1 00:00:02,920 --> 00:00:05,240 Speaker 1: The market has been going up for a while. Nothing 2 00:00:05,240 --> 00:00:08,000 Speaker 1: goes up forever. If you have been away from your 3 00:00:08,000 --> 00:00:10,720 Speaker 1: television set and haven't heard about the stock market, this 4 00:00:10,920 --> 00:00:14,920 Speaker 1: was it. The market declined to practice. It was probably 5 00:00:15,000 --> 00:00:17,160 Speaker 1: the scariest time of when in my sixteen years to 6 00:00:17,200 --> 00:00:20,880 Speaker 1: the SEC that Monday and into Tuesday. But the idea 7 00:00:21,120 --> 00:00:26,560 Speaker 1: was to create a factual reconstruction of what happened. Meanwhile, 8 00:00:26,840 --> 00:00:29,320 Speaker 1: in downtown New York you had the American Stock Exchange 9 00:00:29,440 --> 00:00:32,720 Speaker 1: and that's where Nate Most and Steve Bloom we're working together. 10 00:00:32,960 --> 00:00:36,559 Speaker 1: These are market nerds. So we were hoping that day 11 00:00:36,560 --> 00:00:39,839 Speaker 1: would take debate, so to speak, and the m X did. 12 00:00:49,000 --> 00:00:52,960 Speaker 1: This is Tralians Presents. I'm Joel Weber. Over the course 13 00:00:53,000 --> 00:00:55,400 Speaker 1: of this podcast, we're going to be sharing the story 14 00:00:55,480 --> 00:00:58,840 Speaker 1: behind the e t F. In our first episode, we 15 00:00:58,960 --> 00:01:03,240 Speaker 1: got into what happened on October nineteenth, or Black Monday, 16 00:01:03,360 --> 00:01:06,320 Speaker 1: when the stock market crash. Every American at this day 17 00:01:06,360 --> 00:01:09,600 Speaker 1: of the game needs to get the house in order 18 00:01:09,720 --> 00:01:12,280 Speaker 1: and also the response of the federal government and regulators. 19 00:01:12,360 --> 00:01:16,440 Speaker 1: I'd say for the next three months through early January, 20 00:01:16,480 --> 00:01:18,720 Speaker 1: a bunch of us had two jobs, which was, you know, 21 00:01:18,760 --> 00:01:21,759 Speaker 1: investigating what happened and writing the report up and doing 22 00:01:21,760 --> 00:01:23,640 Speaker 1: our day job. So the FEDS want to make sure 23 00:01:23,640 --> 00:01:26,520 Speaker 1: this never happens again, and the SEC starts digging to 24 00:01:26,520 --> 00:01:29,039 Speaker 1: find answers and a way to prevent another crash like 25 00:01:29,080 --> 00:01:31,759 Speaker 1: this one, which brings us back to these two guys, 26 00:01:32,240 --> 00:01:35,319 Speaker 1: Nathan Most and Stephen Bloom. Nate Most was in his 27 00:01:35,400 --> 00:01:38,400 Speaker 1: seventies with the background in physics and commodities trading, among 28 00:01:38,480 --> 00:01:41,440 Speaker 1: other things. And then there's Stephen Bloom who at twenty 29 00:01:41,480 --> 00:01:44,360 Speaker 1: seven was fresh out of Harvard with the PhD in economics, 30 00:01:44,880 --> 00:01:46,680 Speaker 1: and the two of them were teamed up at AMS 31 00:01:46,840 --> 00:01:49,600 Speaker 1: to create innovative products for the exchange. They had just 32 00:01:49,680 --> 00:01:53,800 Speaker 1: read the SEC Market break Report, and we're beginning to 33 00:01:53,800 --> 00:01:56,960 Speaker 1: toy with an idea for a new financial tool, one 34 00:01:57,000 --> 00:01:59,200 Speaker 1: modeled after a section that they'd read in the report. 35 00:02:03,320 --> 00:02:06,520 Speaker 1: What the SEC effectively did was to provide the sketch, right, 36 00:02:06,560 --> 00:02:10,040 Speaker 1: It's almost like drawing on paper of what they would 37 00:02:10,240 --> 00:02:13,440 Speaker 1: envision as a market basket instrument. So what Most in 38 00:02:13,480 --> 00:02:16,440 Speaker 1: Bloom did was to take this sketch and fill out 39 00:02:16,440 --> 00:02:18,280 Speaker 1: all the colors, make it into sort of a full 40 00:02:18,280 --> 00:02:20,680 Speaker 1: blown painting, if you will. But instead of a painting. 