The Crash

with a three trillion dollar industry that's still growing. What's this We're talking about the exchange traded fund. We're going to trace how it came to be with some of the people who made it happen. We'll look at the state of things before it existed, find out where the spark came from, learn why the idea worked, and what it actually took for this financial tool to get where it is today. This is Trillions presents the et F story. I'm Joel Webber and I'm the editor of Bloomberg Business Week.

Over the course of the next six episodes, with the help of Eric Baltunas, who's an e t F expert, and an analyst with Bloomberg Intelligence. We're going to document the story of the e t F. We'll hear from people who were there at the beginning. Will also take you on a few fuel trips, but mostly we'll be sharing the human stories behind an industry that's hoovering up trillions of dollars every year. So this all really begins when the stock market crushes on October nineteenth, Black Monday.

If you have been away from your television set and haven't heard about the stock market, and this was it, the market declined to Practimately, I think that everyone, every amount and at this stage of the game needs to get their house in order, are ready to jump out of a window. And it was a pretty pretty sickening experience, almost like are we at the apocalypse opprestice right now? Being I'm Tom black Monday is now on the books, then the question is what will happen Tuesday and beyond?

Even got a term black Monday, I mean that that sounds like a horror movie. This, of course, is our resident et F analyst, and for the purposes of the show are historian Eric Balt Noises were a great decade for the American economy. Modern finance was coming into its own. Two cities were especially interesting Chicago, where people who are trading futures contracts of commodities like corn or oil, and New York, where we've got the stock exchanges and people

trading equities. Well, the market had been going up for a while, nothing goes up forever. There was probably a sell off that was gonna happen anyway, So the conditions were ripe for a sell off. And at the same time you had a build up of this hot thing called portfolio insurance, which was to use futures in order to heade your stock position. This portfolio insurance was created by the firm Leland O'Brien Rubinstein to deal with the

big crash of the nineteen seventies. John O'Brien, who was part of the team that developed it, says portfolio insurance really started to take off once JP Morgan started doing it, but most people in the Wall street didn't understand what that was. Some big asset managers did, some big local dealers did, and they realized when the market went down,

portfolio insurance required selling stock and buying bonds. O'Brien says, on the Friday before Black Monday, the market has his biggest drop since nine So all about portfolio insurance folks difficulty getting off enough sales of futures contracts to get down in the equity exposure to the level we should have had at the close of business on Friday, Act

over seventeen. A couple of focus recognized this, so over the weekend they went short the US dock market and foreign exchanges until in the stock market opened on Monday at over nineteen there was a big drop, and right away portfolio on jurors had to sell more features contract and more of that got transmitted to the New York Stock Exchange, and they specialists on the exchange saw every major firm spending all of its runs to all of the posts, selling all of the docks, and the sci

and the specialists didn't understand that this was all a mechanical things and they thought, you know, World War three had broken out somewhere and they didn't know about it. So they just dropped all their bids and went to launch. You went to the doctor or went to the bedroom where just basically wouldn't trade. So the monket just you know collapse, Uh, And it was all mistake a big

mistake that now has to be cleaned up. In terms of government official at the time, it was probably the scariest time of them in my sixteen years at the SEC. That Monday and into Tuesday. This is Howard Kramer. During the crash, he was Assistant Director of the Division of Market Regulation at the U S Securities and Exchange Commission, or the SEC. I had oversight over all of the nation's securities exchanges, so that included both the stock exchanges

and the options exchanges. He says he has a few sharp memories from that day. On the afternoon of the crash, Kramer went over to the Commodity Futures Trading Commission to talk about what was going on. Yeah, pretty distinctly remember being in the room and you know, as the stock market was tanking and thinking, you know, these these were commissioners who have experienced mostly in agricultural products and futures, and here we are discussing what's happening with the stock market.

Another one was being in with some other senior staffers and one of them, Shares, coming down and trying to find out what was happening and then saying that he needed to call the White House. So they needed to call the White House. So they basically asked us to clear out of the room, and I did. It was so bad that the SEC decided to make a task force and immediately for the next few months study what happened. And that's what they do in the form of a

massive report called October Market Break. David Ruder, who is the chairman of the SEC at the time, says the goal of the report was factual. The goal was to say what had happened. The goal was not in an advance to plan some result from the report. But the idea was to create a factual reconstruction of what happened and then to make suggestions based upon that report. And

it was a long, arduous process. I'd say for the next three months through early January, a bunch of us had two jobs, which was, you know, investigating what happened and writing to report up and doing our day job. Did you get paid double for that? No, No, we didn't get paid double, uh I said. But from Thanksgiving a New Years the only day I took off with Christmas. Literally my wife still remembers that. Um No, it was. It was pretty intense period. So this report ends up

being eight hundred and forty pages. It was thicker than the Manhattan phone Book, for sure, it was. You know, obviously we we sent a number of copies off the Congress. You know. It was available for a couple more years, and eventually it became a collector's item. I have two in my office. If anybody wants to bid for it, I'm ready to do it on eBay. Before Creamer could sell anything on eBay, we borrowed one of his copies to see it for ourselves. So it says October market break.

It really is like a phone book. I mean it's that's exactly that. The feel. It's just all right, Joe, I'm gonna flip through it, just so you get an idea of how big this is. Right, So this may take a few seconds hanging there, still going. You're like halfway it is going. That was not quite halfway. It gets more dramatic as you keep going. Wow, I see some shirts. Wow, let's hear it drop. Yeah, take your pick of Harry Potter books to Harry Potter books side

by side. That's about the dimensions. Let me go more high brow here. This is Warren Pace Squared. Oh yeah, nailed it. This thing. Yeah, Like my mom's five ft and she has to use this like little thing in the car. This is like what you could use if you were like an all even year old and you stole your parents car and you need to see you over the steering wheel. I mean it literally could be used. It's like a booster seat. Yeah. Could you imagine reading this?

