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
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