Modern futures markets are generally assumed to have originated and developed on their own with the sole aim of providing a more efficient and effective marketing venue and risk management tool for buyers and sellers of commodities. It has been observed that
[I]t is not too much to say that free commodity markets [âŠ] are symbols of free societies [âŠ] State Socialism, whether Communist, Fascist, or Socialist, means the destruction of free markets and their replacement by governmental buying and selling monopolies [âŠ] Commodities exchanges are vital to the economic stability of a free society.1
The idea of the futures market as the epitome of financial capitalism carries over into the study of the history of the development and governance of modern exchanges. Governments, in the accepted history, attempted, mostly unsuccessfully, to interfere with the laissez-faire Chicago Board of Trade (CBOT), along with its major competitor in Chicago the dominant exchange of the twentieth century. However, futures markets, today ubiquitous in modern finance, were in fact co-constructed during the interwar years by users, individuals and, crucially, the US Federal Government. Early on, the CBOT controlled the process and, often, the outcome, yet government had very important roles to play in what became co-regulation. By the end of the interwar era the government cooperated closely with futures users to refine the regulatory and governance regimes that mostly survive into the present day. This book tells the story of the development of the many modern institutions for trading and governance that were developed in the USA during the interwar years, offering lessons for future regulation and governance debates, especially those following the global financial crisis of 2008â2009 (GFC). Government, then, had both critical and positive roles to play in the development of early financial markets and their governance.
Futures trading truly came of age in the middle of the nineteenth century in many commercial hubs of the USA, particularly the Midwestern city of Chicago.2 The exchange trading of contracts of specified quantities and qualities of a commodity, to be delivered at some future date, has since expanded to include most globally traded commodities and, more importantly, currency, stock, bond and money markets. Such contracts are now ubiquitous in modern finance. In 2014, 21.87 billion futures and options contracts were traded on exchanges globally, for a dollar-equivalent volume of $50,000,000,000,000 ($50 trillion). In 1910, as in 1940, the CBOT was dominant, executing 80 to 85% of all futures contracts traded in the USA.3 Chicago futures exchangesâwith the CBOT now merged into its ex-rival, the Chicago Mercantile Exchange (CME) and the Chicago Board Options Exchange (CBOE) spun off into its own entityâcontinue to lead derivatives trading into the twenty-first century.
The CBOTâas one of the preeminent markets for the trading of futuresâhas remained synonymous with innovative and successful financial market capitalism, and its institutions and modes of governance have been adopted far and wide, including in the 2010 âDodd-Frankâ Act meant to cure the excesses of the 2008â2009 GFC .4 In fact, the GFC has directly impacted the academic study of financial regulation, and regulation in general, while further driving a wedge between those who believe that crises are caused by too little regulation and those who believe there is too much.5 Free market economists tend to argue that the laws and regulations of the land led directly to too much risk in the financial system.6 Even if government regulation was a main cause of the crisis, the solution is still debatable. Barth, Caprio and Levine want to set up an âoverseerâ regulator on top of the already overwhelming and often conflicting extant regulatory regime .7 Others advocate for significantly fewer rules. Indeed, industry pushback on the new post-crisis regime has been quite successful, arguing that over-regulation inhibits economic growth by restraining financial markets.8 Many commentators, especially from the Chicago school, lament that any collaboration between the state and industry must inevitably lead to the capture of the regulations and the regulators by the industry, enabling the latter to extract concessions or powers from those with political power.9 That is, state interference is always bad, either allowing the regulated to extract monopoly (and other) rents or inhibiting growth through unnecessary and throttling regulation and enforcement.
There is an almost endless debate among practitioners, academics and interest groups over whether markets, their users and, indeed, all affected by the markets, are better served by laissez-faire or government control. This book robustly argues that this is a false dichotomy: the Chicago futures markets were demonstrably improved and nurtured by both industry governance and governmental interventions during the interwar years. As is becoming increasingly clear, the state and markets can and do work together effectively to create and nurture new markets.10 This work, with clear substantiated historical evidence that governments and industry can work together to build better governance systems and solid, enduring institutions, should remind our lawmakers and regulators, as well as those in the financial markets, that laissez-faire on its own cannot be relied on to create efficient markets.
Current futures markets share many institutions and governance systems with the markets of 1923â1936. All markets are defined by (i) what is now known as central clearing of all trades, (ii) the reporting and dissemination of large positions in the market, (iii) a requirement for daily margining based on daily closing prices. Further, all exchanges (iv) possess Business Conduct Committees (BCC) and have (v) enacted rules regarding self-dealing, and (vi) segregating clientsâ monies from brokersâ capital. Additionally, market data of all types are provided willingly by all futures exchanges, rather than distributed grudgingly, or even entirely withheld, as they were before 1923. Central clearing is perhaps the most important of all of these innovations, but each and every institution and control listed above is present in modern futures markets all over the world, in products ranging from cotton to crude oil to euro/dollar to stock indices.11 Importantly, all of these innovations were established between 1923 and 1936. Many commentators view the development of central clearing as the most significant. Yet before 1922, elements of the CBOT resisted any such changes. It is my contention that it was specifically government involvement that facilitated, if not always instigated, the institutional and governance changes necessary to ensure reasonably efficient markets for all users by 1936.
For all of Chicagoâs symbolic power and actual dominance of many financial and commodity markets for a century or more, there are very few studies of the origins of modern futures trading. Of those, none can rely, as this one can, on the inside story, told via the formerly private papers of the key actors. This book is intended to fill a major gap in our knowledge of the evolution of these key markets during the interwar years, documenting the role of a newly empowered US Federal Government in co-constructing these financial markets with, rather than in opposition to, the Chicago-dominated grain futures industry. One key conclusion from this study is that governments play crucial roles in developing and maintaining the efficient functioning of markets, since the CBOT may not have been capable of acting in its own best interests, let alone in the interests of society. This finding is still relevant to this day.12 The finding also contradicts the accepted accounts, which are unfortunately based on ideological biases, (shallow) readings of press reports and public government documents.
1.1 Rhetoric over Policy Substance, in 1922
On the Senate floor on 9 August 1921, Senator Arthur Capper , self-described populist newspaperman and sponsor of a bill on the floor at the time, announced that âthe grain gamblers have made the exchange building in Chicago the worldâs greatest gambling house....