FUTURES, THE COVETED SCAPEGOAT

Address before the American Enterprise Institute,
Washington, D.C., October 31, 1985.
Published in the Futures Industry Association Newsletter,
December, 1985.

The ultimate bane of futures markets is their arcane existence. It is the source of a multitude of pejorative beliefs about our marketplace that have plagued us since time immemorial. It has made our markets the ideal scapegoat.

This is not to say that our markets are without fault—utopia has not yet arrived on the floors of futures markets. Rule violations, greed, and avarice are ubiquitous human characteristics and occur in every endeavor. Futures markets are no exception. However, futures markets and their traders are often the brunt of grossly unfair prejudices and accusations that simply have no basis in fact.

The process of repudiating the unwarranted and repugnant slander directed at futures markets throughout history is, to say the least, difficult. One must begin by openly calling attention to the demagoguery and debunking false beliefs.

"It's ludicrous to think that foreign exchange can be entrusted to a bunch of pork belly crapshooters," proclaimed a prominent New York banker back in 1972 on the eve of the Merc's launch of the International Monetary Market.

"The New Currency Market: Strictly for Crapshooters," echoed Business Week and wrote that "if you fancy yourself an international money speculator but lack the resources. . .your day has come!"

Derogatory comments, defamatory innuendos, inflammatory jokes, false accusations, misleading opinions, half-truths, out-and-out lies, that is the fate and burden of futures markets. Thus it has been throughout time, thus it will no doubt continue. And why not?  From time immemorial, predicting the future has been a hazardous occupation.  Good news was universally welcome, but its failure to materialize—or its counterpart—was shabbily treated.  "Behead the messenger of bad tidings" was not an uncommon reward.

Futures and options markets—that little understood corner of business activity, that complex arena of esoteric economics, that noisy place shrouded in mystery, that distant cousin of the financial world—have served as an ideal scapegoat since time immemorial. And why not? Visit the tumultuous, colorful, rowdy trading floor. Observe the rough, boisterous, undignified members and brokers. Clearly, there is something sinister going on there! Clearly, no legitimate business is being conducted! And, even worse, there is speculation going on there. Clearly, dens of speculation cannot be a place for serious investment! Read the headlines—their members are always out to make a killing. Those markets have nothing to do with capital formation. Those markets create volatility. Futures markets, the ideal scapegoat.

Has anything changed? In 1973, a group of Chicago housewives marched on the Chicago Mercantile Exchange to protest high food prices. A few years later, during the 1977-78 farm crisis, U.S. farmers drove their tractors to the Chicago Board of Trade on LaSalle Street to protest low prices on their agricultural products.

Has anything changed? After the War of 1812 played havoc with the U.S. farm economy, anti-speculative sentiment was rampant.  Buying forward was acceptable, but any market that also allowed the opposite—forward sales—was unacceptable.  The New York legislature, applying its ultimate wisdom, enacted legislation banning all forward selling.

Has anything changed? In January 1985, 70 years later, leaders of the American Agriculture Movement demanded that short sales in futures be banned because "selling depresses prices." Later in the year, mounting frustrations over the nation's failed agriculture policy, its low farm prices, its record crop surpluses and sagging land values inspired farm spokesmen—in search of a scapegoat—to denounce the Chicago exchanges as the Bermuda Triangle of Agriculture. A U.S. Senator piously agreed, pointed his finger in our direction and proclaimed that "never have so few done so little to make so much from so many."

Has anything changed? In 1976 when the U.S. Treasury bill and Treasury bond futures markets were introduced, countless articles were published that warned of the negative impacts of these new inventions, of their unfavorable effect on the underlying cash markets by causing price distortions, of their disruptive market influences because of fraudulent acts by traders, and of their adverse consequences to the U.S. Treasury's debt management activities. If it were known then of our eventual 200 billion plus dollar deficit, these futures markets surely would have been an excellent candidate for its probable cause. 

The respected Economist, in its January 17, 1976 issue, in reporting on the new interest rate markets wrote, "Like Linda Lovelace, the girl with the deep throat, the International Monetary Market (IMM) of the Chicago Mercantile Exchange tries to make money by being more outrageous than its rivals.  Now that its currency futures market is well established—it was opened in 1972 by women in fancy dress—the IMM has this month opened a trading pit in United States treasury bill futures.  Bidding for the government paper takes place on the same floor as for pork bellies, live cattle and three month eggs."

Surely, futures and options markets are not immune from criticism. Surely, they are not utopian—what enterprise is? Surely, there are rule violators, there is greed and avarice. Surely, they are not without sin. We agree. But neither are they the work of the devil! And as an industry—they are a great deal better than most.

