N.Y., Chicago Traders : Rivalry: Big Board Vs. the Pits

The traders at the New York Stock Exchange naturally felt a little superior last month when they heard that the Chicago police had nabbed a man for dressing up with a wig and makeup to cheat traders at a Chicago commodity exchange.

The man was claiming profitable trades and using his disguise to duck out on unprofitable ones--the kind of scam that, at the orderly New York Stock Exchange, “just couldn’t happen,” said New York trader James G. Gallagher.

Chicago traders are used to such jabs from their New York rivals and sometimes counter by bringing up Wall Street’s insider-trading scandal or questioning whether New York traders really have a stomach for long odds: “They just don’t seem to have the risk takers over there,” said Howard Dubnow, a Chicago trader.

Time-Honored Feud

Rivalrous exchanges between Chicago and New York traders are a time-honored part of a relationship that has taken on new importance as the financial world debates how to prevent a recurrence of the October stock market crash.

From the days when they swapped stock certificates in swallow-tailed coats, the traders of Wall Street have tended to see their counterparts in the farm-bred Chicago markets as muddy-booted parvenus and gamblers. The Chicagoans, in turn, have seen themselves as the standard-bearers of a vigorous free-market capitalism and sometimes knocked Wall Street as a staid preserve of privilege.

The rivalry has emerged into full public view since the October debacle, as both sides have looked around for a place to pin blame--and found each other. On the debate may hang major changes for the financial markets and the entire economy.

Wary Eye Out

For most of their history, the two markets eyed each other warily across a distance of 800 miles but had few dealings. In recent years, however, they grew intimately interconnected, as huge institutional investors such as pensions and mutual funds discovered that they could cut their risk and lard their profits playing the two markets simultaneously.

These days the two markets are like Siamese twins that ordinarily go about their business in harmony but sometimes set to squabbling, with frightening results.

“It’s a guerrilla war that’s sometimes hot, sometimes cool,” said Merton H. Miller, a University of Chicago economist and champion of the commodity markets’ cause. “At some level, it’s always with us.”

While their arguments seem often to be centered in technical minutiae, some say they are rooted in differences of culture and history between dominating New York and the Midwestern rival that always felt it was just as good.

Some philosophers of the markets trace the rivalry to a gut-level antipathy that shows up in such unlikely places as the humble game of bowling. When a Chicago bowler knocks down eight center pins but leaves two standing on the outside edges of the lane, he curses his luck and calls the blunder a “Brooklyn split.” In New York, bowlers call the same misstep a “Chicago split,” observes John A. Wing, president of a trading and investment banking firm called The Chicago Corp.

“It’s a competition that’s always existed on a very fundamental level, starting with the rivalry between the Cubs and the old Brooklyn Dodgers and extending to other things,” Wing said. “These people have different styles of doing business, different philosophies, different temperaments.”

A visit to the trading floors dramatically shows the differences between the New York market and Chicago’s, which is less regulated, more physical and far riskier.

For all its cacophony, trading at the New York Stock Exchange is an orderly affair. A trader called a specialist supervises activity in each stock, pairing buyers with sellers, buying or selling the stock if others don’t want to, and making some trades entirely for himself.

“If you’re right 60% of the time, you can make a comfortable living,” said William W. Rosenau, a partner in the specialist firm of Fowler & Rosenau.

Furious Disorder

By contrast, the futures trading pits are scenes of furious disorder, where hundreds of traders compete and collide in pursuit of the fastest trade at the best price. Any trader can strike a deal with any other.

The Chicagoans’ views on risk-taking trace to the commodity markets’ origins in the 1840s as a place where Midwestern farmers and grain merchants could pass off the risk they faced from fluctuating agricultural prices. If a farmer wanted to lock in a price for his products, he would strike a deal with a merchant to sell a specified amount of the product at a fixed price at a future date.

The grain merchant, in turn, could pass on the risk by selling the so-called futures contract to Chicago’s growing corps of city-slick commodity traders, who saw that they could profit by correctly guessing the short-term flutterings of the market.

In recent years, commodity traders have greatly expanded their business by trading futures contracts on a smorgasbord of financial investments, such as bonds, foreign currencies and the collections of stocks called stock indexes. Companies and trading firms with big stakes in such investments would buy futures to limit their risk that the value of those investments would suddenly fall.

For Chicago’s traders, all such contracts represent big opportunities--and bigger risks faced by players in the stock market.

Stock prices tend to rise over time, as the companies that issue shares grow and increase in value. So--theoretically, at least--over time all stock market investors can make money. But commodity prices can go down as much as they go up, creating a loser and winner with every trade.

