THE REST OF THE STORY

Inaugural Celebration
of the CME Fred Arditti Innovation Award
Chicago, Illinois
January 18, 2005

In preparing for my remarks tonight, I was in a quandary. Clearly, I had to talk about innovation, but what to say? Much of what I wanted to say is already found in the brochure about the CME Center of Innovation that is at everyone’s table. I was stumped. And then I remembered a book published a while back, actually in 1996, entitled The Greatest Business Stories of All Time. It was written by Harvard-trained historian Daniel Gross in conjunction with the editors of Forbes magazine. Perhaps, I thought, it will give me an idea for tonight.

The book was fascinating. It gave me an insight into some great American innovators who changed the nature of America and the world. Some of these stories I knew, others not.

—For instance, I learned about Robert Morris, America’s First Financier.

—I was reminded about Cyrus McCormick and his reaper factory on the banks of the Chicago river that mechanized American agriculture.

—It was fun to read again about the genius of John D. Rockefeller, and although he was attacked as "the father of trusts, the king of monopolists, the czar of the oil business," how he is credited with inventing the modern corporation.

—It was thrilling to read again about the exploits of J.P. Morgan and why he gets credits for promoting the need of a central government agency–namely, the Federal Reserve System.

—Similarly, I enjoyed the Henry Ford story all over again, and how the Model T completely transformed our nation’s way of life.

—I had forgotten how Charles Merrill is credited with the democratization of stock ownership.

—Of course, I knew about Sam Walton’s "buy it low, stack it high, and sell it cheap."

—I also knew how Ray Kroc made it possible that the French fries a customer bought in Topeka would be the same as the ones sold in New York.

—It was also fun to read about David Sarnoff and how RCA gave us national broadcasting.

—Similarly to be reminded how Walt Disney created the Family-Entertainment empire.

—Or that it was American Express that introduced us to the charge card, forever replacing our need for money.

—And how Intel compacted the power of a 3,000 cubic-foot computer into a chip smaller than a fingernail.

—And finally, to again review the genius of Microsoft and Bill Gates.

While the CME story did not find its way into The Greatest Business Stories of All Time, in my view it deserves consideration for a future edition. The Chicago Mercantile Exchange, once the house that pork bellies built, is today the house that innovation built. That breathtaking history of innovation, I dare say, has few equals and I submit is a great American story. Nobel Laureate, Merton Miller, once stated that the simple standard for judging whether a product increases social welfare is whether people were willing to pay their hard earned money for it. By that standard, these financial futures products proved their worth a billion times over. They inaugurated the era of financial derivatives, accelerated the movement toward financial engineering and OTC products, and spawned financial futures exchanges in every corner of the globe—from Argentina to Australia, from Italy to India, from London to Kuala Lumpur. To paraphrase the words of Alan Greenspan, the financial derivatives markets, which the CME has played a critical role in developing, have significantly lowered the costs and expanded the opportunities for hedging risks throughout the economies of the world.

Still, when I was finished reading, I realized the book had in fact served its purpose. I knew precisely what my mission tonight should be. It was my honor-bound duty to bring to your attention the story of three people whose contributions, while virtually unknown, are directly and materially connected with the success of the CME and tonight’s celebration.

As you know, financial futures began in 1972 with the launch of currency futures at the International Monetary Market, the IMM, a CME division specifically designed to specialize exclusively in instruments of finance. Now there are any number of theories put forth as what prompted the CME chairman of that day to initiate the currency market. Among the most obvious reasons suggested was the breakdown of the Bretton Woods Accord—the fixed exchange rate agreement hammered out in the small resort town in the mountains of New Hampshire after World War II. Another reason given is the financial tsunami caused on August 15, 1971 when President Richard Nixon announced the closing of the gold window. But while these reasons are valid, the question still begs—what or who prompted the idea in the first place?

Well, here is the answer. It happened in Tokyo in April of 1941. An eight year old named Leibl Melamdovich was listening to his father, Isaac Melamdovich, a mathematics teacher, explain how the markets really worked. Specifically, he asked if his son ever thought about how the community of Jewish residents in Tokyo, the so-called members of the newly formed Refugee Committee, who were far from being rich people, had enough money to support the sudden influx of some 3,000 refugees, the likes of the Melamdoviches, who had escaped from the clutches of the Nazis to Japan? No? Well, to understand that, my father explained, you have to understand the intricacies of the marketplace.

He explained that in Japan a citizen was forbidden to hold foreign currency. However, if you were a foreigner who had an exit visa to a foreign country, say, like to the US, you were allowed to withdraw from a bank up to $50. Each dollar, my father explained, was worth (say), 100 Yen, the official rate of exchange. However, he admonished, "you must never trust the official rate announced by government." The real value, he explained, could be found only in the so-called Black Market. "Where," his son eagerly asked, "is this Black Market?" My father responded with a wry smile, "Oh, that’s everywhere, on the streets, in the shops, in the back alleys, everywhere where a government official is not looking." And on the Black Market, he said in hushed tones, each dollar is worth (say), 300 Yen—the real exchange rate for the dollar.

