Speaker 1: One of the things we all love about business stories
Speaker 1: are the humble beginnings, like when two buddies go from
Speaker 1: tinkering in their Palo Alto garage to creating the world's
Speaker 1: most valuable company, Apple. Sometimes everyday events even inspire something remarkable,
Speaker 1: like when a Swiss engineer takes a walk in the woods,
Speaker 1: marvels at the seeds that stick to his clothes, and
Speaker 1: ends up inventing velcro. The story we're about to tell
Speaker 1: you is a little bit like those, and it culminates
Speaker 1: with a three trillion dollar industry that's still growing. What's
Speaker 1: this We're talking about the exchange traded fund. We're going
Speaker 1: to trace how it came to be with some of
Speaker 1: the people who made it happen. We'll look at the
Speaker 1: state of things before it existed, find out where the
Speaker 1: spark came from, learn why the idea worked, and what
Speaker 1: it actually took for this financial tool to get where
Speaker 1: it is today. This is Trillions presents the et F story.
Speaker 1: I'm Joel Webber and I'm the editor of Bloomberg Business Week.
Speaker 1: Over the course of the next six episodes, with the
Speaker 1: help of Eric Baltunas, who's an e t F expert,
Speaker 1: and an analyst with Bloomberg Intelligence. We're going to document
Speaker 1: the story of the e t F. We'll hear from
Speaker 1: people who were there at the beginning. Will also take
Speaker 1: you on a few fuel trips, but mostly we'll be
Speaker 1: sharing the human stories behind an industry that's hoovering up
Speaker 1: trillions of dollars every year. So this all really begins
Speaker 1: when the stock market crushes on October nineteenth, Black Monday.
Speaker 1: If you have been away from your television set and
Speaker 1: haven't heard about the stock market, and this was it,
Speaker 1: the market declined to Practimately, I think that everyone, every
Speaker 1: amount and at this stage of the game needs to
Speaker 1: get their house in order, are ready to jump out
Speaker 1: of a window. And it was a pretty pretty sickening experience,
Speaker 1: almost like are we at the apocalypse opprestice right now?
Speaker 1: Being I'm Tom black Monday is now on the books,
Speaker 1: then the question is what will happen Tuesday and beyond?
Speaker 1: Even got a term black Monday, I mean that that
Speaker 1: sounds like a horror movie. This, of course, is our
Speaker 1: resident et F analyst, and for the purposes of the
Speaker 1: show are historian Eric Balt Noises were a great decade
Speaker 1: for the American economy. Modern finance was coming into its own.
Speaker 1: Two cities were especially interesting Chicago, where people who are
Speaker 1: trading futures contracts of commodities like corn or oil, and
Speaker 1: New York, where we've got the stock exchanges and people
Speaker 1: trading equities. Well, the market had been going up for
Speaker 1: a while, nothing goes up forever. There was probably a
Speaker 1: sell off that was gonna happen anyway, So the conditions
Speaker 1: were ripe for a sell off. And at the same
Speaker 1: time you had a build up of this hot thing
Speaker 1: called portfolio insurance, which was to use futures in order
Speaker 1: to heade your stock position. This portfolio insurance was created
Speaker 1: by the firm Leland O'Brien Rubinstein to deal with the
Speaker 1: big crash of the nineteen seventies. John O'Brien, who was
Speaker 1: part of the team that developed it, says portfolio insurance
Speaker 1: really started to take off once JP Morgan started doing it,
Speaker 1: but most people in the Wall street didn't understand what
Speaker 1: that was. Some big asset managers did, some big local
Speaker 1: dealers did, and they realized when the market went down,
Speaker 1: portfolio insurance required selling stock and buying bonds. O'Brien says,
Speaker 1: on the Friday before Black Monday, the market has his
Speaker 1: biggest drop since nine So all about portfolio insurance folks
Speaker 1: difficulty getting off enough sales of futures contracts to get
Speaker 1: down in the equity exposure to the level we should
Speaker 1: have had at the close of business on Friday, Act
Speaker 1: over seventeen. A couple of focus recognized this, so over
Speaker 1: the weekend they went short the US dock market and
Speaker 1: foreign exchanges until in the stock market opened on Monday
Speaker 1: at over nineteen there was a big drop, and right
Speaker 1: away portfolio on jurors had to sell more features contract
Speaker 1: and more of that got transmitted to the New York
Speaker 1: Stock Exchange, and they specialists on the exchange saw every
Speaker 1: major firm spending all of its runs to all of
Speaker 1: the posts, selling all of the docks, and the sci
Speaker 1: and the specialists didn't understand that this was all a
Speaker 1: mechanical things and they thought, you know, World War three
Speaker 1: had broken out somewhere and they didn't know about it.