I will say the ends a lot of charts, Like I think the last two pages is charts and numbers, but I mean there is a lot of stuff, some footnotes, right, Yeah, And you're saying like one page of this is a huge piece of landscape here, I mean it's a big big I'm also thinking somebody was on a typewriter doing this, Yeah, I mean they had to be. What would it take Eric, This is a huge report. I can't imagine how long

it would take you to read it. But what would it take you to be able to actually, like plat through this. I would probably need illegal substances to get through this thing. If not, okay on the legal side, a lot of coffee, a latte, and some were very quiet because the littlest distraction, the milk, anything that a noise in the attict would be like oh, let me go check that out, because I am not so what

was in this big report we've been talking over. They just broke down what program trading was, They broke down what portfolio insurance was, They broke down what happened that day. That was the first part of the report. The second part gave suggestions about how a future crash could be avoided. But meanwhile, in downtown New York, you had the American Stock Exchange and this is an exchange that was in

third place in trading. It had fallen down. The American Stock Exchange wee we'll call AMEX from here on out, was basically an exchange that was looking for a winner. And that's where Nate Most and Steve Bloom we're working together. These are market nerds. Okay, these are not like salespeople. They're not They're not portfolio managers. They are They're into derivatives,

they're into data, they're into the exchange. So these market nerds, Nathan Most and Stephen Bloom are kind of an unusual pair. Most is seventy four years old at the time and he's the vice president of new Development at AMS and Bloom is just fresh from Harvard with a PhD in economics. Nate died in two thousand four, but we found it our reporting that he made a big impression on those

he worked with. Arthur Levitt, who was running Amyx in the nineties, says he was blessed to have inherited Nate Most who at the time was trying to create products and trading mechanisms that would give AMEX a competitive edge, and to the extent to which PTS became a reality, I give of the credit to Nate. I can remember saying to him that if this is something he believes and it wants to do, he has my full support to go ahead and do it. And Nate Most had

this eclectic background. He'd served in the Navy as a submarine engineer during World War Two, after where he worked as a trader for Pacific Vegetable Oil and then became president of the Pacific Commodities Exchange for a time. Oh he was great, he was wonderful. He was a tall man, and he was kind of not very he was kind of aw shucks almost. This is Kathleen Moriarty, who played a major role on the legal side of the story

and worked quite a bit with Nate Most. I remember one time I was in a meeting with him and some Goldman people, and these guys who were probably like in their thirties looked at Nate and he had thick black glasses, and it was clear that they thought he was like somebody who didn't really know much of anything. So he went up to go to the men's room and they looked at each other and they said, oh, he's not a rocket scientist, and I said, actually, he

is a rocket scientist. Yeah, he was literally a rocket scientist. The guy had a PhD in physics. And what's more, he's got the help of Stephen Bloom and Steve was his assistant. Steve was much, you know, much younger. He was probably, you know, somewhere around my age at the time, and you know, somebody who was, you know, at a very sharp mind for numbers and did a lot of the assistance and kind of secondary lifting for Nate. So they were a good team. They worked very well together.

So you've got these two smart guys who have their work cut out for them and their roles at Amex, which has Levitt puts it, the animates was kind of and had been kind of a backwater exchange struggling for relevance and gradually losing listings to the New York Stock Exchange across the street. And no matter what we tried to do to compete against New York, the stature and status and prestige of New York managed to whittle away

the listings that were the lifeblood of exchange. Here's Creamer again. To stay relevant, it had to continue to develop new products, particularly new options products or or options like products. Steve and Nate were behind that development initiative of the AMEX, so let's fit in pretty nicely into their sweet spot. I trying to come up with a product to stay ahead of of their competitors that may have some investor appeal.

And what Kramer is referring to is a section in chapter three of the Market Brake Report with his suggestion for a market basket trading instrument that could be used instead of the futures to hedge and would be something that the SEC could regulate. So the market Brake Report makes its way to AMEX, and most in Bloom read through the whole thing. Bloom calls it riveting and one particular part especially caught his eye. When Bloom read that paragraph, you know, it was like a light bulb went off,

you know. He told me that he ran into natemost office immediately and basically said, here's an opening we could drive a truck throw. We didn't feel like it was a panacea to what we were trying to address, but we felt it was. It was a novel idea, a panacea or not. Most in bloom go with it, and Kramer says, it's best that they or someone in the marketplace would take up the idea because it wasn't a regulatory proposal, so we were hoping that they would take debate,

so to speak, and and run with it. And uh them X did. Next time, on Trillions Presents, most in bloom share their idea with maybe the most influential investor of all time, Jack Bogle, and I said, However, Nathan, Mr mos Nate, they proposing you sent me last week doesn't work. It has these three flaws and you're gonna have to get them fixed before you can never do anything with it. Thanks for listening to Trillions Presents Until

next time. You can find us on the Bloomberg Terminal, Bloomberg dot com, Apple Podcasts, and whever else you Snip podcast Trillians Presents is produced by Jordan Bell. Francesco Levy is the head of Bloomberg podcast Back, Oh, one more tiny little Thing, here's any strike for you. I have a question when we send this back to him, would you buy it on e Bay? No, I'm not that I'm in deep, but I'm not that in deep.