Bill Brodsky, executive chairman of the Chicago Board Options Exchange (CBOE), has been around. As a young securities lawyer in New York, he joined the American Stock Exchange and helped launch its options products; as CEO and president of the Chicago Mercantile Exchange, he oversaw the start of Globex; and as head of CBOE, he saw the exchange demutualized and the launch of the VIX product line — one of the most successful contracts in modern history. In May, Brodsky left his post as CEO and assumed the role of executive chairman, where he’ll serve over the next year. As someone who has been involved in all aspects of the derivatives business, we wanted to get his candid look back to see how the financial world has changed.
Futures Magazine: What do you see as a game changer for both stocks and derivatives?
Bill Brodsky: One of the prime reasons the CME had asked me to come to Chicago [was] they had just signed the contract with [Standard & Poor’s] to trade stock index futures. I had spent my career up to that point on the stock side, a little on the options side as well, but I understood the stock market, and to their credit they understood that I knew the stock market and they didn’t. And the negotiations actually started exactly when they signed the contract with S&P. It was not a coincidence.
When I think back on how important stock index futures were…it wasn’t that they just created a very efficient vehicle for accessing or hedging in the stock market, but it also was the beginning of the trend toward tradable indexes, and there is no doubt that indexation has been an enormous part of the way the equity markets in particular have evolved. All you have to look at is the growth of stock index futures and stock index options.
But then the automation [of the market] allowed for what we used to call baskets of stocks, which then became portfolios of stocks, which then became the ETFs [exchange-traded funds]. Look at the evolution of equity markets and how they traded and how investors used [them]. You can see the mutual fund companies that embraced indexation and those that didn’t — there’s almost a great divide in terms of people just swarming to ETFs. But ETFs don’t hang there alone because there’s what preceded them, stock index futures and stock index options. So I think indexation is an amazingly powerful force in the investment world, but in the equity world in particular.
And it continues. We have not seen the peaking of the growth. [Just] look at the brokerage firms, the Schwab’s and Vanguard and Blackrock, and through Fidelity, [they are] making these vehicles accessible to individuals and institutions.
FM: That has expanded the market, right?
BB: Not only expands the market, but it’s part of the whole issue of active vs. passive management. That touches everyone, whether it’s a 401k plan or a pension plan, essentially can the active manager outperform the passive fund?
So what we began here in Chicago — stock index futures and a year later the CBOE created the first stock index options — we helped facilitate what really has become a revolution in finance.
FM: In each of the areas, with securities, with futures, with options, what do you see as your greatest accomplishment, or the exchanges’ greatest accomplishments?
BB: You can’t ignore that one of the greatest things that has been brought to finance in [this] lifetime was the creation of CBOE itself, which truthfully was a creation of the Chicago Board of Trade (CBOT) and a testament to the futures structure that existed, and how it was transplanted or reproduced in some fashion in the securities model. What the CBOT created in the CBOE was a way of standardizing options that had existed for hundreds of years, and created a secondary market as a result of the standardization. And it created next day settlement, which did not exist in stocks; it created certificateless trading that didn’t exist in stocks; and it created a clearinghouse in derivative contracts that did not exist in stocks, which ultimately resulted in the Options Clearing Corporation. So that was an enormous innovation.
The CBOE has been what I call a cauldron of innovation in creating so many different things: How to create stock index options, how to create long term [options], what we call Leaps, and probably one of the most dynamic and exciting innovations was the creation of volatility products (of which I’m very, very proud). One of the things that makes CBOE special is not only did we figure out a way to quantify volatility through the index, which is 20 years old this year, but then we [started trading them]. And when we started trading volatility futures, we could have gone to another futures exchange and said please do it for us, but instead we decided to build our own futures exchange, which I submit is probably the most dynamic futures contract created anywhere in the world in the last 25 or more years.
The other thing I’m most proud of is being able to create CBOE as an independent entity. Until three years ago, we were joined at the hip, although I think it was more shackled at the ankles, to the Board of Trade. It was the most vexing issue that we had to deal with, and unfortunately the brilliance of the creation by the Board of Trade was overwhelmed by the difficulty the two memberships had almost from day one...the structure was impossible. From the day I got here it was impossible. [As] other exchanges wanted to demutualize, it became evident to us we were stuck until we could settle [the dual membership issue]. We ultimately [worked out a] financial settlement with the Board of Trade members (not the Board of Trade).