Speaker 1: So they just dropped all their bids and went to launch.
Speaker 1: You went to the doctor or went to the bedroom
Speaker 1: where just basically wouldn't trade. So the monket just you
Speaker 1: know collapse, Uh, And it was all mistake a big
Speaker 1: mistake that now has to be cleaned up. In terms
Speaker 1: of government official at the time, it was probably the
Speaker 1: scariest time of them in my sixteen years at the SEC.
Speaker 1: That Monday and into Tuesday. This is Howard Kramer. During
Speaker 1: the crash, he was Assistant Director of the Division of
Speaker 1: Market Regulation at the U S Securities and Exchange Commission,
Speaker 1: or the SEC. I had oversight over all of the
Speaker 1: nation's securities exchanges, so that included both the stock exchanges
Speaker 1: and the options exchanges. He says he has a few
Speaker 1: sharp memories from that day. On the afternoon of the crash,
Speaker 1: Kramer went over to the Commodity Futures Trading Commission to
Speaker 1: talk about what was going on. Yeah, pretty distinctly remember
Speaker 1: being in the room and you know, as the stock
Speaker 1: market was tanking and thinking, you know, these these were
Speaker 1: commissioners who have experienced mostly in agricultural products and futures,
Speaker 1: and here we are discussing what's happening with the stock market.
Speaker 1: Another one was being in with some other senior staffers
Speaker 1: and one of them, Shares, coming down and trying to
Speaker 1: find out what was happening and then saying that he
Speaker 1: needed to call the White House. So they needed to
Speaker 1: call the White House. So they basically asked us to
Speaker 1: clear out of the room, and I did. It was
Speaker 1: so bad that the SEC decided to make a task
Speaker 1: force and immediately for the next few months study what happened.
Speaker 1: And that's what they do in the form of a
Speaker 1: massive report called October Market Break. David Ruder, who is
Speaker 1: the chairman of the SEC at the time, says the
Speaker 1: goal of the report was factual. The goal was to
Speaker 1: say what had happened. The goal was not in an
Speaker 1: advance to plan some result from the report. But the
Speaker 1: idea was to create a factual reconstruction of what happened
Speaker 1: and then to make suggestions based upon that report. And
Speaker 1: it was a long, arduous process. I'd say for the
Speaker 1: next three months through early January, a bunch of us
Speaker 1: had two jobs, which was, you know, investigating what happened
Speaker 1: and writing to report up and doing our day job.
Speaker 1: Did you get paid double for that? No, No, we
Speaker 1: didn't get paid double, uh I said. But from Thanksgiving
Speaker 1: a New Years the only day I took off with Christmas.
Speaker 1: Literally my wife still remembers that. Um No, it was.
Speaker 1: It was pretty intense period. So this report ends up
Speaker 1: being eight hundred and forty pages. It was thicker than
Speaker 1: the Manhattan phone Book, for sure, it was. You know,
Speaker 1: obviously we we sent a number of copies off the Congress.
Speaker 1: You know. It was available for a couple more years,
Speaker 1: and eventually it became a collector's item. I have two
Speaker 1: in my office. If anybody wants to bid for it,
Speaker 1: I'm ready to do it on eBay. Before Creamer could
Speaker 1: sell anything on eBay, we borrowed one of his copies
Speaker 1: to see it for ourselves. So it says October market break.
