was a milestone for the futures industry. For the first time, futures markets were regulated according to contract type rather than the underlying commodity. This cut across the existing regulatory framework, however, setting up a perennial turf war between the new agency and the more powerful SEC. Moreover, the creation of the CFTC allowed futures trading on intangibles such as interest rates for the first time. By providing a clear and unambiguous regulatory framework, it set the legal foundation for the futures industry to become largely financial. Ironically, it also represented an important moment of recognition for an industry that had so often been overlooked. As Richard Sandor notes: “You know you’ve arrived in Washington when you get your own regulatory agency.”
In the wake of the ban on onion futures, the Chicago exchanges had talked about stepping up their visibility in Washington, but the creation of the CFTC made that a more urgent need. The Board of Trade set up a political action committee in 1976 and the Merc did the same the following year. They raised money quickly: in his first address to the membership as Merc chairman in 1980, Jack Sandner was able to boast that the exchange’s political action committee was second only to Standard Oil’s, with a war chest of $340,000. Both exchanges set up permanent offices in Washington to work with the CFTC and lobby Congress. The exchanges also looked to the US Department of Agriculture when looking for staff, such as the Merc’s appointment of Clayton Yeutter, a former Assistant Secretary of Agriculture (and subsequent Agriculture Secretary) as its chief executive in 1978.
As soon as the CFTC was up and running, the Board of Trade secured approval for Ginnie Mae futures, the first financial futures launched on the exchange. Like the IMM and the CBOE, Ginnie Maes sought to standardise and transfer over to exchange-trading forward contracts from an over-the-counter market. When Richard Sandor began researching Ginnie Mae futures after arriving in Chicago, he soon learned that the Federal Home Loan Bank Board, the Citizens Federal Savings and Loans Association in San Francisco and “Freddie Mac” – the Federal Home Loan Mortgage Corporation – had all been working on the same idea. These organisations provided important political support in Washington during the debates around the creation of the CFTC.
When the Board of Trade launched Ginnie Maes in 1975, there was no long bond market in the US. “If there was a long bond, we probably would’ve done that first,” says Sandor. However, once the US federal government started to issue long-term debt, the exchange instantly recognised it would be more volatile than Ginnie Maes and had the potential to be a far bigger market. “We figured we were in the right church but the wrong pew,” recalls Les Rosenthal. In the meantime, the Merc – which had been advised that Ginnie Mae futures were unfeasible and that there would be more business on the short end of the Treasury curve than the long – responded rapidly to the Board of Trade’s entry into interest rate contracts by launching futures on 90-day Treasury bills in 1976. The Board of Trade countered with 20-year T-bond futures in 1977, the most successful futures contract in the history of the industry. The Merc hit back with futures on one-year T-bills in 1978 and 4-year T-notes in 1979. In 1982, the Board launched futures on 10-year T-notes.
This exchange of contract gunfire suggested another reason why Chicago’s futures industry was so dynamic: there was competition between the exchanges. It was rarely the kind of head-to-head competition that led to them listing similar contracts, however, and more the kind of rivalry between two exchanges both trying to assert themselves as the top trading venue in the futures world. Although the Board of Trade had historically looked down on the Merc and continued to do so for much of the 1970s, it could not ignore how the younger exchange had grown very fast, taking an increasing slice of market share and overtaking by some measures. “The Merc had gone from nothing to a major exchange in a few years,” says Eddie O’Connor. “That was an impetus for the Board of Trade to get into an expansion mode.” For its part, the Merc had a point to prove and a rival to catch up with. “We would try to beat them to the punch on a product design,” says Jack Sandner. The exchanges had tended to dance around each other, even when they competed, although in the 1960s the rivalry had intensified around live cattle and beef contracts. There was no direct tussle in the interest rate products both launched in the 1970s, but there was a general sense of competition to be the “best” exchange in Chicago. This spirit was another advantage Chicago had over New York, where the relations between the exchanges were very different.