How do you deal with that enormous pool of people and try to come to some solutions? It took years to do that. And of course once we did that, we were able to move on to our IPO. And I’m happy to tell you that here we are 35 months later, and I’m incredibly proud of our team and what we created, and our financial success, rewarding investors, the independence of CBOE as an entity. And the fact that in this post-financial crisis environment, we’ve been able to grow in the face of very daunting challenges in terms of volume and investor participation, and other things.
FM: Discuss your time at Amex and CME...
BB: I helped bring options onto the Amex. Forty years ago this month I authored an article on this exchange in Chicago. I had never visited Chicago, and I wrote an article — while I was still at a brokerage firm — about the rules of the CBOE because I had just bought a seat on the CBOE on behalf of my firm...So my relationship with the CBOE goes back literally 40 years…. who would have dreamt 40 years ago not only would I be living in Chicago, I would become CEO and chairman of an exchange that I only really wrote about as a lawyer because I found it interesting.
It’s interesting because of the three reasons [the CME was] interested in hiring me: [First] was my knowledge of the stock market, second was my knowledge of options, because they had just gotten the signal that the CFTC (Commodity Futures Trading Commission) was going to allow them to trade options on futures, and of course no one at the CME knew anything about options, and third was to help manage the exchange that was growing like Topsy.
FM: You were there during the launch of Globex?
BB: Oh, well before that. The CME embraced globalization very early, and was very prescient in creating Globex — and the dream is still being realized in terms of how they can use that system — but what was interesting and frustrating to me was notwithstanding the fact they were avant garde in 24 hours trading, or at least after hours trading (because remember Globex was always just after hours), they refused to embrace technology on the trading floor. The CBOE already was using handheld terminals [while] the CME and CBOT refused.
Here [we were] in the Chicago community where, in fact, members were coming across the bridge to the CBOE and going from throwing papers on the floor at the Board of Trade to using handhelds at the CBOE. It was quite a stark contrast.
So the CME, to its credit, was way ahead of itself in one area but absolutely [behind in on-floor] technology. But the CME and CBOT didn’t have the competition the CBOE had…that’s really what it was about. CBOE was competing with other [options] exchanges and one way to compete was to use technology.
One of the great things the CBOE did years ago was called RAEs — retail automated execution system — [not because of competition], but to deal with heavy volume. One of the other big differences between CBOE and [the futures exchanges] was the large [number] of retail investors, which has only continued to grow. Both groups of exchanges have always done a very good job in educating investors, but the participation is much more retail oriented in options than the futures business.
FM: Seems like it’s more so now with day traders…
BB: It’s not even just day traders. We concentrate on getting people who own stocks or ETFs to learn how to use options to help calibrate their portfolios in terms of the risk profiles. So I’ve always looked at options as an adjunct to stock investing, not a standalone. [They] can be used as a standalone but there are so many people who own stocks out there in 401ks or IRAs where options are very appealing to fine-tune a portfolio.
With the CME, I did a tremendous amount of work in the creation of stock index futures as a credible portfolio management tool and lending credit to it; this was not just a speculative vehicle. And second I helped them get into the options business. Understanding that I came from a stock exchange where the old timers didn’t want to learn options, and here I go to a derivatives exchange and say, ‘hey, these are pretty smart derivatives traders,’ and yet the futures traders refused to embrace options. Like Yogi Berra said, it was like déjà vu all over again. Options add a level of complexity that a lot of old timers just refuse to embrace. We call that mental gear shifting.
The other thing I did at the Merc is try to bring some structure to the staff…again it had grown like Topsy and it needed to be more professional. I took great pride in that, because when I got there, and it was the typical futures exchange structure where the chairmen of the committees basically felt that the staff worked for them. My feeling was no, they worked for me, and if you have an issue with the staff you come to me. But historically, the members of the Merc and Chicago Board of Trade felt that the staff was their own direct employees. And that was very difficult for people to work in that environment.
FM: Now let’s go through some historical events and developments. Let’s start with cash settlement and its importance as far as indexation.
