Fintech disruption: an oral history of the Chicago Board of Trade
Finance and banking have only been moderately disrupted by fintech. But technology has brought an end to one particular corner of financial services. A corner that, if you’re not from Chicago, you might not appreciate.
Last Monday, the Chicago Board of Trade and the Chicago Mercantile Exchange shuttered their open outcry trading floors, which had operated continuously for 167 years.
Upon its closure, open outcry trading represented just 1% of CBOT’s overall volume. Replacing the legions of battle hardened traders standing atop tiered pits are racks of servers, quietly humming away in a nondescript suburban bunker.
If you’re not familiar with the Chicago markets (or the movie Trading Places), the open outcry trading floor is essentially the same as the arena seen at the New York Stock Exchange. It’s a physical space where buyers and sellers gather to barter over the price of goods.
The Midwestern US is the “breadbasket of the world,” and because Chicago is the largest city in the region, it became a natural trading hub for grain harvests and cattle. Due to the nature of the goods traded, “futures” contracts were invented. Basically, the idea of a “future” was to protect farmers from future price fluctuations.
In the years following, brokerage houses, specialist funds, and even individuals were drawn to the trading floor to trade for profit. Speculators and brokers took advantage to profit (or lose) massively by taking on risk that others wouldn’t bear. In the futures market, traders must be willing to cover as much as 10x their principle in the event of a loss.
Good and bad days are the stuff of legend. For a time in Chicago, traders, not professional athletes, were the local celebrities.
Fortunes were made and lost in an instant, and because anyone who could afford a “seat” on the exchange could participate, the trading pits earned a rough and tumble reputation. In order to buy and sell, traders had to shout and physically interact with each other. People were punched, stabbed with pencils, and brawls routinely saw grown men rolling down to the bottom of the tiered pits.
Over time, the products traded extended to financial derivatives (index, bond, and currency futures) and even climate derivatives. One could even trade options on the future prices of assets. Demand for these products increased significantly from big institutions in search of alpha after the repeal of the Glass-Steagall Act in 1999.
To keep up with this demand the Chicago Mercantile Exchange built its own electronic order system (Globex) in the 1990s. A terrific revenue-spinner for the exchange, this signed the death warrant for the open outcry system. No longer a necessary pinch-point, floor traders were bypassed by institutions who were able to trade cheaply and electronically 24/7.
Part of Chicago’s industrial heritage, a once hard-charging, personality-driven industry, began to disappear in the early 2000s.
One of those personalities is my father, Jim Morris who traded in the agriculture futures pits for 25 years, beginning in 1974. In fact, I spent my own summers working on the trading floor as a “runner,” shuttling hand-written orders from the phone banks to the traders and brokers in the pits.
Recently, I sat down with my dad to ask him questions about his industry.
Doug Morris (DM): How’d you get your start at the Chicago Board of Trade?
Jim Morris (JM): I started as a clerk and office worker for a small commission firm in 1974. I was fortunate to begin my career just as trade in the grain market was expanding. Because of the need for more people on the grain floor I started working as a runner and phone clerk.
I was just one year out of college and never had been outside the state of Minnesota until I came to Chicago.
DM: So what was your actual job?
JM: Commodities broker and proprietary trader. As a member of the exchange, I owned a seat, which meant I could trade in any futures or options pit in the building. Yeah, it’s kind of weird that I could spend the morning trading soybean futures and then wander into the Eurodollar pit after lunch, but guys tended to stick to their original pits.
DM: What was the floor like back then?
JM: For starters it was nearly all men, and you could smoke on the trading floor. In the corners of the floor there were clusters of 70’s style lounge chairs. As a younger group of traders appeared the pits became very physical arenas. Arguments were commonplace and fights would break out.
Guys were brash, aggressive, and unlike any group I had ever been around. Almost all were from Chicago and many families had been in the business for generations. The corn pit was comprised almost entirely of Irishmen. The wheat pit was largely Italian.
Most of the existing traders were older men who were used to dull markets only moving a couple pennies week.
All of a sudden It was an uncommonly active market. Prices were gyrating wildly and volume was comparatively huge. The archaic system was hard pressed to keep up with the action.
DM: What makes a good trader?
JM: Aggressiveness, alertness, discipline, and quick thinking. A strong voice is also an attribute and one must be able to push and shove on occasion.
When I first started I was too timid and hesitant to react to changes in the market and I had to overcome those weaknesses in order to succeed. It’s obvious, since I survived down there, that it does not take great intelligence to be a good pit trader.
