The ETF Story 1: The Crash

when it was seated. It started trading on the twenty nine, and so that's exactly thirty years to the day today. And so we made this really good documentary. Of all the things I've done in my career, this is in the top ten um. This will be something people can

go to over and over. Some of the people we interviewed are no longer with us, and we really went all out, got the right people trace the story of the e t F and the evolution, and I think fossilized uh this situation so that over the next for posterity the next you know, five fifteen years, people who want to just kind of get a quick briefer of the e t F market. Can come listen to this sort of Ken Burns esque documentary on it, especially if you know people are would rather listen than read. Uh,

this will do the trick. One thing we should mention is that we have not touched these episodes for five years, so you're gonna hear some numbers that are no longer accurate. At the time that we did the recording, SPY had about two seventy billion in assets. What's it up to now, eric three hundred and seventy five billion, and that includes outflows that the e t F has seen. And what about the e t F industry overall? At the time that we did the recording, I had about three trillion

in assets, more than double today six point eight trillion. Okay, so just incredible. The story of the e t F can gen used to grow, uh, as you're about to find out, it begins with Black Monday and goes so much farther than that. One thing I think we're both really proud of. Here are all the names that we got to speak to about the e t F and its history. Who are some of the ones If you want to rattle through the big names eric that we we spoke with. Yeah, sure, this is this is the

hard part. You gotta go track these people down. I remember recording some of them in like different studios all over Bloomberg. Um, in some cases we went to see them. Um here's some of the names we have. I'll start with two that are no longer with us, Jack Bogel of Vanguard and Kathleen Moriarty, both of which who had a profound impact on the spy and the E t F industry. Some other ones are Bob Toll, who was Morgan Stanley back in the day. UM, Gary Eisenich was

the first market maker on spy. Dave Ritter was the SEC chairman in who was sort of uh overseeing the SEC as the spy documents got filed. And also here over so the eight seven crash. Dave not Egg E t F guru analysts, sort of like the Yoda of E t F analysts. John O'Brien who worked with some competing product to spy back then. Reggie Brown, Mr E t F, Bruce Levine who was early at with Bond ETFs, Bruce Bond who started really Smart Beta. I think he

brought power shares a smart Beta, Robert not also. So some of those names are people who uh sort of took the e t F and evolved it and put all these different things in it. So we don't just track spy, we track the evolution. There's one name I want to end on here that I am most proud of.

When you and I teamed up with Bloomberg Markets to rate sort of the story of the e t F in a written form, what we What we found is that Nate Most and Steve Bloom, who were at the American Stock Exchange, they got the idea or the spark for the idea of the of the first e t F from an SEC report. The SEC report was a post mortem on Black Monday. So we went and found the guy at the SEC who wrote the section of that report that gave Steve Bloom and Nate Most the idea.

His name is Howard Kramer, and he was a young lawyer working at the SEC. Had he not written that, it's it's possible Nate Mos and Steve Bloom do not have that spark of inspiration. Will never know. But we got him too, and that's pretty cool. I also want to give a special shout out to Jordan's Bell, who produced this special series. So this is going to lead straight into the first episode of the E t F Story, and you'll find the rest after that in your feet

this time mon Trillions the E t F Story. One of the things we all love about business stories are the humble beginnings, like when two buddies go from tinkering in their Palo Alto garage to creating the world's most valuable company Apple. Sometimes everyday events even inspire something remarkable, like when a Swiss engineer takes a walk in the woods, marvels at the seeds that stick to his clothes, and

ends up inventing velcro. The story we're about to tell you is a little bit like those, and it culminates 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 e t F Story. I'm Joe Weber, 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 ETF. 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 stuck market crushes on October nine, Black Monday. If you have been away from your television set and haven't heard about the stock market, this was it. The market declined to Practimately, I think that everyone, every American at this stage of the game, needs to get their house in order. I'm ready to jump out of a window. And it was a pretty pretty sickening experience, almost like

are we at the Apocalypse? O Precipice right now? Good evening, I'm Tom Brokaw. Black Monday is now in the book. Then the question is what will happen Tuesday and beyond? Even got a term black Monday. I mean 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 Faltu Nous. The nine eighties were a great decade for the American economy. Modern finance was coming

into its own. Two cities were especially interesting Chicago, where people were trading futures contracts of commodities like corn or oil. In New York, where you'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 hedge 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 outset managers did, some big dealers did, and they realized when the market went down, portfolio insurance required selling stock and buying bonds. O'Brien's is on the Friday before Black Monday, the market has his biggest drop since so all of US portfolio insurance folks had 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 the big focus recognize this, so over the weekend they went short the US dot market and foreign exchanges and joe in the stock market

opened on Monday at over nineteen. There was a big drop and the right away portfolio injurors had to sell more futures 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 run, all of the post selling, all of the doctors, 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 and went to the doctor, went to the bed where basically wouldn't trade. The monke 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 than in my sixteen years to 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 exchange, 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, Cramer 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 the commissioners 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 was 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, I said, but from Thanksgiving a New Year is the only day I took off

with Christmas. Literally, my life still remembers that. It 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 Kramer 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 r Joel. 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, and it is going. That was not quite halfway. It gets more dramatic as you keep going, wow,

I see some charts. Wow, let's hear it. Drop ye, take your pick of Harry Potter books to Harry Potter books side by side. That's about the dimensions. Let me go more highbrow 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 eleven 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 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 hold the milk, anything that a noise in the attic 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 people 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 AMES, and Bloom is just fresh from Harvard with a PhD in economics. Nate died in two thousand four, but we found in our reporting that he made a big impression on those he worked with.

Arthur Lovitt, who was running AMS 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 PHTF became a reality of the credit Tony 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. Afterward 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 all shocks on us. 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 at a meeting with him and some Goldmen 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 out 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 in their roles at AMEX, which has Levitt puts, it was kind of and had been kind of a backwater exchange, struggling for relevance and gradually losing listings to the New

York our 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 we're the lifeblood of exchange, here's Kramer 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. Trying to come up with a product to stay ahead of other competitors that may have some investor appeal. And what Kramer is referring to is a section in chapter three of the Market Breake Report with the 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 break report makes its way to amp X, and

most in Bloom were 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 Nate Most 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, the AMEX 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 to however, Nathan, Mr Moss Nate they

proposed 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 whatever else you listen to podcasts. Trillions Presents is produced by Jordan Belle. Francesco Levy is the head of Bloomberg Podcasts. Bye, 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 right on e bay? M No, I'm not that I'm in deep, but I'm not that in deep. H