Even some of the most successful commodity traders can wipe out. One who did is Leo Melamed, now the chairman of the Chicago Mercantile Exchange, who saw his capital dwindle and disappear when he was getting started in the business many years ago. “The simple fact is, I went bankrupt,” said Melamed, who drove a cab nights to help restore his savings.

Traders at the Merc remember a young accountant who itched to trade for years, and finally borrowed enough to buy an exchange seat. As months passed and his savings ebbed, he realized he couldn’t make a living at it.

Every night his wife taped newspaper employment ads on the refrigerator, with the entreaty: “Get a job!”

The physical strain of futures trading is visible at the amphitheater where the Chicago Merc trades its wildly successful stock index, the Standard & Poor’s 500-stock index. Almost every week, pit officials cite traders for an infraction involving pushing, shoving or even (though rarely) the throwing of a punch. Fines range up to $5,000.

‘In a Vise’

“Ten minutes before trading starts, I’m already in a vise--with some guy’s arm across my face and somebody’s elbow in my side,” said trader Patrick J. Shannon.

When trading gets active, the crowd of traders often surges many feet in one direction, then back, as a tide ebbs and flows. Twenty-nine-year-old Norman C. Peterson, who not long ago left the S&P; pit to work at the calmer Chicago Board Options Exchange, recalls how a young clerk recently stepped in the way of this tide--and was thrown 10 feet onto her backside.

“I don’t know how people can put up with that,” said Peterson, who says the Merc traders consider his current place of business a “country club.”

At busy moments brokers on the New York Stock Exchange often must yell across competitors standing several yards deep in front of the post where the specialist conducts his auction. Traders at the Merc’s S&P; pit often make deals across its full 42-foot diameter--which explains their perennial hoarseness.

Trader Jerry Friedman, 33, used to skip meals during the days, hoping his hunger would keep him alert. Maybe it did, but the lack of food combined with the stress of trading and coffee also gave him an ulcer when he was 32.

Among other complaints, futures traders suffer from varicose veins, vocal-chord polyps, fallen arches and backaches. A back and massage specialist runs a flourishing business in the Merc’s building.

Chicago traders use hand signals to ensure that both traders understand when they’re part of a deal that’s been struck from across the pit. But there’s always a risk of misunderstanding. The former trader arrested in Chicago last month was allegedly trying to exploit the pit’s potential for confusion.

The risk in the futures pits is reflected in the turnover rate among traders, which Melamed estimates at 20% a year among newcomers. Others put the figure at 30%.

As the stock market’s collapse battered the stock-index market the week of Oct. 19, about 50 traders at the Chicago Merc voluntarily sold seats, compared to a usual weekly turnover of three or four seats.

Turnover among specialists is less frequent at New York’s Big Board, partly because it’s almost impossible for the inexperienced to get a position on the floor. And despite post-crash complaints that specialists are undercapitalized, they generally are backed with more capital than commodity traders.

The Big Board’s specialists most often start as clerks and spend seven to 10 years working their way up, specialists say. Typically, they will first trade in a seat that has been bought by one of the specialist firms for prices that currently run $700,000.

In the commodities pits, an aspiring trader can get on the floor if he can pay a leasing fee that now costs about $500 a month at the S&P; pit, pass a basic test of trading knowledge and win the backing of one of the exchange’s clearing members. These clearing members function as insurers, promising to back up any of the trader’s transactions.

Since the crash, clearing members have sharply increased the amount of capital that they require to back traders in stock-index futures, usually to $75,000. Before October, some firms were backing traders who had as little as $10,000, said trader Shannon.

Must Perform

Big Board officials stress that specialists can keep their stock-trading privilege only so long as they perform well in directing the trading of their stocks. Chicago’s traders, who like to point out that NYSE specialists rarely lose their trading privilege, tend to view the specialists as holders of a monopoly that insulates them from the gales of the free market.

The Chicago traders chafe at their image as gamblers and the talk that their capital would be put to better use in stocks and bonds or other investments. Some at the Merc could have done without last month’s publicity about a Merc trader who won the world poker championship in Las Vegas.

“We’re always a little sensitive about that gambling image,” says Andrew Yemma, a Merc public relations official.

To burnish the image, the commodities markets have embraced the philosophical support they have received from the University of Chicago-style free-market economists, such as Milton Friedman and Merton Miller.

“Around here, it’s ‘free markets for free men,’ ” said Dave Alpert, a longtime trader who offers visitors a business card identifying him as “David M. Alpert, Capitalist.”

The lofty principles of capitalism have been invoked by the stalwarts of New York and Chicago as they have skirmished over the years.