BB: To the best of my recollection, cash settlement came in the early 1980s. It first manifested itself in the creation of Eurodollar futures, which is interesting because it was based on Libor. When I got to the Merc, Eurodollar futures had just started trading. It was really small then; T-bill futures were much more active. But the Shad-Johnson [Accord] allowed cash settlement in securities-related products. Shad-Johnson basically divided up the world on equity products between futures and securities. And that happened right before I joined the Merc because the Shad Johnson bill, one signed into law, allowed the first trading of stock index futures. So cash settlement really preceded it.
Cash settlement really started in Australia, not in the U.S. So it wasn’t invented in the U.S. but certainly was taken to a high level of success because of Eurodollar futures and because of stock index futures, and then stock index options.
[It also helped] the whole issue of globalization and internationalization of these markets.… My first week at the Merc, Liffe (London International Financial Futures Exchange) had just opened — it was the first futures exchange outside the U.S. for financial products. CBOE created the first options exchange outside the U.S. in Amsterdam, which is still the home of the most vibrant equity options market in Europe. You could say it goes back to the 1600s, but it certainly goes back to the 1980s when the EOE first started. So the CME helped create LIFFE by giving advice to John Barkshire and his cronies; the CBOE helped create the EOE in Amsterdam.
FM: It’s interesting how much futures and options education of the world came from the U.S. —
BB: No, it came from Chicago.
FM: And now these exchanges have become competitors…
BB: One of the fascinating trends is how 30 years ago as exchanges started up — and was so significant to me having come from a stock exchange — was how arrogant the stock exchanges were about the evolution of futures markets and options markets. In most cases the futures markets were separate from the options markets. When I think about how the stock exchanges looked down on the futures markets, and now you do a fast forward, and you see ICE (the IntercontinentalExchange) that didn’t exist 15 years ago buying the New York Stock Exchange, it’s stunning. There’s no other way to look at it other than it’s stunning.
I remember when I was at the CME, I was in Paris doing some business and I stopped into Matif, and [then] I stopped into the FIBV, the Federation of International Bourse de Valour, which became the WFE (World Federation of Exchanges). They looked at me in a very curious way, saying ‘you know, we don’t deal with [futures]….it’s kind of on the fringe of financial markets at best.’ Then I became the first chairman of WFE — from a derivative market! But [back] then [the way] they looked at me, to say an outsider would have been a compliment in those days.
So here you are with upstarts — the futures and options markets that traded financial products. There were always commodity markets, [but] they didn’t create in most cases the financial futures markets or options markets. [The stock exchanges] continued to be stand alone; take almost every country, whether it was Germany or Sweden or France or England, and it wasn’t the stock exchanges that helped create these markets. Now look back and because of demutualization and public ownership, and the growth of derivatives, and all of a sudden it’s derivatives driving the stock exchange bus. It’s funny to have lived through all of it and having come from the stock world and seeing how the stock people looked down on the creation of these markets, [they] missed the bus completely, and now are being — basically — swallowed up by them.
FM: Yes…remember the reaction in 1987 after the crash?
BB: Right, but the interesting thing is the lessons of 1987 are still barely comprehended. Take a look at the Brady report [Report of The Presidential Task Force on Market Mechanisms], which of course I’ve memorized. [He pulls out report from his bookcase].
Look at the conclusions: “Our understanding of these events leads directly to these recommendations to help prevent the events of mid-October and to have an effective and coordinated response in the face of market discord, we recommend: One agency should coordinate the few, but critical, regulatory issues that have an impact across the related segments and throughout the financial system; clearing systems should be unified across markets to reduce financial risk; margins should be made consistent across marketplaces to reduce speculation and leverage; circuit breaker mechanisms should be formulated and implemented across market systems....” This is 25 years ago; nothing has been done of any consequence.
FM: Except for circuit breakers, right?
BB: Well, that’s only because what happened with the Flash Crash. In other words, circuit breakers came in but they really weren’t that coordinated. They are now being much more coordinated. [Earlier] they were coordinated, it’s true, and I helped do that at the Merc. I helped negotiate that with the New York Stock Exchange but a lot of these things haven’t been addressed.
FM: Especially the one agency.
BB: Yes, Dodd-Frank had a section in there that said the SEC and the CFTC should get together and identify those areas where there are opportunities for harmonization. In September 2009 there were hearings — one day at the SEC, one day at the CFTC — when all the commissioners of both agencies came together and we gave testimony, and it was really very good, very substantive. For two days there were 10 commissioners sitting there, and nothing has happened [since]. You don’t have to combine the agencies to have harmonization. You need them to work together.
