Chicago Board of Trade
Chicago Board of Trade
Operating Revenues: $184.7 million (1999)
NAIC: 52321 Securities and Commodity Exchanges
Chicago Board of Trade (CBOT) is one of the busiest commodities exchanges in the world. The Board of Trade has more than 3,600 members, who trade almost 50 different futures and options products, including U.S. Treasury bonds, silver, soy beans, wheat, and Dow Jones Industrial Average futures. Annual trading volume is more than 200 million contracts. The CBOT operates as a not-for-profit corporation run by its members and a Board of Directors. Trades are accomplished through a so-called open outcry system, where traders meet face-to-face to make transactions in trading rooms known as pits. The CBOT adopted a computerized trading system for some trades in the late 1990s. Open outcry trading fell out of use at other leading exchanges in the 1990s, and the future of CBOT’s trading pits was increasingly called into question. By the early 2000s, the future direction of the CBOT was still under consideration. The CBOT announced a decision to transform itself into a for-profit corporation with two separate trading areas, one electronic and one open outcry. This restructuring was bogged down by negotiation and litigation between the CBOT and the other Chicago exchanges, the Chicago Board Option Exchange and the Chicago Mercantile Exchange, and by indecision on the part of CBOT members and executives. As of March 2001, the CBOT planned to move ahead with restructuring and to form an alliance with the electronic German/Swiss exchange Eurex.
The Chicago Board of Trade was formed in that city in 1848 by a group of businessmen who wanted to bring order to the Midwest’s chaotic grain market. Farm prices were ruled by boom and bust cycles. In the winter, when grain was scarce, the price was high. At harvest time, Chicago was inundated with grain, and farmers had to accept extremely low prices. Some farmers kept their grain back from market, preferring to burn it for fuel rather than waste money shipping it when prices were low. Other farmers found that they could not get a fair price for their corn or wheat, and they ended up dumping it into Lake Michigan rather than pay to haul or store it. The Board of Trade offered farmers a way to get a guaranteed price for their goods ahead of time by offering “to arrive” contracts, or futures. At planting time, a farmer could negotiate the price he would get at harvest time. Big buyers of grain benefited by assuring themselves in advance a specific supply.
The Chicago Board of Trade first consisted of 25 directors who met in a space above a feed store on Water Street. The directors were not all grain merchants. The founding group also included a grocer, a tanner, a hardware merchant, a banker, a bookseller, and a druggist. The Board standardized bushel sizes and established ways of identifying different grades of grain.
Trading was not extremely active in the beginning, and the Board tried to lure business by offering free lunches. But Chicago was on its way to becoming the predominant grain market in the Midwest. Chicago’s first railroad link was being laid the year the exchange began. Soon Chicago was a rail hub for ten major railroads, and more than a hundred trains came in and out of the city every day. A new canal linked the city to river traffic leading to the Mississippi. Its logistical convenience helped make the city a center for meat packing. Chicago became a national and even international center for agricultural commodities in the 1850s. In 1855 the French government abandoned its practice of buying grain in New York and came to Chicago instead. By 1856, the CBOT had about 150 members, and it moved to new quarters on the corner of South Water and LaSalle Streets. In 1859 the Illinois legislature granted the CBOT a charter, which allowed it authority to govern itself. The CBOT found itself a very popular institution by the end of the 1850s. It had established a new system of grading grain that helped the market run more smoothly. Under the old system, a farmer’s lot of grain had to be inspected at many points in the selling process, to make sure it was of the quality and cleanliness it was supposed to be. If a farmer stored his grain with other farmers’ lots, grains of differing qualities might get mixed, affecting the price later. The Board of Trade instituted a new system where grain was graded before storage and dumped in a bin only with grain of the same quality. The farmer received a receipt for × amount of grain of × quality. Thus the farmer did not have to retrieve his individual bags of grain for resale, or trust that his grain’s quality had not been downgraded by promiscuous storage. Use of the receipts made it easier to trade large volumes of grain. Instead of buying and selling actual bags of wheat or corn, brokers could trade the receipts. Soon they began vigorously trading grain futures. For the farmer, the futures contract guaranteed a certain price in a distant month. Speculators also could buy a futures contract, gambling that they could make money off it by selling it later if the price changed.
While Chicago became an agricultural center, the Board of Trade ensured that the city also became a financial center, with a huge liquid market in agricultural commodities futures. The CBOT standardized its futures contracts in 1865, and moved to its first permanent facility, in the Chicago Chamber of Commerce Building.
In the early years of the CBOT, many disreputable traders tarnished its reputation. Some traders tried to “corner” a market, that is, buy up most of the available corn or wheat to drive the price up. The Board acted to expel traders who cornered, but it was not successful in abolishing the practice. Another blemish on the CBOT was the existence of illegal outfits known as bucket shops. The bucket shops presented themselves as legitimate commodities brokers, but customer orders were not actually traded on the CBOT floor. In fact the bucket shops ran a numbers game using Board of Trade market figures. In the 1880s the CBOT worked hard to drive the bucket shops out of business.