41 00:02:20,680 --> 00:02:23,600 Speaker 1: It was a legit product that was given back to 42 00:02:23,600 --> 00:02:26,560 Speaker 1: the SEC that was above and beyond what they initially 43 00:02:26,600 --> 00:02:30,520 Speaker 1: put down in their sketch. And here's that initial sketch 44 00:02:30,760 --> 00:02:33,079 Speaker 1: read by one of its artists who you'll remember from 45 00:02:33,080 --> 00:02:37,000 Speaker 1: episode one, the secs, Howard Kramer. We suggest that an 46 00:02:37,040 --> 00:02:41,120 Speaker 1: alternative approach be examined. Presently, program trades must be broken 47 00:02:41,200 --> 00:02:43,919 Speaker 1: up and distributed around the stock floor, with the resulting 48 00:02:43,960 --> 00:02:48,400 Speaker 1: substantial transaction costs and effects discussed above. The creation, however, 49 00:02:48,560 --> 00:02:51,520 Speaker 1: of one or more posts where the actual market baskets 50 00:02:51,560 --> 00:02:54,960 Speaker 1: could be traded, might alter the dynamics of program trading. 51 00:02:55,240 --> 00:02:57,840 Speaker 1: The availability of basket trading on the n y C 52 00:02:58,320 --> 00:03:01,760 Speaker 1: would in effect restore program trades two more traditional block 53 00:03:01,800 --> 00:03:05,120 Speaker 1: trading techniques. The basket specialists would be able to identify 54 00:03:05,240 --> 00:03:07,680 Speaker 1: the nature of each trade. We are hopeful that this 55 00:03:07,720 --> 00:03:11,160 Speaker 1: would encourage block positioners to again become active in providing 56 00:03:11,200 --> 00:03:15,600 Speaker 1: capital to position the program blocks, while arbitrage would continue 57 00:03:15,639 --> 00:03:18,440 Speaker 1: to flow directly to the individual stocks to maintain their 58 00:03:18,480 --> 00:03:22,400 Speaker 1: pricing efficiency. Other institutional trades could be focused on the 59 00:03:22,440 --> 00:03:25,840 Speaker 1: basket posts, where the specialists and trade and crowd could 60 00:03:25,840 --> 00:03:29,480 Speaker 1: provide an additional layer of liquidity to the system and 61 00:03:29,520 --> 00:03:33,200 Speaker 1: cushioned somewhat the individual stocks from the intra day volatility 62 00:03:33,280 --> 00:03:37,560 Speaker 1: caused by program activity. Okay, that was a little dense, Eric, 63 00:03:37,680 --> 00:03:39,480 Speaker 1: Can you help us make sense of what that means. 64 00:03:39,760 --> 00:03:42,720 Speaker 1: What they're basically outlining here is, Look, you're gonna have 65 00:03:42,760 --> 00:03:45,000 Speaker 1: a product that represents a bunch of stocks, it's gonna 66 00:03:45,000 --> 00:03:47,840 Speaker 1: be traded by market makers, and it's gonna be physically 67 00:03:47,880 --> 00:03:54,560 Speaker 1: backed after the SEC publishes this thing. Grammer says he 68 00:03:54,600 --> 00:03:57,560 Speaker 1: remembers getting a slew of phone calls about the report. 69 00:03:57,760 --> 00:04:00,200 Speaker 1: The report came out with some time in early eighty eight, 70 00:04:00,320 --> 00:04:04,040 Speaker 1: so I'm guessing, you know, just just a guess, you know, 71 00:04:04,560 --> 00:04:06,760 Speaker 1: six months later, eight months later or something like that. 72 00:04:06,880 --> 00:04:10,120 Speaker 1: Then he hears from most in Bloom and they're like, hey, 73 00:04:10,120 --> 00:04:13,880 Speaker 1: you know, we we noticed that you have this suggestion 74 00:04:13,920 --> 00:04:16,560 Speaker 1: in the report, and we'd like to hear a little 75 00:04:16,560 --> 00:04:19,240 Speaker 1: bit more about it. And there are some discussions back 76 00:04:19,240 --> 00:04:22,880 Speaker 1: and forth. I highly respected name Moos and Steve Bloom. 