I testified. It was not shrill; it was a very factual thing: What works and what doesn’t work and how [they could be] coordinated more. And it was mandated by Dodd-Frank. Unfortunately because a lot of other things in Dodd-Frank had deadlines, this didn’t — they can’t even meet the deadlines they have. But there was a mandate in Dodd-Frank that the agencies should come up with a list of areas where there could be harmonization. It’s regrettable [nothing happened].
Other than a very constructive two days of hearings, nothing resulted from it. Now admittedly, all [regulators] had many other issues..including the mandates in Dodd-Frank. Then [we] had the LIBOR crisis, then the Flash Crash. When you think about it, from September 2009 and all the stuff that’s happened since, it hasn’t been easy, but the shame is the stuff is as relevant today as it was 25 years ago when [the Brady]report was written.
FM: Let’s talk about the advent of electronic trading…
BB: I don’t think anyone thought the change would ever be so swift. One of the biggest challenges that I had [at CBOE] was electronic trading.
[Traders] were wearing buttons on the floor saying “Brodsky must go.” My wife said to me, “If it’s so important they made a button with your name on it, I want one, and I want you to quit.” And I said, “I’m not giving in to those Luddites.”
The electronic push [intensified here] because the [International Securities Exchange] had started and [was] eating away at our market share.... In other words, until ISE, there was not good pressure in 1998-99.
So we got a membership vote to spend $50 million to build an electronic system so we had it in the ready. The problem was the members said you can have the money, you can have the system, but you can’t turn it on unless you have another vote. And of course they didn’t want to turn it on because they believed when we turned it on they would be out of business. So it was at that point in time we modified the system to create a truly hybrid system. And people were fearful that when we turned on the hybrid system, they would be intermediated, and in a large part they were right.
The Board of Trade didn’t have competition [in the U.S.]; it was as from Europe; it wasn’t mandated or at least fostered by the U.S. government against them. Dramatic difference. We were watching our market share erode month by month. I did not want to stand by and preside over and see this fine and amazing institution reduced to a dust heap because there were people on the floor more interested in their own careers or income than the future of the place. In fact, many of the floor traders were renting seats, but the owners seem to identify with the floor even though their future was tied more to the institution than to the monthly rent. It was kind of a perverse situation.
It started in 1999…we knew it was coming, and in two years [we could] either sit there and wait for it or [we could] try to do something. Interestingly the other options exchanges did nothing; Amex, the Pacific and the Philly didn’t do anything. We built a system but couldn’t turn it on. Then when we realized how dire it was,we modified the electronic system so the orders could come directly electronically, or they could go to the floor. It was a question of how the order was directed to give people WYSIWYG….WHAT YOU SEE IS WHAT YOU GET. So when an order came to the floor it wouldn’t be up to the whim of a guy if he’s going to trade with you.
Electronic trading made things more transparent, it made them quicker, and it certainly made them cheaper. And you combine that with the advent of the personal computer, and it was a revolution, not an evolution, of the markets. In our world in particular, if you align that with what we called discount brokers, the Schwabs, the Fidelities, the e*Trades, Ameritrades, Interactive Brokers… they allowed customers to access these markets essentially directly.
And the options customers are the most savvy retail customers in the business; they are self-motivated, they are smart, they are knowledgeable and they trade a lot. All that combined created this tremendous power. Of the millions of customers that we have, to be able to direct their own business and their own strategy. It’s breathtaking.
[Electronic trading] is one of the great revolutions we lived through. And of course it’s transcended our business. Who makes a plane reservation by calling a travel agent? How many people buy books on line? And in our business the immediacy, the transparency, the speed is absolutely breathtaking. I can sit at my computer, buy stock and it’s executed before I can see it happen. It’s been a revolution of all sorts, but it certainly revolutionized our business…its added to the volume, to the liquidity, just broadened the base.
Think of how we educated people 30 to 40 years ago. [We] would send people out on the road for two weeks and they would go to this hotel and have a seminar and go to that hotel and have a seminar. Now we do it online. We have our website in Spanish, Mandarin and English. So [electronic trading) has dimensions way beyond entering trades.
FM: Did the FBI Investigation of the industry have any lasting effect?