The next time you hear a story, see a headline, hear a rumor maligning futures and options, ask yourself the following questions:  Would the world's financial system have survived the economic stresses and strains of the 1970s and early 1980s as well as it did without these markets? Would the shrinking base of private sector capital have been equal to the increased public sector demands without throwing the free world into financial turmoil, were it not that futures markets provided a new and more efficient means of capital utilization? Would the speculative fevers unleashed by volatile price movements due to unprecedented inflation and record interest rates, followed by unprecedented disinflation and falling interest rates, not have materially disrupted the world's financial fabric were it not that futures and options acted as a buffer and a pressure valve? Would our shrinking world—where a bank in South East Asia is as near as your downtown counterpart, where an event in Abu Dhabi is as close as your nearest telephone—not demand a means, such as our markets provided, to instantly partake and protect yourself from the financial effect of a significant world event. 

If there had not been futures and options markets, wouldn't they have been invented by now? And if there were no economic justification for financial futures, how could these markets have achieved such phenomenal growth in a matter of just thirteen years.  How could they have attracted so many financial institutions, so many banks, money managers, foreign exchange traders and pension fund managers worldwide?  How could exchange membership scrolls have swelled so quickly with the names of so many of the world's most prestigious institutions? How could the transaction volume of these markets have experienced such unparalleled increases unless there were a fundamental need for them as a modern tool of business, finance, and risk management. How could these markets be as evil as their detractors claim, and yet be as coveted and copied as they are by every major world financial center.

And how could these markets have completely fooled four U.S. federal agencies of exemplary credentials and unquestionable qualifications—the Federal Reserve Board (Fed), the Commodity Futures Trading Commission (CFTC), the Securities and Exchange Commission (SEC), and the U.S. Treasury—in their recent study to determine the effects on the U.S. economy as a result of trading in futures and options? This study—mandated by the U.S. Congress and conducted under the helmsmanship of the Fed—was so all inclusive that it covered virtually every issue ever raised about these markets. The resulting document, together with the Fed's separate report on securities and futures margin, represented the most comprehensive report on the subject ever produced.

Ask yourself how these reputedly wicked markets could be the recipient of the following Federal Reserve Board findings: That financial futures and options serve a useful economic purpose by providing a more efficient way to manage risk; That the liquidity of related cash markets such as those for U.S. Treasury securities and common stocks have been improved by the presence of futures and options; That the Fed's ability to conduct open market operations in an orderly manner across a range of maturities in government securities has been enhanced by futures and options contracts; That this also means that the Treasury's ability to conduct debt management operations is similarly enhanced; That the improved liquidity in the Treasury securities market means interest rates paid by the taxpayer on debt incurred by the Federal government is lower than it would be without financial futures markets; That the ability to hedge corporate bond underwritings results in a lower all-in cost of funds for the private sector; and, That there appear to be no significant regulatory problems concerning either manipulation or customer protection.

If you asked yourself these questions and reflected on the answers, you would, in all candor, become skeptical about the derogatory comments, defamatory innuendos, inflammatory jokes, false assertions, misleading opinions, half-truths, and the out-and-out lies one reads and hears about futures and options. 

Can we therefore now expect things to change?  Can we expect a fairer review now that the mandate of Congress has been satisfied, now that we have some credible answers to those age old concerns that historically have plagued and inhibited these markets.  Can we now expect futures and options to become a universally accepted and integral tool of risk management? 

Forget it.  Listen to the cover story of Business Week, September 16, 1985, "Playing With Fire: As Speculation Replaces Investment Our Economic Future Is At Stake:" "Ah, progress.  Spurred by deregulation, the financial inventors have been working overtime.  They've churned out a vast array of new instruments and created whole new markets.  It's now possible for even the average citizen or company to take a financial position almost instantaneously in just about anything, anywhere.  What only 15 years ago was an oppressively restrictive financial system has been recast in a pluralistic, almost anything goes mold. . . .by stoking a pervasive desire to beat the game, innovation and deregulation have tilted the axis of the financial system away from investment toward speculation.  The U.S. has evolved into what Lord Keynes might have called a `casino society'—a nation obsessively devoted to high-stakes financial maneuvering as a shortcut to wealth."

Imagine that, Business Week paying homage to Lord Keynes. Will wonders never cease!

Or listen to Barron's, "Pin-Striped Pork Bellies: Why Stock Index Futures Are Red Hot:" "Like their lightening-paced video game counterparts, stock index futures offer instant gratification or instant annihilation depending on the accuracy of your impulses and the quickness of your reflexes."

Some things never change.  Thus, it is imperative that we inform and instruct, divulge and debunk, proclaim and protest, again and again.

Reprinted by permission. Excerpted from Melamed on the Markets, by Leo Melamed. John Wiley & Sons, 1993

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