Capital Market Evolution 1960-1999
This series “Capital Market Evolution” is sponsored by Teamo “Where Teamwork Matters”, see on Open Collective and is part of the project Smart "Master" Contract for Equity Distribution, we truly believe that we should understand our past to build our economic future more wisely.
The digital revolution started around 1950 when William Bradford Shockley Jr. creates the bipolar junction transistor and took off when the traitorous eight create Fairchild Semiconductor in 1957. In the early 1960s, Fairchild helped make computer components for the Apollo program. Later in the decade, many of the "Traitorous Eight" left Fairchild and founded their own companies. Including Gordon Moore and Robert Noyce, who in 1968 founded their own company in Santa Clara called Intel went to create world's first commercial microprocessor chip in 1971 that become widely used in the personal computer. . Soon after, other ex-Fairchild employees and "Traitorous Eight" members helped found AMD, Nvidia, and venture fund Kleiner Perkins.
In 1969, the Stanford Research Institute became one of the four nodes of ARPANET. A government research project that would go on to become the internet. In 1970, Xerox opened its PARC lab in Palo Alto. PARC invented early computing tech, including ethernet computing and the graphical user interface. In 1971, journalist Don Hoefler titled a 3-part report on the semiconductor industry "SILICON VALLEY USA." The name stuck.
In 1960 the Quotron was created and became the first financial data technology company to deliver stock market quotes to an electronic screen rather than on a printed ticker tape. The Quotron offered brokers and money managers up-to-the-minute prices and other information about securities
Next big evolution that took 30 years to unleash is full potantial is the electronic communication network (ECN) is a type of computerized forum or network that facilitates the trading of financial products outside traditional stock exchanges. An ECN is generally an electronic system that widely disseminates orders entered by market makers to third parties and permits the orders to be executed against in whole or in part. The primary products that are traded on ECNs are stocks and currencies.
The growth in stock trading in prosperous post-World War II America, and the burgeoning financial sector’s own ambitions, eventually overwhelmed exchanges and brokers. In 1969, a firm that was later folded into Merrill Lynch employed 600 people just to manage stock certificates. The whole, paper-based system left plenty of room for mix-ups and foul play, resulting in missed trades, brokerage failures, market shutdowns, and theft. According to a New York Times report from the era, up to $400 million in lost or stolen securities were reported between 1967 and 1970—in 2015, that would be equal to $2.8 billion, adjusting for inflation. In 1967, a 22-year-old stock clerk was indicted for stealing $900,000 in IBM stock certificates—a cool $6.3 million in today’s dollars.
The RAND Corporation, a policy research group, was called in to help solve the problem. Technology seemed to be the solution. Computerized punch cards soon began to take over the exchanges. But as late as 1973, financial advice columns urged people to take delivery of their stock certificates rather than leave them “in the street,” that is, in the hands of their brokers. When brokerages failed, any investments they still held for their customers would disappear, too. Is only when Tandem Computer launches the Nonstop server computers series in 1976 which is the first fault tolerant system for recording transactions that the exchange really become computerized, an exchange could not fail, period, Apple the most successful personal computer, Tandem was the most successful commercial computer.
Shortly after the creation of ECN, the Nasdaq was born, At first, it was merely a "quotation system" and did not provide a way to perform electronic trade. It took several years and many changes in regulation before the Nasdaq and ECN really took off in 1990 with the dot.com boom. Two major regulatory change influence the ECN market, at first the Securities Acts Amendments of 1975 and the ATS Regulation 1998.
During this era, we did see incredible innovation on the technology side, but the financial side was exciting too with the financial market alchemy at play in the currency market, the commodity market and the bond market.
Black Monday (1987)
In finance, Black Monday refers to Monday, October 19, 1987, when stock markets around the world crashed. The crash began in Hong Kong and spread west to Europe, hitting the United States after other markets had already sustained significant declines. The Dow Jones Industrial Average (DJIA) fell exactly 508 points to 1,738.74 (22.61%).
Possible causes for the decline included program trading, overvaluation, illiquidity and market psychology.
A popular explanation for the 1987 crash was computerized selling dictated by portfolio insurance hedges. However, economist Dean Furbush pointed out that the biggest price drops occurred during light trading volume. In program trading, computers execute rapid stock trades based on external inputs, such as the price of related securities. Common strategies implemented by program trading involve an attempt to engage in arbitrage and portfolio insurance strategies. As computer technology became widespread, program trading grew dramatically within Wall Street firms. After the crash, many blamed program trading strategies for blindly selling stocks as markets fell, exacerbating the decline. Some economists theorized that the speculative boom leading up to October was caused by program trading, and that the crash was merely a return to normalcy. Either way, program trading ended up taking the majority of the blame in the public eye for the 1987 stock market crash. U.S. Congressman Edward J. Markey, who had been warning about the possibility of a crash, stated that "Program trading was the principal cause."
