The Rules of the Game

A couple of years ago, an editor at Scribner asked me to write a book covering the entire history of Wall Street. I was reluctant. I’d already written a book on the Wall Street of the Civil War era, and I have never liked writing about anything for a second time. However, suitably bribed with a generous advance, I agreed to undertake the task of making a story from a piece of the past that is now 346 years long, running from 1653, when the wall that gave the street its name was built, to the present.

Writing books is a funny business. For one thing, it is one of the very few commercial endeavors that are undertaken in solitary; for another, the writer is often working hardest when he seems to be doing nothing at all. Writers stare out windows a lot. Some are very disciplined (Anthony Trollope wrote fifteen hundred words every morning before going off to his job at the British post office). Others, myself most definitely included, are adept at finding excuses to write tomorrow instead of today. Some write only at night, some only in the morning. More than a few writers, including very great ones, have found alcohol useful in the creative process.

I didn’t try demon rum to stimulate the muse (I’m a bad enough typist as it is), but, for a long while, I didn’t get very far because I didn’t know what story I wanted to tell. Narrative history is storytelling, just as a novel is. The only real difference is that novelists make up their characters and situations and historians don’t. That is fine by me because God creates far better characters and events than I ever could. But while the history of Wall Street is full of extraordinary human beings and thrilling events, that does not alleviate the problem. If you simply string them together, one after the other, the result is boring and unsatisfying. What would make the history of Wall Street hang together as a single story?

Then I happened to stumble upon a passage in a classic book on Wall Street’s ways, Edwin Lefevre’s Reminiscences of a Stock Operator. “Nowhere does history indulge in repetition so often or so uniformly,” Lefevre writes, “as in Wall Street. … The game does not change and neither does human nature.”

It seemed to me that Lefevre was only half right. While the basic game that is played on Wall Street every working day does not change, the rules of that game certainly have. The reason is simple enough. The game has been played during the course of the most concentrated period of change—economic, technological, social, and political— in the history of the world. And much of this change provided Wall Streeters with new opportunities to profit.

But how did Wall Street keep its game from self-destructing as the players devised more and more new tactics and strategies to pursue their self-interests? This problem—that the trouble with capitalism is capital ists — was recognized as long ago as Adam Smith. “People of the same trade,” he writes in The Wealth of Nations, seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public or in some contrivance to raise prices.”

The urge to win must therefore be restrained by the rules (and by the referees who enforce those rules; imagine the Super Bowl without those men in striped shirts on the field). So the history of Wall Street, it seemed to me, was not that different in a sense from the history of American football. That game (which is a zero-sumone in the mathematical sense, but a multibillion-dollar industry in the economic one) began shortly after the Civil War. It came about because some colleges, such as Princeton and Rutgers, played a form of football that resembled modern-day soccer while others, such as Harvard, played a game more akin to rugby. Over about 40 years, the two games were fused into a profoundly new game quite unlike either.

Just as on Wall Street, where the basic game has always been to buy cheap and sell dear, in football, the basic game has always been to get the ball to the opponent’s goal line. In the course of those 40 years, however, all sorts of ideas for exactly how to get it there were tried out. Some were quickly abandoned while others were just as quickly adopted. The flying wedge, in which the line formed a V around the ball carrier, began to evolve in 1884, but it was banned ten years later, when it was decided that it gave too much of an advantage to the offense (and produced far too many injuries as well). The forward pass, on the other hand, first introduced in 1906, transformed the game in very positive ways and was quickly made an integral part of it.

This constant experimenting with the rules of the game to make it both fair and exciting is exactly what happened on Wall Street. I had my story.

There have been four major bursts of rule making on Wall Street since it began as a financial market in the early 1790s. It is instructive to look at these episodes and see just who was the driving force behind each.

In the early days, before the Civil War, the market was so small and had so few players that it could be governed as informally as a backyard touch-football game. But, when the war suddenly transformed the Street into the second-largest securities market in the world, with billions in play, that system broke down almost at once. And the legal system could not help out, because it was, at the time, utterly corrupt.

Wall Street was on its own and saw some of the wildest days that capitalism has ever known. Commodore Vanderbilt was prevented from buying control of the Erie Railroad when the management adopted the simple expedient of secretly printing more and more shares and throwing them on the market. But the brokers, who made their livings by taking small commissions, realized that such tactics were lethal to the Street in the long run. After all, who would want to buy a share of a company if there was no way to know the percentage of ownership each share represented?

So, when the New York Stock Exchange and the Open Board of Brokers merged in 1869 and formed an institution large and powerful enough to dominate the Street, the brokers moved. They quickly imposed a set of rules requiring advanced disclosure of stock issues, an open registry of shares outstanding, and so forth. Furthermore, they required all members to trade in listed securities only on the trading floor, where the Exchange could keep an eye on things. Wall Street settled down almost at once.

By the 1890s, the great investment banks, epitomized by J. P. Morgan & Company, were becoming the dominant institutions on Wall Street as they raised the capital needed for the industrialization of the country by floating stock issues and bonds. But they needed to know the exact financial situation of each company in order to protect their own interests and the interests of their customers as well. Thus it was the investment bankers who were the main force behind the new requirement that companies issue quarterly and annual reports and adhere to a common set of accounting standards now known as Generally Accepted Accounting Principles (GAAP).

In the 1920s, it was the brokers— the force for reform in the 1860s— who needed reforming. The Exchange was owned by the brokers and was largely controlled by the specialists, who were supposed to see that trading in each stock was orderly, and by the floor traders, who owned seats on the Exchange but traded only for their own accounts. The specialists, by the nature of their jobs, were richly supplied with insider information, and the floor traders were perfectly positioned to take advantage of that information. Together, they manipulated stocks to their own profit but to the detriment of the investing public.

There was little to be done in the 1920s. But the Great Depression brought the Securities and Exchange Commission into existence as a watchdog. Moreover, the disgrace of Richard Whitney, the highly respected president of the Exchange and leader of its anti-reform forces, who was caught embezzling from his clients, changed the atmosphere on Wall Street. Rules forbidding insider trading and safeguarding investors’ money were issued, and the Exchange got a new constitution that took its important public functions much more into account, despite its private ownership.

By the 1970s, the growth of pension and mutual funds had caused a surge in volume, and the microprocessor had begun a new communications revolution. Markets such as NASDAQ were competing ever more effectively with the NYSE by offering lower commission costs. The large brokerage houses such as Merrill Lynch that had developed after World War II and brought Wall Street investing to Main Street America wanted to end the oldest rule of all on the New York Stock Exchange: fixed commissions, which obliged everyone to charge the same price. In 1975, with the help of a timely shove from the SEC, the brokers were able to eliminate the fixed commission. Volume soared and paved the way for the extraordinary bull market of the 1980s and 1990s.

Today, Wall Street is changing once again, thanks to the internet. Day traders are not unlike the floor traders of the 1920s, able to trade in and out of a stock hundreds of times in a day at very little cost. More important, the world’s financial market is now a completely integrated whole. But where are the referees? Unlike the market, they are still limited to acting within sovereign countries. In the not too distant future, a global Wall Street with only local regulators is likely to provide the market with days of excitement unseen since the Civil War.

But somebody besides me will have to write that story.