In spite of Chicago’s increasing presence in Washington, the exchanges could not insulate themselves from the broader political climate. Just as the Nixon administration had been good to the futures world, President Jimmy Carter looked on it less favourably. In 1978, Carter even floated the idea of scrapping the CFTC. James Stone, Carter’s choice as CFTC chairman in 1979, was seen by the industry as hostile, and product approval under his leadership slowed to a sluggish crawl. Stone, a former Massachusetts insurance commissioner and brother of Oliver Stone, the Hollywood director, clashed with both Chicago exchanges in 1980 – struggles that the exchanges were able to win by using their new lobbying might on Capitol Hill. Although the Stone years were challenging, industry lobbying was able to block the appointment of Hugh Cadden, Stone’s special assistant, and Jamie Wade, another Stone protégé (known in Chicago as the “Stone Clone”) to seats on the Commission.
When Ronald Reagan became president in 1981, a more benign environment prevailed towards the Chicago exchanges. Reagan named Philip McBride Johnson to be the new CFTC chief. For the first time, the agency had a chairman who knew the industry from the inside – and from the perspective of Chicago. Within several months, the Chicago exchanges would be thankful for having their own ‘man on the inside’. In 1981, the CBOE applied to trade options on Ginnie Maes. The Board of Trade – fearful of any damage to its lucrative futures contract – first objected to the SEC and then sued when the Commission approved the contract, bringing the CFTC-SEC conflict into a federal courtroom. The resolution of this case ultimately enabled the creation of index-based futures, finally severing the exclusive link between derivatives and physical assets. The great hurdle between the futures exchanges and the juicy opportunity of index-based contracts – long a dream of the futures industry – was deliverability. The obvious solution was cash settlement, yet this was the very issue that in the minds of many had long drawn the line between ‘legitimate’ commercial trading and ‘illegitimate’ financial speculation. In the 19th century, the Board of Trade had successfully waged a legal war against ‘bucket shops’, which took bets on what prices the markets would quote, even persuading the state of Illinois to change its gambling laws to outlaw cash-settled contracts.most were settled by offsetting the trade by buying or selling an ‘opposite’ contract), but the underlying commodity was always deliverable. On the face of it, Eurodollar futures – another highly successful contract, developed by Fred Arditti, the Merc’s chief economist and launched in 1981 – were cash-settled, but the underlying commodity was itself US dollars. That was not the case for stock index-based contracts, which for the first time required that an underlying asset be translated into cash for settlement. John Shad, then chairman of the SEC, and Philip McBride Johnson both understood the market disruption that would occur in securities markets if they were to insist on delivery in index-based futures. By 1981, for decades only a tiny fraction of contracts had been physically settled (
The 1982 Shad-Johnson Accord that emerged from negotiations between the chairmen formally established two critical principles: that securities were within the CFTC’s jurisdiction when futures trading was involved; and that cash-settlement was valid for futures (even though the CFTC’s statute referred time and again to a delivery right). This brought the idea of cash-settlement out of its 80-year-old exile, finally ‘legitimising’ the practice and paving the way for the introduction of index-based derivatives. Once again, Johnson – backed up by the exchange’s powerful lobbying arms – had secured Chicago’s interests in Washington. Bill Brodsky, who was the Amex’s executive vice-president at the time, remembers feeling that in the negotiations, the Chicago exchanges “ate our lunch”, outwitting and outmanoeuvring both the SEC and the New York exchanges, who felt that politics and lobbying were somehow beneath them and underestimated how good the Chicago exchanges had become at the Washington game.
The advent of cash-settlement and the increasing strength of Chicago’s voice on Capitol Hill did not mean that arguments about speculation were over. The bankruptcy of the Hunt brothers, which caused ructions in silver, gold and cattle markets in 1980, forced the Chicago exchanges to make their case much more widely than to the agriculture committees on Capitol Hill with whom they were used to dealing. There had been such hearings on the futures markets before, but the Hunt scandal caught the public’s imagination, shining a bright, accusatory light on the industry. Jack Sandner remembers testifying in front of Senate banking committee presided over by William Proxmire, the Wisconsin Democrat. Butting in ahead of Sandner’s opening statement, Proxmire began the hearing saying: “Before you speak, I want to tell you what I think what you do: what you do is like Klondike fever at the Indianapolis 500.” The mixed metaphor may have been hostile, but at least by calling the Merc to give evidence, Congress was recognising that the exchanges had become important financial institutions.