New York University's Richard Sylla divides the causes into macroeconomic and internal reasons. Macroeconomic causes included international disputes about foreign exchange and interest rates, and fears about inflation.
The internal reasons included innovations with index futures and portfolio insurance. I've seen accounts that maybe roughly half the trading on that day was a small number of institutions with portfolio insurance. Big guys were dumping their stock. Also, the futures market in Chicago was even lower than the stock market, and people tried to arbitrage that. The proper strategy was to buy futures in Chicago and sell in the New York cash market. It made it hard – the portfolio insurance people were also trying to sell their stock at the same time.
1973 Oil Crisis
The 1973 oil crisis began in October 1973 when the members of the Organization of Arab Petroleum Exporting Countries proclaimed an oil embargo. The embargo was targeted at nations perceived as supporting Israel during the Yom Kippur War. The initial nations targeted were Canada, Japan, the Netherlands, the United Kingdom and the United States with the embargo also later extended to Portugal, Rhodesia and South Africa. By the end of the embargo in March 1974, the price of oil had risen from US$3 per barrel to nearly $12 globally; US prices were significantly higher. The embargo caused an oil crisis, or "shock", with many short- and long-term effects on global politics and the global economy. It was later called the "first oil shock", followed by the 1979 oil crisis, termed the "second oil shock."
At the start of the digital revolution, something major happens on the currency market “The Nixon Shock”that put an end to the gold standard and make the Bretton Wood system inoperative, by 1973 currency from all developed nation became free floating with the US dollars acting as a reserve currency, welcome to the fiat world
1985 Plaza Accord
The Plaza Accord is a 1985 agreement among the G-5 nations—France, Germany, the United States, the United Kingdom and Japan—to manipulate exchange rates by depreciating the U.S. dollar relative to the Japanese yen and the German Deutsche mark.
Also known as the Plaza Agreement, the intention of the Plaza Accord was to correct trade imbalances between the U.S. and Germany and the U.S. and Japan, but it only corrected the trade balance with the former.
1992 Black Wednesday
Occurred in the United Kingdom on 16 September 1992, when John Major's Conservative government was forced to withdraw the pound sterling from the European Exchange Rate Mechanism (ERM) after it was unable to keep the pound above its agreed lower limit in the ERM. In 1997, the UK Treasury estimated the cost of Black Wednesday at £3.4 billion. In 2005, documents released under the Freedom of Information Act indicated that the actual cost may have been slightly less, £3.3 billion.At that time, the United Kingdom held the Presidency of the European Communities.
The trading losses in August and September were estimated at £800 million, but the main loss to taxpayers arose because devaluation could have made them a profit. The Treasury papers show that if the government had maintained $24 billion foreign currency reserves and the pound had fallen by the same amount, the UK would have made a £2.4 billion profit on the pound sterling's devaluation.
1998 LTCM Collapse
Long-Term Capital Management was a massive hedge fund with $126 billion in assets. It almost collapsed in late 1998. If it had, that would have set off a global financial crisis.
LTCM's success was due to the stellar reputation of its owners. Its founder was a Salomon Brothers trader, John Meriwether. The principal shareholders were Nobel Prize-winning economists Myron Scholes and Robert Merton. These were all experts in investing in derivatives to make above-average returns and outperform the market.
Investors paid $10 million to get into the fund. They were not allowed to take the money out for three years, or even ask about the types of LTCM investments LTCM. Despite these restrictions, investors clamored to invest. LTCM boasted spectacular annual returns of 42.8 percent in 1995 and 40.8 percent in 1996.
That was after management took 27 percent off the top in fees. LTCM successfully hedged most of the risk from the 1997 Asian currency crisis. It gave its investors a 17.1 percent return that year.
But by September 1998, the company's risky trades brought it close to bankruptcy. Its size meant it was too big to fail. As a result, the Federal Reserve took steps to bail it out.
Like many hedge funds, LTCM's investment strategies were based upon hedging against a predictable range of volatility in foreign currencies and bonds. When Russia declared it was devaluing its currency, it defaulted on its bonds. That event was beyond the normal range that LTCM had estimated. The U.S. stock market dropped 20 percent, while European markets fell 35 percent. Investors sought refuge in Treasury bonds, causing long-term interest rates to fall by more than a full point.
As a result, LTCM's highly leveraged investments started to crumble. By the end of August 1998, it lost 50 percent of the value of its capital investments. Since so many banks and pension funds had invested in LTCM, its problems threatened to push most of them to near bankruptcy. In September, Bear Stearns dealt the deathblow. The investment bank managed all of LTCM's bond and derivatives settlements. It called in a $500 million payment. Bear Stearns was afraid it would lose all its considerable investments.