77 00:04:23,000 --> 00:04:25,560 Speaker 1: They were rocket scientists at that time and in that 78 00:04:25,720 --> 00:04:28,200 Speaker 1: sense of the word, and they were really good at 79 00:04:28,200 --> 00:04:33,240 Speaker 1: and adapted developing the products. Myself and others in the 80 00:04:33,320 --> 00:04:36,320 Speaker 1: division had some discussions, and at some point, I don't 81 00:04:36,320 --> 00:04:40,359 Speaker 1: remember when, they probably sent in a draft prototype and 82 00:04:40,400 --> 00:04:43,200 Speaker 1: or draft of what they were talking about. Creamer and 83 00:04:43,200 --> 00:04:45,800 Speaker 1: the others at the SEC are not the only ones 84 00:04:45,880 --> 00:04:50,160 Speaker 1: with whom they share this prototype. Most took the idea 85 00:04:50,240 --> 00:04:53,440 Speaker 1: to Jack Bogel, who was running Vanguard at the time. 86 00:04:53,560 --> 00:04:56,440 Speaker 1: Bogel says he gets a cold call from Nate Most. 87 00:04:56,880 --> 00:04:59,920 Speaker 1: And it's important to note here that Jack Bogel may 88 00:05:00,200 --> 00:05:03,760 Speaker 1: be the most influential investor of all time, even more 89 00:05:03,760 --> 00:05:08,320 Speaker 1: so than Warren Buffett. Bogel basically invented indexing and founded 90 00:05:08,320 --> 00:05:12,240 Speaker 1: the behemoth Vanguard, whose low cost mutual funds have helped 91 00:05:12,279 --> 00:05:15,279 Speaker 1: millions of Americans retire. So it's a big deal to 92 00:05:15,320 --> 00:05:18,080 Speaker 1: just cold column. And he has very clear thoughts about 93 00:05:18,080 --> 00:05:23,240 Speaker 1: Wall Street and investing, namely, watch the fees, diversify, focus 94 00:05:23,279 --> 00:05:26,600 Speaker 1: on the long term. But Bogel says Nate was different 95 00:05:26,600 --> 00:05:28,920 Speaker 1: than all the other cold colors he's had through the years. 96 00:05:29,040 --> 00:05:32,080 Speaker 1: But he was not a promoter type. You could warm 97 00:05:32,160 --> 00:05:34,200 Speaker 1: up to Nate Most and maybe he's he more of 98 00:05:34,279 --> 00:05:37,680 Speaker 1: my type of guy than some flashy US star salesman, 99 00:05:37,800 --> 00:05:40,440 Speaker 1: if you will. So, Most gives Bogol an outline of 100 00:05:40,480 --> 00:05:43,680 Speaker 1: his proposal. The proposal was that we would let him 101 00:05:43,800 --> 00:05:47,120 Speaker 1: use our s and P. Five hundred for his spire 102 00:05:47,800 --> 00:05:50,640 Speaker 1: as as I guess it was called. Man, anyone who 103 00:05:50,680 --> 00:05:54,040 Speaker 1: knows Jack Bogel knows that that's like, you know, I'm 104 00:05:54,080 --> 00:05:58,440 Speaker 1: gonna say this, that's borderline insulting. I mean, he's so 105 00:05:58,520 --> 00:06:00,600 Speaker 1: anti trading. He wants you to will win the fund 106 00:06:00,640 --> 00:06:04,000 Speaker 1: and like never touch it for twenty five years. And 107 00:06:04,040 --> 00:06:06,320 Speaker 1: he said he wanted to come down and talk to 108 00:06:06,320 --> 00:06:08,479 Speaker 1: me about and I said, fine. He seemed like a 109 00:06:08,560 --> 00:06:10,760 Speaker 1: nice person. And he came into my all of a 110 00:06:10,800 --> 00:06:14,000 Speaker 1: sudden the Monday morning, and he was not a nice person. 