Speaker 1: It really is like a phone book. I mean it's
Speaker 1: that's exactly that. The feel. It's just all right, Joe,
Speaker 1: I'm gonna flip through it, just so you get an
Speaker 1: idea of how big this is. Right, So this may
Speaker 1: take a few seconds hanging there, still going. You're like
Speaker 1: halfway it is going. That was not quite halfway. It
Speaker 1: gets more dramatic as you keep going. Wow, I see
Speaker 1: some shirts. Wow, let's hear it drop. Yeah, take your
Speaker 1: pick of Harry Potter books to Harry Potter books side
Speaker 1: by side. That's about the dimensions. Let me go more
Speaker 1: high brow here. This is Warren Pace Squared. Oh yeah,
Speaker 1: nailed it. This thing. Yeah, Like my mom's five ft
Speaker 1: and she has to use this like little thing in
Speaker 1: the car. This is like what you could use if
Speaker 1: you were like an all even year old and you
Speaker 1: stole your parents car and you need to see you
Speaker 1: over the steering wheel. I mean it literally could be used.
Speaker 1: It's like a booster seat. Yeah. Could you imagine reading this?
Speaker 1: I will say the ends a lot of charts, Like
Speaker 1: I think the last two pages is charts and numbers,
Speaker 1: but I mean there is a lot of stuff, some footnotes, right, Yeah,
Speaker 1: And you're saying like one page of this is a
Speaker 1: huge piece of landscape here, I mean it's a big
Speaker 1: big I'm also thinking somebody was on a typewriter doing this, Yeah,
Speaker 1: I mean they had to be. What would it take Eric,
Speaker 1: This is a huge report. I can't imagine how long
Speaker 1: it would take you to read it. But what would
Speaker 1: it take you to be able to actually, like plat
Speaker 1: through this. I would probably need illegal substances to get
Speaker 1: through this thing. If not, okay on the legal side,
Speaker 1: a lot of coffee, a latte, and some were very
Speaker 1: quiet because the littlest distraction, the milk, anything that a
Speaker 1: noise in the attict would be like oh, let me
Speaker 1: go check that out, because I am not so what
Speaker 1: was in this big report we've been talking over. They
Speaker 1: just broke down what program trading was, They broke down
Speaker 1: what portfolio insurance was, They broke down what happened that day.
Speaker 1: That was the first part of the report. The second
Speaker 1: part gave suggestions about how a future crash could be avoided.
Speaker 1: But meanwhile, in downtown New York, you had the American
Speaker 1: Stock Exchange and this is an exchange that was in
Speaker 1: third place in trading. It had fallen down. The American
Speaker 1: Stock Exchange wee we'll call AMEX from here on out,
Speaker 1: was basically an exchange that was looking for a winner.
Speaker 1: And that's where Nate Most and Steve Bloom we're working together.
Speaker 1: These are market nerds. Okay, these are not like salespeople.
Speaker 1: They're not They're not portfolio managers. They are They're into derivatives,
Speaker 1: they're into data, they're into the exchange. So these market nerds,
Speaker 1: Nathan Most and Stephen Bloom are kind of an unusual pair.
Speaker 1: Most is seventy four years old at the time and
Speaker 1: he's the vice president of new Development at AMS and
Speaker 1: Bloom is just fresh from Harvard with a PhD in economics.
Speaker 1: Nate died in two thousand four, but we found it
Speaker 1: our reporting that he made a big impression on those
Speaker 1: he worked with. Arthur Levitt, who was running Amyx in
Speaker 1: the nineties, says he was blessed to have inherited Nate
Speaker 1: Most who at the time was trying to create products
Speaker 1: and trading mechanisms that would give AMEX a competitive edge,
Speaker 1: and to the extent to which PTS became a reality,
Speaker 1: I give of the credit to Nate. I can remember
Speaker 1: saying to him that if this is something he believes
Speaker 1: and it wants to do, he has my full support
Speaker 1: to go ahead and do it. And Nate Most had
Speaker 1: this eclectic background. He'd served in the Navy as a
Speaker 1: submarine engineer during World War Two, after where he worked
Speaker 1: as a trader for Pacific Vegetable Oil and then became
Speaker 1: president of the Pacific Commodities Exchange for a time. Oh
Speaker 1: he was great, he was wonderful. He was a tall man,
Speaker 1: and he was kind of not very he was kind
Speaker 1: of aw shucks almost. This is Kathleen Moriarty, who played
Speaker 1: a major role on the legal side of the story
Speaker 1: and worked quite a bit with Nate Most. I remember
Speaker 1: one time I was in a meeting with him and
Speaker 1: some Goldman people, and these guys who were probably like
Speaker 1: in their thirties looked at Nate and he had thick
Speaker 1: black glasses, and it was clear that they thought he
Speaker 1: was like somebody who didn't really know much of anything.