LTCM had been out of compliance with its banking agreements for three months.
Federal Reserve Intervention
To save the U.S. banking system, the Federal Reserve Bank of New York President William McDonough convinced 15 banks to bail out LTCM. They spent $3.5 billion in return for a 90 percent ownership of the fund.
The Fed started lowering the fed funds rate. It reassured investors that the Fed would do whatever was needed to support the U.S. economy. Without such direct intervention, the entire financial system was threatened with collapse.
1970 Mortgage-Backed Security (MBS)
The first mortgage-backed security (MBS) was issued in 1968. Thereafter, the MBS market grew rapidly with outstanding issuances exceeding $9 trillion by 2010. The growth in the MBS market was accompanied by numerous innovations such as collateralized mortgage obligations (CMOs) and the emergence of private label alternatives to MBS issued by government-sponsored entities. We trace the evolution of the MBS market and we review debates surrounding such questions as whether the MBS market has reduced the cost of housing finance, whether the MBS market is a market for lemons, and what role, if any, MBS played in the run-up and subsequent decline of home prices during the decade of the 2000s. We also detail the evolution of models for MBS valuation as developed by academics and practitioners.
What Is Securitization?
Securitization is the procedure where an issuer designs a marketable financial instrument by merging or pooling various financial assets into one group. The issuer then sells this group of repackaged assets to investors. Securitization offers opportunities for investors and frees up capital for originators, both of which promote liquidity in the marketplace.
1970 Junk Bonds
Is really difficult to have consensus on when junk bonds I’ve been created, some would say many centuries ago and that makes sense, but is a combination of the (LBO) levered buyout with junk bonds that make thing interesting and a highly profitable endeavor for Wall Street, see Micheal Milken incredible journey.
What Is a Leveraged Buyout?
A leveraged buyout (LBO) is the acquisition of another company using a significant amount of borrowed money to meet the cost of acquisition. The assets of the company being acquired are often used as collateral for the loans, along with the assets of the acquiring company.
To this day, high-yield bonds, as they are now more genteelly known, remain a brilliant innovation because they elegantly solve a simple yet ubiquitous problem: They give companies with less than stellar credit ratings access to capital.
These bonds created and grew entire industries, such as wireless communications and cable television, just as they created and grew immense pools of wealth. Their invention— combined with the packaging of credit card receivables, mortgage payments, and car loans into securitized products that loosened lending for individuals — has done nothing less than bring about the democratization of finance.
1994 Credit Derivative Swap (CDS)
Through a credit swap, a buyer can take risk control measures by shifting the risk to an insurance company in exchange for periodic payments. Just like an insurance policy, a CDS allows purchasers to buy protection against an unlikely event that may affect the investment.
Credit default swaps came into existence in 1994 when they were invented by Blythe Masters from JP Morgan. They became popular in the early 2000s, and by 2007, the outstanding credit default swaps value stood at $62.2 trillion. During the financial crisis of 2008, the value of CDS was hit hard, and it dropped to $26.3 trillion by 2010 and $25.5 trillion in 2012. There was no legal framework to regulate swaps, and the lack of transparency in the market became a concern among regulators.
ARC: At first I want to apologize to not make it better, so much could be said from the digital revolution era, I hope we will make it 10x better in the near future. To make it short and sweet I will share my observations inside a short personal list that will go point by point.
- Spoiler alert Something Ventured is my favorite documentary.
- Stable coin endeavour mesmerize me currency peg, the first to collapse was the british pound in 1992, next the mexicain pesos 1994 and after the 1997 asian crisis, what comes next is Tether, the only thing I could say is auditing is a simple business whatever snake oil men tell you, numbers never lie on a public ledger.
- Petrodollars recycling , when inflation catch up with primary utility, the end result is stagflation which is pretty bad for any economic system. Ethereum get hit by this phenomenon into full swing, what happen is the dramatic rise of Ether price produce great wealth for creating the Ether ecosystem but at the same time Ether serve as fuel to run application hurting the ecosystem expansion.
- Today distributed ledger technology like Corda, Quorum, Fabric etc...is a reminiscence of Tandem computer legacy, what Tandem did back then at the hardware level (fault tolerant system with 99% uptime) now we do it at the network level closing the loop for a full digital world.
Thanks for reading, I truly apologize for not producing a better series, I’m lacking time, we are always looking to add more contributor to join Teamo mission “Where Teamwork Matters”. To be a Teamo contributor you need to ask yourself two questions, the first question are you ready to “create richness” for all stakeholders, the second question are you ready to “share the pursuit of happiness”, if the answer yes on both questions welcome on board.