How Bad Weather Built The 'World's Biggest Markets'

The Mercantile Exchange building in Chicago in 1929. i i

The Mercantile Exchange building in Chicago in 1929. AP hide caption

itoggle caption AP
The Mercantile Exchange building in Chicago in 1929.

The Mercantile Exchange building in Chicago in 1929.

AP

You can blame a lot of things on the weather — even the futures market.

Emily Lambert, author of The Futures: The Rise of the Speculator and the Origins of the World's Biggest Markets, tells Weekends on All Things Considered host Guy Raz that it was Chicago's cold winters that triggered the beginning of commodities trading.

The futures market trades in abstract commodities rather than actual goods. For example, a contract might lock in the price for a quantity of corn to be delivered at a future date. Traders essentially make or lose money depending on how well they've predicted the price of corn on that date.

These days, the corn itself might not matter much in futures transactions, but in the beginning, it was all about hedging bets against bad weather, spoilage — or an accidental dump in the river.

Farmers Meet Gamblers

In the mid-19th century, the Chicago River transported grain from Illinois farmers for sale in the city. It could be a slow trip fraught with hazards, Lambert says.

"The river would freeze up, and they couldn't get their grain to Chicago, and there was a delay," she says. "During that delay, there was the risk that the price of grain would fall."

The Futures
The Futures
By Emily Lambert
Hardcover, 240 pages
Basic Books
List Price: $26.95

Read An Excerpt

At the time, gambling was in style. That risk created an opportunity for speculators to make a hefty profit.

"Chicago was a boom-and-bust kind of town," Lambert says. "It was growing like mad. Basically, there were a lot of people in the city who were looking for opportunities and looking to make their fortunes — and looking to take risks."

In 1848, grain traders formed the Chicago Board of Trade. Then, in 1898, they created the Chicago Butter and Egg Board, which would eventually become the Chicago Mercantile Exchange. Together, those boards composed the original, most bustling futures market in the world.

Getting Into 'The Pit'

Making it into the Chicago Mercantile or the Chicago Board of Trade was like trying to join an exclusive country club. To be a trader, you had to be a member, and in order to be a member, you had to have someone else vouch for you. Lambert says most people started on the floor as runners, taking slips of paper from traders who were making deals in a frenzy and bringing them to the back office.

"Then you might graduate to working on the phone, taking orders from people calling in," Lambert says. "And then you might become a broker, who was in the pit, or a trader, trading for yourself in the pit."

The pit is an octagonal area that used to be filled with men screaming orders and prices at each other (think of the movie Trading Places). Although both the Chicago Mercantile and the Chicago Board of Trade had pits, the characters in each were a part of very different cultures.

"The Chicago Board of Trade was identified most closely with the southside Irish community of Chicago," Lambert says. "The Chicago Mercantile Exchange, a few blocks away, was predominately Jewish."

Emily Lambert is a senior writer at Forbes magazine.

Emily Lambert is a senior writer at Forbes magazine. Fred Teifeld hide caption

itoggle caption Fred Teifeld

The two exchanges were rivals. "In fact, they developed a boxing match every year," Lambert says.

Today that rivalry is mostly gone, and because of the switch to electronic trading, the pits are almost empty.

Corruption Makes A Comeback?

The futures markets were easily corrupted at the beginning, but over the next few decades, Lambert says, they became regulated markets and worked reasonably well. Today, gaming the market is making a comeback.

"Now, there are also related derivative markets and those derivatives markets [are], one might say, like the futures markets in the late 1800s," Lambert says.

Over the past few years, the derivatives market has come under considerable scrutiny for its role in the current financial crisis. With a notional value of $1.2 quadrillion, it's no surprise some regulators are pressing for a serious overhaul. The story sounds familiar to Lambert.

"It's almost like we're living back in Chicago in the 1800s," she says. "We're hammering out the kinks of the market so that the markets will continue to function."

Excerpt: The Futures

The Futures
The Futures
By Emily Lambert
Hardcover, 240 pages
Basic Books
List price: $26.95

The place that became Chicago was founded on land known as Illinois Territory, named in a hat tip to the Native American groups that long inhabited the area. In 1808 the government built Fort Dearborn on a small hill above a river, near the shore of a large freshwater lake. The soldiers defended the fur trade. Chicago was built, literally, for trading.

By 1812 the people pushing into the western territory had annoyed and frightened the natives, who allied with the British to stop American expansion. On a hot summer morning that year, a few dozen men, women, and children evacuated the fort. They followed the lakefront and made it about a mile and a half south — to the area that would become Prairie Avenue, Millionaires' Row — where they were attacked by natives, who killed fifty-some people in a matter of minutes. The surviving settlers surrendered. The natives burned the fort. This was called the Fort Dearborn Massacre.

The attack scared off plenty of people, but the great national march westward was ultimately unstoppable. The army returned in 1816, and Illinois was admitted to the union two years later. Fur traders and military men gave way to a parade of farmers, merchants, and other entrepreneurs who built log cabins and sod houses on the prairie and farmed some of the richest soil on the planet. They fought off disease, bad weather, animals, bandits, and the other unpredictable elements of life on the fringe.

In the 1830s, they started digging a canal. The goal was for the Irish workers doing the labor to dig a ditch that would connect the Chicago and Illinois Rivers, thus linking the Great Lakes to the Mississippi River and putting Chicago in a good position to become a hub. It could be a center for business to rival and maybe overtake other hopeful cities, like St. Louis.