Speaker 1: So he went up to go to the men's room
Speaker 1: and they looked at each other and they said, oh,
Speaker 1: he's not a rocket scientist, and I said, actually, he
Speaker 1: is a rocket scientist. Yeah, he was literally a rocket scientist.
Speaker 1: The guy had a PhD in physics. And what's more,
Speaker 1: he's got the help of Stephen Bloom and Steve was
Speaker 1: his assistant. Steve was much, you know, much younger. He
Speaker 1: was probably, you know, somewhere around my age at the time,
Speaker 1: and you know, somebody who was, you know, at a
Speaker 1: very sharp mind for numbers and did a lot of
Speaker 1: the assistance and kind of secondary lifting for Nate. So
Speaker 1: they were a good team. They worked very well together.
Speaker 1: So you've got these two smart guys who have their
Speaker 1: work cut out for them and their roles at Amex,
Speaker 1: which has Levitt puts it, the animates was kind of
Speaker 1: and had been kind of a backwater exchange struggling for
Speaker 1: relevance and gradually losing listings to the New York Stock
Speaker 1: Exchange across the street. And no matter what we tried
Speaker 1: to do to compete against New York, the stature and
Speaker 1: status and prestige of New York managed to whittle away
Speaker 1: the listings that were the lifeblood of exchange. Here's Creamer again.
Speaker 1: To stay relevant, it had to continue to develop new products,
Speaker 1: particularly new options products or or options like products. Steve
Speaker 1: and Nate were behind that development initiative of the AMEX,
Speaker 1: so let's fit in pretty nicely into their sweet spot.
Speaker 1: I trying to come up with a product to stay
Speaker 1: ahead of of their competitors that may have some investor appeal.
Speaker 1: And what Kramer is referring to is a section in
Speaker 1: chapter three of the Market Brake Report with his suggestion
Speaker 1: for a market basket trading instrument that could be used
Speaker 1: instead of the futures to hedge and would be something
Speaker 1: that the SEC could regulate. So the market Brake Report
Speaker 1: makes its way to AMEX, and most in Bloom read
Speaker 1: through the whole thing. Bloom calls it riveting and one
Speaker 1: particular part especially caught his eye. When Bloom read that paragraph,
Speaker 1: you know, it was like a light bulb went off,
Speaker 1: you know. He told me that he ran into natemost
Speaker 1: office immediately and basically said, here's an opening we could
Speaker 1: drive a truck throw. We didn't feel like it was
Speaker 1: a panacea to what we were trying to address, but
Speaker 1: we felt it was. It was a novel idea, a
Speaker 1: panacea or not. Most in bloom go with it, and
Speaker 1: Kramer says, it's best that they or someone in the
Speaker 1: marketplace would take up the idea because it wasn't a
Speaker 1: regulatory proposal, so we were hoping that they would take debate,
Speaker 1: so to speak, and and run with it. And uh
Speaker 1: them X did. Next time, on Trillions Presents, most in
Speaker 1: bloom share their idea with maybe the most influential investor
Speaker 1: of all time, Jack Bogle, and I said, However, Nathan,
Speaker 1: Mr mos Nate, they proposing you sent me last week
Speaker 1: doesn't work. It has these three flaws and you're gonna
Speaker 1: have to get them fixed before you can never do
Speaker 1: anything with it. Thanks for listening to Trillions Presents Until
Speaker 1: next time. You can find us on the Bloomberg Terminal,
Speaker 1: Bloomberg dot com, Apple Podcasts, and whever else you Snip
Speaker 1: podcast Trillians Presents is produced by Jordan Bell. Francesco Levy
Speaker 1: is the head of Bloomberg podcast Back, Oh, one more
Speaker 1: tiny little Thing, here's any strike for you. I have
Speaker 1: a question when we send this back to him, would
Speaker 1: you buy it on e Bay? No, I'm not that
Speaker 1: I'm in deep, but I'm not that in deep.