The Shad-Johnson Accord enabled the exchanges to launch the stock index-based derivatives that Elmer Falker, Murray Borowitz, Joe Sullivan and Eddie O’Connor had dreamt of but been unable to trade. Kansas City had just beaten Chicago to the starting line but with the vibrancy of their trading floors, the Merc and Board of Trade knew they could do better. The Board of Trade mis-stepped, listing a contract based on the Dow Jones Industrial Average without first consulting Dow Jones. “We thought it was like the word ‘aspirin’, that it had become generic,” says Sandor. The exchange had to withdraw the contract. The Merc had tried to collaborate with Dow Jones but were rebuffed, which propelled them into the arms of Standard and Poor’s. The exchange negotiated an excellent deal for use of the S&P 500 – one so favourable in the Merc’s favour that it voluntarily reworked the agreement two years later to give more revenue to S&P. The year after the Merc launched S&P futures, the CBOE launched options on what was to become the S&P 100, the first cash-settled index option.
As they moved into the world of stock indexes, the Chicago futures exchanges needed to tap expertise from Wall Street – especially since New York was becoming increasingly aware of the potential for financial futures and threatening head-on competition. The Merc acted boldly in 1982 by poaching Bill Brodsky from the Amex to be its executive vice-president and chief operating officer. It was the first time the Chicago exchanges had gone to New York to find a senior executive with expertise in stocks and options. “It’s a sign of the times that William Brodsky doesn’t know beans about pork bellies,” the Chicago Tribune observed wryly.
A year that had already proved its place in futures history was capped when later in 1982, the Board of Trade launched options on Treasury bond futures, a move that would be echoed throughout the 1980s with the launch of options on a wide range of financial and agricultural futures.
In terms of new products, industry growth and the wider use of derivatives, the “decade of innovation” marked just the beginning for the financial futures and options industries. But much of the groundwork for that future expansion was already set. The growth of financial products was so explosive that it was clear by 1982 that they represented the industry’s future. The most popular products of subsequent decades would be contracts launched between 1972 and 1982: equity options, Treasury futures, Eurodollars, index-based derivatives. In subsequent decades these contracts would provide entire suites of products, with a host of new contracts based around the original building blocks put in place during the “decade of innovation”. They became part of mainstream finance, widely used by companies, money managers, financial institutions and trading houses as an integral part of their investment strategies. In 1979, Salomon Bros made news by hedging part of a $1bn IBM bond offering using T-bond futures. Morgan Guaranty Trust set up Morgan Futures Corp in 1981, becoming the first big commercial bank authorised as a futures commission merchant. The US government rapidly came to depend on the Treasury futures market, to the extent that a few days before Christmas in 1982, the government held an auction for $3bn of 20-year bonds one day ahead of schedule so as to allow the Board of Trade to close at noon on December 23 as usual. The arguments about speculation did not disappear (they were to re-emerge a few years later after the 1987 crash) but the futures industry had its own Washington watchdog and a clearly defined legal framework.
Chicago’s need to promote the futures and options industry and its belief in its value to modern financial markets also prompted a willingness to share its intellectual capital. The CBOE helped the European Options Exchange launch in Amsterdam in 1978. Not only was the EOE modelled on the CBOE, traders also used the same kinds of jackets as their counterparts in Chicago and conducted business in English. Veterans of the Chicago exchanges also helped launch the London International Financial Futures Exchange in 1982. Chicago would go on to aid the launch of the Singapore International Monetary Exchange in 1984 by providing clearing services through an electronic link. Some in financial circles wondered why Chicago would give away its secrets, but in the Windy City the belief was that the more people that understood the value of derivative instruments, the more the Chicago exchanges would ultimately benefit. By contrast, the New York stock exchanges lacked both the same kind of know-how to share and the proselytising ethos of their Chicago counterparts.
Chicago’s exchanges had shrugged off their purely agricultural past and created a brave new world, one in which the city was an important international centre. They had succeeded because they had experience of developing new products and liquidity; because their trading floors were vibrant and aggressive; because they had built a presence in the corridors of political power; because they possessed energetic, entrepreneurial and determined leaders; because they attracted the brightest theoretical minds; because of cross-town rivalry; because they believed in spreading the word about derivatives markets; because they took nothing for granted.
