Listen to this article
The Futures: The Rise of the Speculator and the Origins of the World’s Biggest Markets, by Emily Lambert, Basic Books, RRP£18.99, 240 pages
When the Dow Jones Average index plunged by 1,000 points only to bounce back again in May last year – all in the space of 20 minutes – it looked very much like American capitalism was having a near-death experience akin to the “Black Monday” crash of 1987.
The event was quickly dubbed the “ flash crash” and exposed serious flaws in the way the US share markets work, with trades done at lightning speed across multiple venues.
Yet what regulators and much of the US investing public were surprised to find was that the trigger for the crash lay not with a “fat finger” error in a share trade but hundreds of miles west in Chicago, at the city’s biggest futures exchange, the Chicago Mercantile Exchange. There, a big institutional investor had used a computer algorithm to drive trades automatically in a futures contract on a US stock market index. The algorithm malfunctioned, sending the wrong signal to the share markets. In effect, the flash crash started in Chicago.
When most people think about Chicago, they default to images of the 1950s gangster, pork belly trading and the big grain pits where men waved their arms in a curious semaphore that signalled when to buy and sell.
Those images are hopelessly out of date, of course. The Chicago Mercantile Exchange’s biggest contracts are futures on financial instruments such as the Dow Jones stock index, or US Treasurys, interest rates or commodities like copper. Economically, their significance is greater than share trading since they represent the bets people are taking on important underlying instruments.
How Chicago’s trading pits were transformed from parochial gambling dens in the wake of the great fire of Chicago in 1871 to the electronic trading powerhouses they are today is Emily Lambert’s lively narrative, told with a sharp eye for the characters involved.
Their egos matched the size of the risks they took. Lambert, a Forbes magazine journalist, introduces us to Vincent Kosuga, a 5ft 4in onion grower who drove stock cars, carried around a .38 revolver and a billy club, and gave so generously to the Catholic Church that he was allowed to ride in the Pope’s elevator in the Vatican. In 1955, Kosuga and an accomplice tried to corner the onion futures market and were investigated by federal regulators, leading to a ban on onion futures trading that still stands.
The key figures are Leo Melamed and Richard Sandor, who drew a line under the Chicago markets’ image as being run “by a bunch of crooks” by creating the financial futures that make Chicago the “risk capital of the world”.
That journey has been – and remains – pivoted on a persistent tension between free-market risk-takers who saw financial invention as a legitimate way to manage risk, and those who regarded this as speculation at the expense of farmers, consumers and the public.
In 1878, a letter appeared in a newspaper attacking Chicago’s grain traders as “brotherhood banditti” who robbed farmers of their livelihoods with their bets. Even when Melamed was proposing to launch futures on foreign exchange contracts in 1972, a Nobel Prize-winning economist questioned whether speculators should be involved. And last month US senator Sherrod Brown hit out at “speculators” for sending petrol prices towards $4 a gallon.
It is a tension that is likely to persist. But that has not stopped the Chicago model from being emulated around the world. Last year, China allowed trading in stock index futures. But perhaps mindful of Chicago’s rough start, the authorities have placed restrictions on who can trade to keep out the speculators. Whether animal spirits can be constrained will be fascinating to watch.
Jeremy Grant, a former FT correspondent in Chicago, is editor of FT Trading Room