So, he said, looking at his son to see if he understood, once a foreigner has been given an exit visa, like, say, to go to the US, a representative of the Refugee Committee, goes with him to the bank, shows the exit visa, deposits 5,000 Yen and receives $50. The money is then registered with the ship’s Purser, and very quickly and quietly returned to the Refugee Committee representative. Naturally, the Refugee Committee now sells the $50 dollars on the Black Market at 300 Yen to the dollar and receives 1,500 Yen in return. "The 1000 Yen profit," my father explained, again with a smile, "is used to support the refugees in Tokyo."

Credit the IMM’s currency idea to innovator Isaac Melamdovich.

One of the salient aspects of financial futures contracts, indeed one of the greatest plaudits that I have received over the years, was in devising the quarterly listing of contract months. I have been told by economists and business experts time and again that this was perhaps one of my most brilliant moves. By establishing March, June, September, and December as the primary contract months of trade, I hit upon the perfect cycle for the purposes of corporate needs, financial applications, quarterly tax payments and so forth. Little wonder, that as the IMM financial futures idea spread throughout the world, with but singular exceptions, this quarterly formula was followed.

Well, here is the skinny. When the original IMM Interim Committee met in 1972 to establish contract specifications for currency contracts, the question of delivery months was high on our agenda. Let me underscore three critical factors of that day: 1) The products of trade were exclusively in agriculture, 2) There had to be physical delivery, and 3) The nature of trading was predominantly still on blackboards. The pits were reserved for only the most active products.

According to Thomas Hieronymus, whose book on the "Economics of Future Trading," was the bible at the time, the months for futures trading was chosen on the basis of trade practices relating to the times of growing, harvesting, and marketing of crops. Thus, our committee had an unusual problem. There were no known time for growing, harvesting, or marketing of money.

The issue was hotly debated. There were two schools of thought. There were the purists who said that since currency was in constant supply, without a growing or harvesting season, there ought to be a continuous flow of trade. In other words, if we were to list a year of trade, as was our intention, there should be 12 trading months, straight through from January to December. It was logical and simple. However, I led a the second school of thought. In my opinion, for a futures market to be successful, there had to be a little bit of mystery. In other words, a continuous flow of trading months left nothing to chance and no room for doubt. Rather, if some months of trade during the course of a given year were missing, it would create additional mystery and increase trade. Since I was chairman, my view prevailed. The Interim Committee unanimously approved the listing of six contracts per year, in other words, every other month. End of story----Not quite.

As I was walking out of the committee room, Tomas W. Peak, a CME employee in charge of floor operations, tugged at my sleeve. "Leo," he whispered, "I have to tell you something." When I stopped to listen to what Tom had to say, I learned that because we intended to list seven currencies—British Pounds, Canadian Dollars, Deutsche Marks, Italian Lira, Japanese Yen, Mexican Pesos, and Swiss Francs—he would need six blackboards for each currency to cover the year and accommodate the Committee’s decision.

"Right," I agreed, "we have to go out a full year."

"Well, that’s just it, Leo," he said, "we don’t have enough wall-space for 42 blackboards."

Stunned, I stuttered, "How much space do we have, Tom?"

"We can manage 28," Tom replied.

The committee was called back into session.

Credit the IMM’s quarterly listings to innovator Thomas Peak.

Finally, the idea of stock index futures, surely, one of the mainstays of the CME. How and where was this idea born?

When I was a young man at the CME, I often hung around with the old-timers who roamed that floor. One of them was a little guy named Elmer Falker. Here is how I describe Elmer in my memoirs:

"On any given day in the late 1950s, he’d stroll across the floor, an elderly, cigar-chomping bachelor just under five-feet tall, still wearing spats and driving to and from work in his spiffy 1932 Franklin. He could send an oyster into the corner spittoon from 30 feet. I don’t know how many fortunes he had gone through, but by the time I met him, he was broke. Rumor had it he lost all his money waiting for a gap to be filled on the butter chart, but the market never came back to fill the gap."

When I became chairman in 1969, I again sought out Elmer Falker’s counsel. I was looking to diversify the CME and I wanted to talk about new products. We talked, potatoes, oranges, turkeys, shrimp and all kinds of other things. Then one day, Elmer became thoughtful and said, "The ultimate futures contract is of course Dow Jones futures." I instantly understood the beauty of the concept. "Why hasn’t anybody done it?" I demanded. Elmer looked at me and smiled. "You can’t make delivery," he explained.

I never forgot that conversation. "You can’t make delivery," would echo through my mind again and again. But over time, Elmer’s words took on a different refrain in my mind, "What if you didn’t have to make delivery?" That question would not give me peace until I could do something about it. When at last in 1981 the CFTC approved the concept of cash settlement, Elmer’s ultimate contract was finally possible.

Credit stock index futures to innovator Elmer Falker.

As Paul Harvey would say, "Now you know the rest of the story."

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