Good timing, prescience and luck also played their part. A prime example was the Black-Scholes formula, which had little to do with Chicago’s efforts. Rather, it sprang from what Myron Scholes regarded as the “interesting academic exercise” of trying to value options based on over-the-counter data collected by his students. Black and Scholes had first presented their ideas in a 1970 paper, but had difficulty publishing it until 1973, shortly after the CBOE launched. By coincidence, around the same time, handheld calculators were introduced, proving extremely valuable to options floor traders – so much so that Texas Instruments hard wired the formula into their models specifically to be sold to traders at the CBOE. While the story of the CBOE, Black-Scholes and the handheld calculator marked the unique confluence of three unrelated events, broader trends also helped other Chicago markets to flourish. The IMM capitalised on the collapse of Bretton Woods. Ginnie Maes were born out of the creation of the CFTC. Treasury futures benefited from the 1979 “Saturday Night Massacre”, when Paul Volcker, then chairman of the Federal Reserve, decided to target the money supply instead of interest rates, and the issuing of huge amounts of government debt. Index-based futures had the Shad-Johnson Accord. Portfolio theory was increasingly coming into play, making derivatives more attractive to financial institutions.
Innovation did not cease after 1982. The Chicago exchanges still launched new products and made them successful. However, the “paradigm shifts” of the kind that the IMM, the CBOE, Treasury futures and index contracts represented became much fewer and further between. The CBOE’s Volatility Index, introduced in 1993, was a genuinely “basic invention” of the same kind. Other attempts at new products – such as weather (also developed by Fred Arditti), real-estate and carbon emissions contracts (championed by Richard Sandor) – have not yet attracted large trading volumes. In the years after the “decade of innovation”, organic growth in the new financial markets meant there was simply no need for exchanges to look aggressively at “blue sky” inventive activity. There was the entire yield curve on Treasuries to be filled in, indices to be added, options on futures to be rolled out. By the 1990s, the exchanges’ attention turned to issues such as demutualisation, electronic trading and infrastructure building to accommodate the massive new markets. Later on, a good deal of product innovation began to move from exchanges to electronic trading firms, which developed their own algorithms rather than depending on the exchanges to launch new instruments. The CME’s purchase of the CBOT in 2007 put an end to cross-town rivalry and created the largest financial exchange in the world, an institution that could easily afford to buy innovation.
Today, thanks to the “decade of innovation”, Chicago is comfortably among the world’s financial centres. However, that period demonstrates that incumbency can slide into inertia; and Chicago cannot afford to become complacent. In the days of electronic markets, rivals can as easily emerge from Atlanta or Kansas City as New York. As competition becomes ever more global, new competitors are springing up in emerging economies, which have the power to develop their relatively untapped markets in innovative directions. In the 1970s, Wall Street and securities markets operated in a quite different world from derivatives. The “decade of innovation” transformed finance by changing the very idea of what capital markets could become. Nowadays, barriers between asset classes have largely been eliminated – at least, outside the US – opening up the world of finance to new trading possibilities. The experience of Chicago suggests that to take advantages of these new opportunities, exchanges around the world would do well to think more imaginatively than simply mimicking products that have already been established elsewhere. With electronic trading dominating markets and most exchanges no longer owned by traders, they cannot depend on the pits to generate ideas. That makes it even more important for exchanges to maintain open lines of communication with their customers, both as a sounding board for the new kinds of financial instruments they are trying to develop and to encourage liquidity when it comes to launching them. Moreover, as the “decade of innovation” showed, a good sense of timing is everything. As the global economy continues to become ever-more interwoven, international trends will throw up new opportunities for trading as-yet-unthought-of financial instruments. In an age in which financial markets are truly global, the competition is furious, but the rewards are vast and the possibilities endless.
 All quotes are from interviews with the author unless otherwise footnoted. The author thanks those who gave time to be interviewed for this chapter: Bill Brodsky; Charlie Carey; Corky Eisen; Scott Gordon; Philip McBride Johnson; Wayne Luthringshausen; Leo Melamed; Eddie O’Connor; Les Rosenthal; Jack Sandner; Richard Sandor; Myron Scholes; and Joe Sullivan.
 Tamarkin, Bob, The Merc: The Emergence of a Global Financial Powerhouse New York: HarperBusiness, 1993. p. 61; p. 86
 The 1958 Onion Futures Act was prompted by lobbying by the National Onion Growers Association, which argued that speculation at the Merc had driven down onion prices. The law was introduced into Congress by Gerald Ford, at the time a Republican representative from Michigan who went on to become US President. It has never been repealed.