Some of the best pit traders that I knew could hardly tie their shoes but did far better than some highly educated individuals. Some of the same attributes that competitive athletes possess make for good traders.
Traders have to guard against becoming emotionally involved and can’t be afraid to take a loss and admit that they are wrong. Survival is the name of the game.
DM: So you were a 1970’s disruptor? You were a broker and traded your own account simultaneously, correct?
JM: Well, I eventually became a broker in the soybean pit in 1976. I worked for two older men who wanted out of the order filling business because of the stress and risk. It wasn’t long before I and another young guy established a large “deck” as it was called and were handling large volumes of orders. All of our clients were commission houses. Merrill Lynch was the largest.
DM: How did you do that before computers?
JM: Keeping track of what we had to do at each price was a huge challenge. Cancellations were a huge problem as were stop loss orders. There was no electronic entry of data. Every order was taken by phone, written down, and carried to the pit by runners. Filled orders were thrown on the steps and the floor behind us. It sounds like a ridiculous system but it actually worked quite well.
DM: When I think of global market events, I think of the tech bubble or 9/11. What events affected your business?
JM: Droughts. freezes, floods. The one sudden event that greatly affected the agricultural markets was the nuclear meltdown at Chernobyl. There was panic in the markets because no one knew how serious the situation was. Reliable information was very difficult to come by as the Soviet Union was secretive and agronomists had no informed opinions about if the land would be barren forever or if the contamination would spread. It was a scary time for the markets!
The biggest event, however was the crash of 1987. It almost caused the meltdown of the exchanges, as the capital of many firms was in serious jeopardy.
DM: All of a sudden it was the 1990’s, an era of global stability and market prosperity. I recall this being at odds with your business?
JM: The events of the 80’s lend to many changes, which were mostly good for the industry. Trading oversight was ramped up significantly and the CFTC and exchange regulatory bodies became much more involved in regulation.
Many old timers such as myself were against government involvement but I must admit that it was mostly good for the industry especially the customer. Capital requirements for clearing firms were increased dramatically which led to the demise of many small trading houses including the one that I had become a partner in.
We were forced to sell our business to a larger concern. All of these factors moved the industry toward larger capitalized firms and consolidation.
DM: When did you notice the effects of technology on the trading pits?
JM: Our system was near its saturation point for order entry and clerical capability. Then a huge explosion in volume occurred when interest rate and stock index futures were developed. These events changed the entire scope of the industry as I knew it.
Once the Globex system for trading was developed it was just a matter of time until electronic trading became the dominant method of trading.
Pit trading was just not nearly as efficient. Commodity funds and hedge funds became much larger and more dominant. The small trader still existed but his importance to the market was minimized.
DM: How did you position yourself as a result? Was the end of the floor in sight?
JM: The “screen” and open outcry trade co existed for quite a few years and it was possible to make a living in the pit. In fact, a cottage industry developed to take advantage of the arbitrage between the two systems.
There was a feeling of denial among the floor traders. Everyone knew that the inevitable was going to happen but most felt it was a way off in the future.
Personally, I hired a clerk who made trades on the computer to offset whatever edge I was getting in the pit. This system was quite profitable for a couple of years and I wished I would have made the move earlier!
In the old days a savvy pit trader or broker could “feel” a market and sense when things were going to change. As the electronic trade gained market share the pit traders lost that ability. I experienced first hand being blindsided by large orders coming out of nowhere from the screen. Eventually the customer orders entered into the pit became fewer and fewer.
DM: Do you think derivatives and futures are a net benefit to the market?
JM: I really don’t know. I think derivative ETFs are a good tool for the public customer. What has changed, in my opinion, is that the number of decision makers using the market has decreased.
More and more public money has been put into hedge funds, commodity funds, etc. The small speculator or hedger now places his capital with a fund rather than deciding when and how to enter and exit the market individually. I think that has made the markets less liquid.
As the funds got larger they mostly turned to algorithms. Now they’re all going the same way at the same time which makes for liquidity disruptions. A trading friend of mine said the futures market is a mile wide but sometimes only a few inches deep!
DM: Even as some of my friends began working on the floor, and doing quite well, I recall you distinctly telling me not to follow in your footsteps.
JM: I never encouraged you to seek the life as a pit trader or broker because it was apparent to me that the system would eventually die.
It was a great place to be for 25 years! I never thought of it as work and loved every day.