BB: No, but it was very traumatic for the Merc and Board of Trade and the community in general. I think it created a realization of how visible this business is [overall]. But I don’t think it had any lasting impact because whatever abuses were going on, there was quick action to address them. But a lot of it was because there wasn’t electronic trading and [consequently] hard to do surveillance.
FM: What is your impression of the 1987 stock market crash?
BB: To a certain extent the stock market crash was a positive because it showed [stocks and derivatives] weren’t separate markets, they were linked. So although for a long time [we had] to defend the viability and the economic utility of stock index futures, the reality said that basically there was one market and can’t be looked at as independent markets.
It also shows the barometer for the stock market because it moved so quickly because of indexation. You can do a single trade in a stock index future and in a sense trade the whole stock market with one execution.
But [post-1987 crash] was a very difficult period, a very difficult period. I was CEO [of the Merc at the time]… and spent a lot of time in Washington. Of course although we and the Board of Trade worked together, the fact is [the CME] had the stock index futures; the Board of Trade didn’t. It was viewed as an attack on futures markets, but it really was stock index futures that were the focus.
FM: Was your background in securities helpful at the time?
BB: It was very helpful in dealing with the New York Stock Exchange because I knew the people, they knew me, and I knew how their markets worked.
The most memorable thing was when we did circuit breakers and Leo [Melamed, CME Group chairman emeritus] called me at home and asked, “Is it okay that we change the expiration of the stock index futures from the afternoon to the morning?” Remember triple witching? The big triple witching controversy was that the markets would be roiled the Friday afternoon of expiration. So on one hand it was the right thing to do because of the political pressure at the time…unfortunately it wasn’t always the right thing for the marketplace because an a.m. settlement isn’t the close, it’s just the opening of the day. And one of the big issues we’ve had [at CBOE] is the difference in our stock index contracts; the difference what is p.m. settled and a.m. settled. This all goes back to the triple witching concept [that] preceded the stock crash [of 1987] just a little bit.
I remember being pivotal in that negotiation because I understood how the specialists in those days opened a stock, they didn’t close the stock. Opening the stock was an art form and it was a managed process as opposed to the close, which just happens to be whatever happens to be the last trade of the day. So if you’re settling a stock index contract, and someone walks up to the specialist at 3:59:58, and says ‘I have a hundred thousand to sell, I’m going to dump them on you,’ and it’s a Friday afternoon in the summer and [the specialist] wants to get out to the Hamptons, he’s going to drop the price. But the opening was not at the time of the bell, the opening was a process of equilibrium. And I understood that. I remember being the pivotal person to say that’s a fairer way of getting the result we wanted even though as I look back on it’s not the best way to have contracts settled because no one worries about the opening price, they worry about the closing price. But the market couldn’t adjust to it; the mechanics couldn’t handle it, which now they can do much better. Today we have the electronics;there were no electronics of consequence back then.
So I was very much involved with triple witching, in fact my most famous quote in my role as CEO of two exchanges for almost 30 years was when the Wall Street Journal reporter said to me, ‘so how did it go?” when the settlement of the S&P was moved to the opening, I said “Ding dong the witch is dead.” Here is was the first time we had done it and I knew we were going to succeed.
We did not roil the market at the opening, but we were roiling it at the close. Because the market would swing 200 points, the head of General Motors would call up and say how did my stock move two points on the close? Well, it moved two points on the close because there was a tremendous crush of orders and there wasn’t a way to get orders to come in.
FM: And that system is still in place today?
BB: It is, but probably if we were starting over we wouldn’t do it that way. Remember this was 1987, the [futures] product was barely five years old, and there was great suspicion that [it] was some sort of virus on the stock market. Remember the stock market was viewed as the Holy Grail and these crazies in Chicago were screwing up ‘our’ Holy Grail.
FM: Let’s talk about the 2008 financial crisis.
BB: One thing that was so significant was with the breakdown of the housing market, the breakdown of Fannie Mae, Freddie Mac, banks going bust, brokerage firms going bust, what worked so well? Regulated exchanges. All regulated exchanges — stock, options, futures, all over the world. Why do they work? Because they are regulated, there are safeguards, transparency, and there’s a uniform system of margining. Think about all the problems of the financial crisis, one of the big problems was OTC (over-the-counter) derivatives and the lack of margining and the lack of marking-to-market, which is like the [JPMorgan] London Whale [loss], another OTC issue.