111 00:06:14,440 --> 00:06:16,839 Speaker 1: He was the nicest person I've ever met in my life. 112 00:06:17,240 --> 00:06:21,400 Speaker 1: And I said to however, Nathan, Mr mos Nate, they 113 00:06:21,440 --> 00:06:24,800 Speaker 1: proposing you sent me last week doesn't work, but has 114 00:06:24,880 --> 00:06:28,520 Speaker 1: these three flaws, and you're gonna have to get them 115 00:06:28,560 --> 00:06:31,039 Speaker 1: fixed before you can never do anything with it. The 116 00:06:31,080 --> 00:06:33,279 Speaker 1: way he told me the story later was he got 117 00:06:33,279 --> 00:06:36,479 Speaker 1: back on the train and fixed the three things and 118 00:06:36,600 --> 00:06:41,240 Speaker 1: got on the next train to stay stree Bois says 119 00:06:41,279 --> 00:06:44,800 Speaker 1: he doesn't remember what those three things were. Wasn't that 120 00:06:44,880 --> 00:06:47,200 Speaker 1: the big concern was you're gonna just rack up costs 121 00:06:47,200 --> 00:06:49,120 Speaker 1: for the linehold people if you'd let this thing trade 122 00:06:49,120 --> 00:06:52,120 Speaker 1: all the time. You know, Eric, I'm sorry, but A 123 00:06:52,400 --> 00:06:55,920 Speaker 1: just taking his toll. Hey. He remembers the meeting though, 124 00:06:56,200 --> 00:07:00,600 Speaker 1: but a nice meeting. We parted friends, and I like that. 125 00:07:01,320 --> 00:07:03,720 Speaker 1: You know, you can have different ideas with people in Jonathan, 126 00:07:05,480 --> 00:07:08,320 Speaker 1: what our ideas ideas or Diamond doesn't and friends are 127 00:07:08,360 --> 00:07:11,760 Speaker 1: much more important. So whether or not it was on 128 00:07:11,800 --> 00:07:14,680 Speaker 1: that train ride back from meeting with Bogel, Most goes 129 00:07:14,720 --> 00:07:17,920 Speaker 1: back to the drawing board, or more specifically, back to 130 00:07:17,960 --> 00:07:21,560 Speaker 1: his days of running the Pacific Commodities Exchange. And there 131 00:07:21,600 --> 00:07:25,720 Speaker 1: you had these warehouses that would store the commodities. Let's see, 132 00:07:25,720 --> 00:07:29,240 Speaker 1: you had like soybean oil, and you would take your 133 00:07:29,240 --> 00:07:31,800 Speaker 1: soybean oil in store it in the locker, and you 134 00:07:31,840 --> 00:07:34,800 Speaker 1: get a receipt, and the receipt then you could trade 135 00:07:34,960 --> 00:07:38,520 Speaker 1: with somebody without having to move merchandise. So Most thought, well, 136 00:07:38,840 --> 00:07:41,560 Speaker 1: what if we took that model of commodity warehouse receipts 137 00:07:41,760 --> 00:07:44,120 Speaker 1: and instead of the actual physical commodity, we just made 138 00:07:44,120 --> 00:07:54,280 Speaker 1: it in the sp So this concept of the receipt 139 00:07:54,360 --> 00:07:57,720 Speaker 1: trading back and forth, that trading does nothing to the 140 00:07:57,760 --> 00:08:00,800 Speaker 1: soybean oil sitting in the warehouse or in this case 141 00:08:01,000 --> 00:08:04,800 Speaker 1: the stocks. That is a way to keep the investors 142 00:08:05,240 --> 00:08:10,160 Speaker 1: from incurring costs from people who are trading. Most in 143 00:08:10,200 --> 00:08:13,360 Speaker 1: Bloom now have their idea. It's been vetted. Now they 144 00:08:13,360 --> 00:08:16,800 Speaker 1: have to name it, and they go with spider SMP 145 00:08:17,000 --> 00:08:21,880 Speaker 1: for the snp F and d R for depository receipts. 146 00:08:26,320 --> 00:08:29,440 Speaker 1: And to me, that is the heartbeat of the e 147 00:08:29,520 --> 00:08:32,040 Speaker 1: t F and that's what made it a very special product. 