Financial History Issue 116 (Winter 2016) | Page 19

By Edward Peter Stringham A commonly held belief is that markets can only emerge after government sets the rules of the game and creates an effective regulatory framework. But if one looks back in history, the world’s first three major stock markets, in 17th century Amsterdam, 18th century London and 19th century New York, developed amazingly sophisticated financial contracts even though most were unenforceable in courts of law. From the first stock markets in Amsterdam and London, government officials viewed most contracts in these markets as forms of gambling that were used to manipulate prices; the same was true in New York. In a 1791 letter to Thomas Jefferson, James Madison wrote, “stock jobbing drowns every other subject. The coffee house is an eternal buzz with the gamblers.” On April 10, 1792, the New York state legislature passed “An Act to Prevent the Pernicious Practice of StockJobbing,” which declared the unenforceability of all but the simplest contracts: © Francis G. Mayer/Corbis All contracts, written or verbal, public or private, made after the passing of this act, for the sale or transfer, and all wagers concerning the prices, present or future, of any certificate or evidence of debt, due by or from the United States, or any separate state, or any share or shares of the stock of the bank of the United States, or any other bank, or any share or shares of the stock of any company established or to be established, by law of the United States or any separate state, shall be, and all such contracts are hereby declared to be absolutely null, void, and of no effect. Despite the unenforceability of contracts, brokers continued trading anyway. The contracts were made possible not because of government, but because of private rules and regulations that emerged from the market. In Amsterdam brokers Tontine Coffee House (left), Merchant Coffee House (center) and Wall Street (right) facing east, by Francis Guy, 1797. made their contracts in open air venues like the Amsterdam Bourse, and in London and New York brokers congregated in coffeehouses and taverns that they transformed into private rule enforcing clubs. Long before government enforced contracts for them, traders engaged in forward contracts, short sales, securitization, hypothetication and options. Traders in Amsterdam relied on reputation and the discipline of repeat dealings, and traders in London transformed Jonathan’s Coffeehouse into a private club to create and enforce rules. But it is the New York markets that will be the focus of this article. Self-Policing Clubs A year after the famous Buttonwood Agreement of 1792, where 24 brokers pledged to deal with each other, an association of merchants created The Tontine Tavern and Coffee House “for the purpose of a Merchants Exchange with 203 subscribers at $200 each.” One commentator described it in 1794: The Tontine Tavern and Coffee House is a handsome, large brick building; you ascend six or eight steps under a portico, into a large public room, which is the Stock Exchange of New York, where all bargains are made. Here are two books kept, as at Lloyd’s, of every ship’s arrival and clearing out. This house was built for the accommodation of the merchants, by Tontine shares of 200 pounds each. It is kept by Mr. Hyde, formerly a woolen draper in London. You can lodge and board there at a common table, and you pay 10 shillings currency a day, whether you dine out or not. They adopted a “Constitution and nominations of the subscribers to the Tontine Coffee-House” as early as 1796; by 1817, brokers created a more formal membership club and trading venue, the New York Stock and Exchange Board. The 1817 “Rules to be adopted and observed by the ‘New York Stock and Exchange Board’” were quite simple. They included “fines for non-attendance at the calling of the Stocks,” and stated that “any member refusing to comply with the foregoing rules may have a hearing before the Board, and if he shall still persist in refusing, two-thirds of the Board may declare him no longer a member.” Members added different resolutions over the years, and by the 1860s, in addition to blacklisting those who did not follow through with their contracts, to make sure everyone was proper they had rules prohibiting “indecorous language” (suspension for a week), fines for “smoking in the Board-room or in the ante-rooms” ($5) and fines for “standing on tables or chairs” ($1). In the 1860s, they shortened the name to the New York Stock Exchange (NYSE), had an initiation fee of $3,000 and soon after had seats that could be bought and sold. They moved to the corner of Wall and Broad Streets in 1865 and into their current building in 1903. Entrance requirements and an initiation fee screened for reliability up front and acted as the equivalent of a bond that would be forfeited by anyone who broke the rules. Private Listing and Disclosure Requirements In addition to having rules of membership, the exchanges started having rules about the securities that could be listed. Letting any entity, including likely fraudulent ones, approach investors had the potential to create a tragedy of the commons situation where the fraudulent ventures crowded out the good. To deal with this problem, they adopted listing and disclosure requirements to make the market more transparent. By 1865 the NYSE had two lists of securities — the regular list and the secondary list — and the first list would be called at the “First Board” in the morning session that members had to attend. For a company to be on that list, the exchange required that applications “be made directly to the Board, with a full statement of capital, number of shares, resources, &c.” Over time they adopted more explicit listing requirements and required companies to maintain a transfer agency  |  Winter 2016  |  FINANCIAL HISTORY  17