The CBOT tried to keep its market information inside the building, banning telegraph employees, cutting telegraph lines, and even soaping its windows so bucket shop clerks could not see in and read the latest figures off the chalkboard. Fraud and manipulation of the market caused public outcry against futures trading. When the CBOT moved again in 1885, this time to its own building on LaSalle Street and Jackson Boulevard, protesters called the organization the “board of thieves.” Nevertheless, the CBOT continued to grow and prosper. Spectacular attempts to corner grain markets continued. In 1897 Joseph Leiter, 28-year-old son of one of the founders of Chicago’s famed Marshall Field department store, attempted to corner the wheat market, driving the price per bushel up from 67 cents in April 1897 to $1.85 a bushel a year later. Leiter’s corner broke down in May 1898, reputedly at the same time his father returned to Chicago and found out what he was doing. Leiter lost an estimated $20 million on this escapade. Despite Leiter’s dramatic failure, another trader, James Patten, attempted a wheat corner in 1908. Because of Patten’s hoarding, the price of wheat went up, though the supply of wheat was plentiful. Chicago newspapers speculated that the rising cost of bread might spark riots. Patten’s corner was successful: his personal profit was estimated at more than $1 million. But Patten was vilified in the press, and the U.S. Congress contemplated a bill to ban futures trading altogether.
During World War I, the CBOT attempted to set reasonable prices for grain so that the price would not rise and fall continuously. Then the federal government asked the Board of Trade to stop trading wheat futures. The ban lasted almost three years. At the war’s end, wheat prices plummeted. It was not clear that the resumption of wheat trading had anything to do with the slump, but enraged Midwestern legislators claimed that unregulated futures trading was behind the price fluctuations. President Wilson ordered an inquiry into the grain market. Eventually, the investigation led to the Grain Futures Act of 1922, establishing the first federal control over futures trading. Even after the new law’s enactment, CBOT traders tried cornering the wheat market. Arthur Cutten tried to corner wheat in 1924, driving prices up more than a dollar per bushel. The CBOT formed its own regulatory body, the Business Conduct Committee, to investigate Cutten. The committee urged Cutten to stop buying up wheat, and he did, for the time being. But Cutten returned to futures trading in the 1930s, until the Grain Futures Administration, the government regulatory body, banned him from the market. Other cornering incidents in the 1930s, which sparked great fluctuations in wheat prices, led to increasing oversight of the CBOT from Washington. The 1922 Grain Futures Act was replaced in 1936 with the Commodity Exchange Act. This placed explicit limits on the number of contracts individual traders could hold, so that speculators like Arthur Cutten could not corner, and outlawed other practices as well. The new act still left the CBOT with many self-regulatory powers.
Changes After World War II
During World War II, trading at the CBOT came to a virtual standstill. The corn and wheat crops were under government control. CBOT traders had to content themselves with trading in rye and soybeans. Soybean futures trading had come to the CBOT in 1936. Eventually, this became one of the Board’s most active commodities. After the war, the CBOT continued to trade an array of agricultural commodities. The CBOT added trading in soybean oil and soy meal in the early 1950s. The Board’s first nongrain commodity was added in 1968, when the meat product known as Iced Broilers began trading. Then in 1969, the CBOT added two more significant commodities: plywood and silver. Silver was the first precious metal on the Chicago exchange.
The CBOT’s principal role is to provide contract markets for its members and customers and to oversee the integrity and cultivation of those markets. Its markets provide prices that result from trading in open auction or electronic platforms. The marketplace assimilates new information throughout the trading day, and through trading it translates this information into benchmark prices agreed upon by buyers and sellers.
In the 1970s, the CBOT began to move out of exclusively agricultural commodities and deal in financial instruments. In 1975, the CBOT began trading in futures on Government National Mortgage Association certificates, called GNMAs, or Ginnie Maes. Like corn or wheat, the price of GNMAs fluctuated over time, and they could be bought or sold by traders speculating on future price changes. Then in 1977, CBOT began offering trading on U.S. Treasury bonds. Treasury bonds became the CBOT’s most actively traded product.
Other changes came to the CBOT as well. The Board founded a sister entity in 1973, the Chicago Board Options Exchange (CBOE). This was established specifically to trade securities options. Options trading is governed by complex mathematical rules, where traders have the option, but not the obligation, to buy a futures contract at a specified price before a specified expiration time. The CBOT had been trading securities options since 1970, but by setting up a separate facility, the Board’s traders were insulated from the risks of options trading. But CBOT members could exercise trading privileges at the CBOE as well. The CBOT also began to introduce more computers into its trading system in the 1970s. Financial data was tracked by computer at a separate facility starting in 1970. In other ways, though, trading at the CBOT continued as it had in the 19th century. Many traders were the sons and even grandsons of traders, keeping the skill in the family. The open outcry practice continued, where traders shouted out their orders to the entire trading pit. Traders at the CBOT had developed a complex system of hand signals, since it was often so loud in the pit that voices could not be heard across the room. Even as computers replaced Morse code and chalkboards, traders bought and sold by flashing fingers at each other. Orders were written on pocket-sized cards and conveyed here and there by a bevy of runners. The CBOT had admitted its first women traders in 1969. But the CBOT remained a mostly male world of shouting, jostling traders. No specific educational background was needed to become a trader. The CBOT was by most accounts a unique financial institution, where people with only a high school education could rise to prominence.