Obviously I’m partial, but look at the financial crisis: A dozen different things didn’t work, and what in finance did work? The regulated exchanges. And you know what else worked? Chicago trading firms. Lehman went down, Bear Stearns went down. Merrill Lynch had to be saved, right? And how many firms in Chicago went out of business? Not one…and you know why? It was their money. They managed their own risk; they weren’t playing with the public’s money.
Think about Lehman…biggest bankruptcy in U.S. history, and for the Merc clearing and OCC, it was almost a non-event [despite] big Lehman positions.
FM: Can you talk about the Barings failure as well as Long Term Capital Management and their effects on the industry and market from your point of view?
BB: With Barings, I was involved because the Merc at the time, and still has, the mutual offset agreement with Singapore.Barings was really about Singapore. I got very involved with that; I remember the CEO of Merrill Lynch calling me on the phone and saying ‘we’re thinking of pulling out of Singapore.’ I called up the Monetary Authority of Singapore and said, “are you standing behind this clearing house?” and they said ‘yes.’.I called the ML chairman back and said you shouldn’t have to worry.
FM: The biggest key is that they froze everything.
BB: We told (Simex) they have to keep this thing moving. It wasn’t very long but we basically told them you’ve got to (release the money). It was very tense times between the CME and Simex at the time.
FM: Did it have a global effect?
BB: No, but unfortunately it was the first of several defalcations by traders against big banks. One of the biggest failures of Barings was the lack of supervision by the London guys. Here was a firm that was 300 years old and one stupid guy in Singapore caused it to blow up. I remember at the time the lack of controls that they had over him.
FM: What about Long Term Capital Management?
BB: It was pretty much on the periphery of our business, but I remember it vividly because I was and still am on the International Advisory Board of the New York Fed, which was in the middle of it. But Long Term Capital [recalls] the whole issue of OTC derivatives and the fact that there was this counterparty risk issue and the fact that there was no central place that this risk was maintained. Quite frankly, I look at Long Term Capital as the canary in the coal mine before the 2008 financial crisis and what happened with AIG and Lehman. The real issue of Long Term Capital was overleverage and OTC derivatives. And all these things Dodd-Frank is still trying to resolve.
Here we are three years after the bill passed, five years after the crisis and it’s still not resolved.
FM: Well banks still fight against new regulation …
BB: Because of profits. But this is what Dodd-Frank is supposed to be doing.
FM: Regarding Lehman’s failure and the government bailout it seems banks are bigger today than ever.
BB: In terms of aftermath of financial crisis, the private sector and public sector are inextricably linked; It’s very concerning the gridlock that we see. Both on the federal and state level, and I worry terribly having the global perspective I have, and having been in Asia and China many times, I am frightened that our free system and democracy can be losing ground to other countries because we have so much partisanship [and] we’re losing sight of what’s important. It’s very troublesome. Before we didn’t have to worry about the power in the world, and we still are the leaders in many respects, but on an international basis we’re just losing ground because we’re not focusing properly on infrastructure, education and there’s too many people who can’t get jobs because they’re not educated.
One of the things I’m very grateful for is our political involvements, which fundamentally are about business, but also gives us an opportunity to work with leaders. We had a U.S. senator in this week and we’re having the number three man in the House of Representatives coming on Monday. We don’t miss an opportunity to say “Can’t you guys figure it out? We’re losing our edge. We’re not in the powerful position we were 30-40 years ago because of the rise of China, the rise of India. One of the things I try to do is use our own bully pulpit to transcend our business [because] it’s important [for]the whole country…I can be pretty rough on these guys.
FM: Can you give perspective on the huge international growth of this business and its impact?
BB: There are two parts [to our business overseas]: one was while at the CME, we wanted to educate people on the legitimate uses of financial futures for commercial hedging purposes. And [second] it was to bring business to us. And it was a testament in doing that it spurred the growth of (global) exchanges to do their own products: DTB, Matif, and LIFFE, [all sprang] from nothing. Think of that — when we all got in this business, none of these existed. And why [did they form]? Because of the financial viability of the products plus the fundamental integrity of how the systems worked, and continue to work, and, truthfully, all [based] on the Chicago model. A tried and true system. Those people are vibrant competitors in many respects, even though the products are very much siloed as you well know.
FM: We talked about consolidation but there also are new exchanges popping up.