148 00:08:32,160 --> 00:08:34,360 Speaker 1: And you have to know that at this time Nate 149 00:08:34,400 --> 00:08:37,079 Speaker 1: Most and Steve Bloom aren't the only people thinking about 150 00:08:37,160 --> 00:08:39,640 Speaker 1: index is being able to be traded like that. There 151 00:08:39,640 --> 00:08:43,000 Speaker 1: were several other types of versions, but most of them 152 00:08:43,120 --> 00:08:46,040 Speaker 1: had a variety of issues. And just like any invention, 153 00:08:46,080 --> 00:08:47,960 Speaker 1: you know, Steve Jobs and Wozniak weren't the only two 154 00:08:47,960 --> 00:08:50,760 Speaker 1: guys in a garage. There were plenty of people in 155 00:08:50,840 --> 00:08:54,120 Speaker 1: Silicon Valley working on things like that. They just happened 156 00:08:54,160 --> 00:08:57,200 Speaker 1: to just get the right way to do it. And 157 00:08:57,240 --> 00:09:00,160 Speaker 1: in this case it was the creation redemption mac is. 158 00:09:00,360 --> 00:09:04,840 Speaker 1: I think that gave spy its edge. That creation redemption 159 00:09:04,880 --> 00:09:08,280 Speaker 1: mechanism is ultimately what they put into the SPY filing. 160 00:09:08,559 --> 00:09:12,040 Speaker 1: They followed it with the SEC and then they had 161 00:09:12,080 --> 00:09:18,560 Speaker 1: to wait. And this is where a superhero comes in. 162 00:09:19,080 --> 00:09:23,160 Speaker 1: Spider Woman. I got that nickname right around the time 163 00:09:23,200 --> 00:09:26,800 Speaker 1: we launched Spiders. You may remember her from episode one. 164 00:09:27,160 --> 00:09:31,439 Speaker 1: Her name is Kathleen Moriarty. My legal assistant, Debbie Ferraro, 165 00:09:32,240 --> 00:09:34,720 Speaker 1: gave me a present. It was a front cover of 166 00:09:34,720 --> 00:09:38,400 Speaker 1: a comic book with like the Hulk going after some 167 00:09:39,400 --> 00:09:42,040 Speaker 1: huge monster, and she doctored it all up and she 168 00:09:42,120 --> 00:09:44,679 Speaker 1: made the Hulk me, and she made the Monster of 169 00:09:44,679 --> 00:09:47,280 Speaker 1: the SEC, and she changed all the numbers to make 170 00:09:47,400 --> 00:09:50,920 Speaker 1: SEC things and you know, sort of tongue in cheek, 171 00:09:51,280 --> 00:09:53,720 Speaker 1: and then she wrote Spider Woman on the top of it, 172 00:09:53,800 --> 00:10:01,760 Speaker 1: and it's still in my office. Next time on Trillions, 173 00:10:02,280 --> 00:10:04,840 Speaker 1: we'll hear more from Spider Woman about what it was 174 00:10:04,880 --> 00:10:08,680 Speaker 1: like to actually design Spy. People were afraid that a 175 00:10:08,720 --> 00:10:11,320 Speaker 1: lot of arachnophobes would be turned off and not want 176 00:10:11,320 --> 00:10:13,600 Speaker 1: to buy the E t F, but we ultimately called 177 00:10:13,640 --> 00:10:16,400 Speaker 1: it Spider anyway. Oh and in case you are wondering 178 00:10:16,440 --> 00:10:18,760 Speaker 1: what Jack Bogo thinks of ETS, well, in E t 179 00:10:18,920 --> 00:10:21,599 Speaker 1: F it is just another form of index fun, a 180 00:10:21,760 --> 00:10:24,200 Speaker 1: sort of bastardized forum for the one of a better word. 181 00:10:31,920 --> 00:10:35,840 Speaker 1: Thanks for listening to Trillions Presents until next time. You 182 00:10:35,840 --> 00:10:39,240 Speaker 1: can find us on the Bloomberg Terminal, Bloomberg dot com, 183 00:10:39,360 --> 00:10:44,000 Speaker 1: Apple podcast, and where else you listen to podcasts. Trillions 184 00:10:44,040 --> 00:10:48,480 Speaker 1: Presents is produced by Jordan Belle. Francesca Levy is the 185 00:10:48,520 --> 00:10:50,280 Speaker 1: head of Bloomberg Podcast