Chicago and New York have clashed as promoters of competing investments, argued over how the financial world should be regulated and disagreed on how to handle eruptions of trading volatility. Their battles are often fought by proxy: by academics who support their points of view, by allies in Congress and by the regulators who oversee them and tend to sympathize with their positions.

Like a storm that first appears as distant clouds, today’s clash over market reform has been taking shape since 1982, when the trading of the highly volatile investments called stock-index futures forged a link between the Chicago and New York markets.

These investments caught on because they allowed investors essentially to bet on whether the stock market as a whole was headed up or down. Such bets could protect investors from punishing losses on stocks if that market suddenly plunged.

And they were cheap: they could be purchased for a down payment, or “margin,” of 5% to 15% of their value. Purchasers of stocks, by comparison, have to put up 50% of their price.

Trading in these index futures boomed as billion-dollar investors developed lightning-quick, computerized strategies for buying and selling huge blocks of stocks, stock-index futures and related investments. These new trading tactics made huge profits for the New York stock traders as they stimulated more and more trading in both cities during the five-year bull market.

But many New York traders feared the volatility that accompanied them. The big investors’ split-second buying and selling shook the markets like a rhinos’ stampede, driving the Dow up or down 30, 50--even 75 points in day.

Well before the crash, many on Wall Street contended that these price gyrations would scare investors from the market and threaten a way American businesses had always raised money to run their offices and build their factories.

Worst Fears Realized

The stock traders’ worst fears were realized when the Dow fell 508 points on Oct. 19, 1987. New York soon seized on speculative futures trading as a key cause, and called for sharply higher margins on futures. Higher down payments would discourage such trading by making it much more expensive.

“There’s been a fear that speculation has been overwhelming the other functions of the marketplace,” said John J. Phelan Jr., chairman of the New York Stock Exchange.

The Chicagoans saw New York’s call for higher margins as a frontal assault. “The New York Stock Exchange knows you can’t say to government: ‘Kill my competitor so I’ll be better off,’ ” said Prof. Miller, the free-market advocate. “So they went to Washington and said: ‘Kill my competitor so the country will be better off.’ ”

The Chicago commodities markets have marshaled strong political forces over the years to fend off efforts to increase regulation. The industry has staunch allies in Congress and political action committees that are among the most heavily funded anywhere.

But it is unclear whether its might will be sufficient to fend off the current efforts to increase regulation. Many observers believe that NYSE Chairman Phelan has already won the public relations offensive by persuading the public of the connection between the stock market’s dangerous swings and the new kinds of trading.

While most observers don’t expect a major regulatory overhaul, such influential members of Congress as Sen. William Proxmire (D-Wis.), head of the Senate Banking Committee, are pushing for change. SEC Chairman David S. Ruder has asked Congress for broad new powers over index futures and wants to raise margins as high as 25% for some traders.

Proposals to give greater control to the SEC has aroused an ancient fear in the futures industry, since the SEC is reputed to be a far tougher regulator than its current overseer, the Commodity Futures Trading Commission.

Spooked by fears of a regulatory crackdown, the Chicago exchanges have imposed new rules on their own operations. The Merc has raised margins sharply since the crash and set limits on how much its S&P; 500 stock-index futures can rise or fall during the day.

The post-crash debate has been given added urgency by a falloff in the index futures business. While Big Board trading volume has slipped only about 7% since October, trading in the Merc’s S&P; 500 index is off more than 40%.

A continuing contraction of stock-index trading would be a particular blow to Chicago, since the city’s success with the investment has shone as a particular triumph in its rivalry with New York. While both cities began trading the new kind of investment six years ago, it was soon clear that New York didn’t have the Chicago-style traders willing to risk millions to get the market going.

While the Merc’s trading volume in the S&P; 500 index zoomed to 21 million contracts last year, the New York Futures Exchange’s index volume languished at 2.9 million contracts. “This shocked New York,” said John Damgard, president of the Futures Industry Assn. “They had always tended to look down their noses a little at the people in Chicago.”

In recent weeks, exchange officials have quietly held talks to try to work out their differences. But though they have discussed such steps as setting up a “hot line” between New York and Chicago to improve communications, they are far from settling their fundamental disagreements.

Far From Solution

Only last week, SEC Chairman Ruder complained in Senate testimony that the exchanges and regulators are still far from finding a way to prevent a repeat of the October crash.

Congressional observers believe the jousting over market reform will continue in Washington even if Congress takes no action this year. It is likely to resume next year, they say, as Congress considers reauthorization of the Commodity Futures Trading Commission.

“This is a naked competitive struggle,” said Prof. Miller. “It isn’t going away soon.”