BB: It amazes me as someone who has been chairman of the WFE until a couple years ago and still on the board, with all the consolidation we have more members today in the WFE — [and] we have tough admission standards — more exchanges today than we had five years ago. Mind boggling. When you think about it, the NYSE [Euronext/Liffe] is the consolidation of about eight exchanges, and we have more exchanges today than we did then. Of course a lot of them are in Asia, [as well as] elsewhere whether it’s Warsaw or Kazakhstan, or even the Middle East. So it’s very exciting. These exchange markets work and people know if you want to have a vibrant commercial community you need exchanges. And it’s easier to create exchanges today than it was in the past because you don’t need physical floors, you don’t need a cadre of people trading on the floors. You buy a system from wherever and essentially you’re in business.
The SEC has made it very easy for people to start exchanges, and so has the CFTC, but the securities side has common clearing, so….
FM: Let’s discuss some trouble areas on segregated funds, i.e. Sentinel, MF Global, PFG?
BB: Well if you’re talking MF Global and Peregrine, which are the most concerning developments on the futures side since I left it. If I were in the futures market today I would be spending a whole lot of time trying to figure out how to overcome the structural weaknesses of the system. [The securities side] has SIPC [Securities Investor Protection Corp.]…It’s not perfect but it’s there and it works. I think people will be very cautious in terms of opening futures accounts with a limited number of firms without knowing that their cash is protected in seg funds.
FM: What do you think the futures and options industries can learn from each other?
BB: [The options] industry, from day one, because of the SEC structure was part of the securities industry, and if you have a securities account you automatically have the protection of SIPC. What’s important is everyone in our business pays something into SIPC and it is a very strong anchor for customer confidence.
FM: People with Bernie Madoff lost their money, right?
BB: Actually the biggest hits taken because Madoff depended on how the account was carried. If you had an account with a broker/dealer, SIPC covered it. There were different structures that Madoff used through feeder funds — but if you had an account with a broker/dealer, like if you had an account with an FCM, the broker dealer has the coverage of SIPC. I don’t know what the numbers were but it was an extraordinary amount of money SIPC paid out.
FM: How do you see the markets changing?
BB: I have a different perspective…two ways of looking at it. One is not withstanding some of the problems that have existed, like the Flash Crash, or Facebook’s IPO, or outages that have existed, we have gone to a whole new era of reliance on highly sophisticated computer systems. Whether it’s an airline or other businesses that depend on computers, we have accounts with banks and there are problems. We’re just going to have to get better and better at running these systems.
But the positives so outweigh the negatives from the point of view of individual investors. I’m very interested from a professional point of view of what I call financial literacy. I’ve given lectures on that. That’s one of the things I want to do when I have more time. One of the great failures of our country educationally is in not teaching people the financial literacy they need, particularly in a world where they are dependent on their own investments in terms of 401ks and IRAs, not what they call your father or mother’s pension plan. On one hand I think it’s terrific, we have in my view in this country the best financial products, the most transparency, the best liquidity of any country in the world. You give me $500,000 or $10 million, and I can invest as well as any institutional investor with the same financial power almost. It used to be if you had a small amount of money you would get raked over the coals, but if you had a lot of money you had great bargaining power. That’s not true particularly on the securities markets today.
We’ve done a poor job in teaching people how to manage their investments, and I think it’s a great failure at every level of education....Start in high school, [continue] in college, and in graduate schools. I know I’ve given classes at University of Chicago and Northwestern...the best and the brightest, graduate students! And it’s shocking…shocking. So I look at it and say with all the good we have, how do we get people to that level where they don’t say, ‘I have a guy who does it for me.” Or “I don’t really understand it.” My favorite line to people is you should spend as much time on your financial future as you do on planning your vacations.
FM: So what’s your next move?
BB: First of all, I’m going to be chairman here for a year. I will be engaged. Can’t tell you exactly how much time it will be, but it certainly will not be [just] a day a week. My goal is to be the best example of a public company’s transition, which we hope to be able to demonstrate.... After that... I’ve been chairman of Northwestern Hospital for the last 14 months, so I’ll do that for a while. I’ll be doing some other civic activities that I can’t go into now. I hope to do some teaching, and ultimately I hope to do some things in other areas of the investment world, some of which I hope to do with some of my sons who are all in business. That’s part of the menu.