 By 1969, Everette Harris, CME chairman, was boasting that pork belly futures at the Merc had overtaken corn futures at the Board of Trade in August of that year as the world’s most traded futures contract, with cattle futures a close third. Volume at the Merc was also ahead of the Board of Trade’s in August 1969 (see ‘History of the Chicago Mercantile Exchange’ by Everette B. Harris, available to download on www.cmegroup.com
 Comment by Richard Sandor, in interview with author.
 Tamarkin, p.179
 Falloon, William D., Market Maker: A Sesquicentennial Look at the Chicago Board of Trade Chicago: Board of Trade of the City of Chicago, 1998 p. 209; Tamarkin p. 157; Lothian, John, ‘Who is Murray Borowitz?’, John Lothian Newsletter, September 16, 2004
 Falloon, p. 210
 Cited in Tamarkin, p. 99
 Tamarkin, p.270; author correspondence with Matthew Gibbs, Manager Corporate Relations at ASX, March 16, 2010
 Tamarkin, p.429
 Sandner, Jack, address to the Financial Times World Financial Futures Conference, London, September 14, 1982
 Falloon, p.211
 Tamarkin, p. 183
 Cited in Falloon, p. 220
 Interview with Joe Sullivan.
 Interview with Philip McBride Johnson.
 Interview with Joe Sullivan.
 Cited in Falloon, p. 226
 “Before World War One, the Board of Trade was very WASPy, but then the Irish started to take clerk jobs at the exchange,” says Corky Eisen. “Later, there was a three-pronged membership: Irish, Jewish and WASP.” Certainly, many senior leaders and traders at the Merc had been Jewish immigrants.
 Falloon, p. 221
 Falloon, p.218
 Eddie O’Connor recalls that it was easier selling CBOE memberships to CME members than to getting support for the idea at the CBOT, because “they were used to backing new concepts”.
 Recollection by Richard Sandor, in interview with the author.
 The IMM subsequently became a division of the Merc in 1976.
 Sullivan recalls that this would have made CBOT traders subject to regulation by the SEC.
 Joe Sullivan remembers this group as “the McDonald’s lunch bunch”, as they would tend to trade McDonald’s options, whose post was the closest to the main CBOT trading floor.
 Most of the active options traders were new members, however. Eddie O’Connor recalls that only about 20 traders made the move from trading in the CBOT pits to the CBOE.
 Tamarkin, p. 166
 Tamarkin, p.12
 Interview with Leo Melamed. Richard Sandor, who was charged with organizing the research department at the Board of Trade, recalls that there was also opposition to the professionalsation of staff among the members there.
 Falloon, p. 241
 The 1966 DeAngelis salad oil swindle had exposed the CEA’s weakness when the General Accounting Office and the USDA both found evidence that the CEA had known of illegal activities but had failed to act. By 1973 the USDA was openly criticising the CEA for exercising only “minimal surveillance” over exchanges. Moreover, the CEA was unready for a world of financial futures. Leo Melamed recounts that to win approval for currency futures, the CME had to fill out a form that requested information about the size, location and condition of the warehouses in which the underlying commodities would be stored.
 Sander, Jack, Address to the Membership, 1980
 Falloon, p. 238
 In popular imagination, cash-settlement and illegal betting became synonymous, painting the notion of financial contracts as immoral: bucket shops figured in the Congressional debates of the early 1930s that led to the establishment of the SEC.
 As the sociologist Yuval Millo notes: “in a market where index-based contracts are traded, an obligatory delivery would be equal to calling for a market crash. Therefore, what was a condition of the legal existence of trading in the ‘real assets’ world became unbearably dangerous in the world of index-based contracts.” (Millo, Yuval, ‘From Green Fields to Green Felt Tables and Back: The Origins of Index-Based Derivatives’, Centre for Analysis of Risk and Regulation Discussion Paper No. 44, 2007)
 The bank received regulatory approval in 1982, shortly after the North Carolina National Bank in Charlotte was also approved. Morgan’s FCM application met with stiff resistance from some commodity brokers and dealers, who feared the banks would lure away their customers.
 Falloon, p. 252