The canal sparked a land rush. An Englishwoman traveling through town in the 1830s described streets crowded with land speculators and storekeepers hawking farms and lots. In 1835 a man named William B. Ogden arrived from New York to oversee his brother-in-law's 150-acre real estate investment. He sent back word that speculators were driving prices to ridiculous levels. Sure enough, it was a bubble, and land prices crashed in 1837.

Then came 1848, a year that a Chicago trader would describe 160 years later in his office with such fondness that it almost seemed like he had been there. That year the canal opened, the city's first railroad tracks were laid, and the telegraph arrived. Chicago stared excitedly, optimistically, into the future.

As Chicago became a hub, Ogden and eighty-two other men created a business organization that became the Chicago Board of Trade. At first the Board was just a group of businessmen. They met in a long, narrow room upstairs from a flour store at 101 South Water Street, on the south bank of the river, near where Fort Dearborn stood until 1857. Besides Ogden, there was Gurdon Hubbard, a Vermonter and future meatpacker and the city's first insurance man. There was John H. Kinzie, who was a son of one of the first settlers and who had seen and survived the Fort Dearborn Massacre. Some of these men had names destined for the Chicago street map. They got together to discuss and promote the city's commerce.

Before long, they started talking about grain, which was a big business in the frontier town. Some farmers hauled it in on rutted, muddy, bandit-ridden roads. But most were too busy taking care of their farms to make the trip. They sold their grain to local merchants, who brought it to Chicago by boat or railcar and then haggled in the streets. The Board of Trade decided that it made more sense to have one meeting place for everyone with grain to buy or sell and tried to lure them to their room on South Water Street, and to other rooms they rented around the area, eventually resorting to crackers, cheese and ale.

Few showed up, but Chicago's weather gave them reason. The city was built roughly halfway between the North Pole and the Equator. Warm fronts from the south clashed with cold fronts from the north. As the seasons changed, temperatures swung from bitter cold winters to hot, humid summers. That's part of the funny story of this business, and one reason why it developed in Chicago instead of, say, Florida.

In late fall and winter, farmers growing corn along the river hauled it by oxcart and sled to the local grain elevator. The river and canal were sometimes already frozen, and merchants couldn't get the corn to Chicago, so they stored it in corn cribs during the winter. In the spring, the river thawed and sellers converged on Chicago and drove prices down to the point that it wasn't always worth making the trip. Farmers, traders liked to say later with theatrical flourish, would dump their corn in the river.

So river merchants started arranging to sell the corn in advance. Someone said, "Hey, I know it's cold and only March now, but I'll deliver three thousand bushels of corn to you next June for a penny cheaper than what you'd pay me today. Deal?" On March 13, 1851, three years after the Board of Trade was formed, two traders signed the first such timed contract — or at least the first one to make the textbook. A seller promised to deliver corn the following June for one cent per bushel less than the March price.

Similar contracts were traded at other places and times around the globe. Some traders point to the Bible, ancient Greece, medieval Europe, and seventeenth-century Japan to show they were following an established path. But this trade took root in Chicago in a way it hadn't before. People in the grain trade who were worried that prices would go up or down started trading these contracts.

People who knew nothing about corn also started trading them. They saw an opportunity to make money by guessing the direction of corn prices, and they bought and sold the contracts before having to take or deliver corn. By the mid-1850s, a single contract could pass through several hands before finally ending up in the hands of a merchant who wanted corn. Around that time, traders finally started gathering in large numbers at the Board of Trade.

By 1856, the Board of Trade had several hundred members, and the trading room had grown crowded. The gypsy like exchange moved to the corner of South Water and La Salle Streets. In 1860 there were still more people who wanted to trade, so the Board moved again, to a new building built steps away at South Water and Wells Streets. The second story had a large hall, more than four thousand square feet, with frescoed walls and ceiling and uninterrupted views from one side of the room to the other. In that new

space, they traded furiously because the demand for grain skyrocketed as northern and southern soldiers fought in civil war. The Union quartermaster, who was responsible for keeping the troops fed, ordered oats and pork in advance, and speculators dove in — those that didn't join the Board's own regiment. One of these traders, a man named Benjamin Hutchinson, made a small fortune in 1864. The next year, he must have heartily shaken hands with both General William Tecumseh Sherman and General Ulysses Grant when they visited the exchange.

It's hard to pinpoint the moment when the transformation occurred. But eventually the contracts started to look alike. Instead of buying and selling specific bags of grain, traders bought and sold grain that met a specific description — a certain grade of corn, for example. The contracts called for standardized grades of grain, to be delivered in standardized amounts, on standardized dates.

With contracts that looked alike, it became easier to buy and sell them and to trade them like baseball cards. On October 13, 1865, two months after moving yet again to La Salle and Washington Streets, the Chicago Board of Trade adopted some rules for this trading. According to the late University of Illinois agriculture professor Thomas Hieronymus, who wrote a textbook on futures, that's the closest anyone can come to assigning a birth date to the modern futures contract.

From The Futures: The Rise of the Speculator and the Origins of the World's Biggest Markets by Emily Lambert. Copyright 2011 by Emily Lambert. Excerpted by permission of Basic Books, a member of the Perseus Group.

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