The CBOT did not leave cornering scandals behind in the 1970s. One of the most remarkable incidents of market manipulation came in 1979, when two wealthy Texas brothers, William Herbert Hunt and Nelson Bunker Hunt began buying up silver. The Hunts began buying and stockpiling silver in 1979, causing the price to rise. It was evident what they were up to early on, and the CBOT’s president urged them to stop. By early 1980, the Hunts controlled 70 percent of the silver traded on the CBOT, and half the silver traded on the rival Commodity Exchange of New York (Comex). The regulatory Commodity Futures Trading Commission (CFTC) was empowered to act in case of a “market emergency,” but the commission’s board could not agree that the silver corner was an emergency. Finally, the CBOT and Comex put limits on how much silver could be traded in each month, and then issued orders that silver trading was for “liquidation only,” meaning it could be sold, but not bought. Silver had climbed from under $9 an ounce to more than $50 because of the Hunt brothers’ actions. Yet the collapse of the corner bankrupted the Hunts. The incident showed how vulnerable the commodities market still was to manipulation. However, the CBOT acted successfully to put a stop to the illegal activity.
Growth and Problems in the 1980s and 1990s
The CBOT had grown from a trading center for the Midwest grain market to a national financial center in the 1970s, especially because of its active market in U.S. Treasury bonds. By 1981, Treasury bonds were the most actively traded commodity contract in the United States. The growing activity of the Board led to more physical expansion. Since 1930 the CBOT had been housed in an impressive 45-story building at LaSalle and Jackson Streets, a landmark Chicago structure. The Board began a 23-story addition in 1980, to provide for more offices and more trading space. The new 32,000-square-foot trading floor opened in 1982. The CBOT introduced new options trading that year, beginning to trade options on Treasury bond futures. In 1984 it introduced options on soybean futures. The CBOT also had put together an energy complex, with trading on futures contracts in heating oil and crude oil. The cost of membership in the CBOT swung higher and higher, reaching $550,000 in 1987. Despite the stock market crash of October 1987, the CBOT remained open. It was the only major exchange in the world not shut down by the crisis. Trading volume also grew in the 1980s. By 1990, the CBOT traded 154 million contracts annually, making it the busiest exchange in the world.
Despite its increasing importance as a world financial market, the CBOT could not escape its reputation as a somewhat lawless, arcane place rife with market manipulators. In 1989 the CBOT suffered one of its worst embarrassments when dozens of traders there and at the Chicago Mercantile Exchange (CME) were arrested after an undercover FBI investigation. The FBI had put its agents into CBOT trading pits beginning in 1987. There the agents made trades while watching and recording the actions of their fellows. Many traders were charged with defrauding customers and were hauled in under federal racketeering laws. The traders were charged with illegal practices like trading ahead of a customer order. That is, when a trader knew he was going to execute a trade for a customer that might cause prices to go up or down, he would trade first on his own account, to his own advantage. Traders also were charged with completing trades after hours and with destroying evidence of losing trades. The resulting trials were long and drawn out, but in 1991 eight CBOT soybean traders were convicted and sentenced to prison terms. The Board of Trade upped its own surveillance of its members and increased the amount of fines it could levy.
- The company is founded by 25 Chicago businessmen.
- A charter is granted by the Illinois legislature.
- Grain Futures Act of 1922 establishes first federal control over futures trading.
- Chicago Board Options Exchange is founded.
- CBOT begins trading in U.S. Treasury bonds, which become the exchange’s most active item.
- Project A is launched.
- New CEO reaffirms plans to restructure CBOT as for-profit company, with electronic trading component.
The public scrutiny of the CBOT resulting from the FBI sting led to calls to update its operations. Trades made by a flash of fingers and recorded in pencil on a note card seemed to outsiders to invite confusion, if not fraud. But the CBOT was resistant to change. In the early 1990s, the CBOT began exploring different merger and joint venture options. The Board negotiated with the Chicago Mercantile Exchange to develop a new trading system, when in 1993 the CME suddenly announced it would work on its new system with the New York Mercantile Exchange instead. The CBOT also negotiated to buy the New York Commodity Exchange, but the deal fell through in mid-1993. The CBOT set a new record for number of contracts traded in 1994, and began construction of a huge new trading floor in 1995. The new floor would be for face-to-face trading, the same system that had been in place since the CBOT’s founding. At the same time, the Board began an Internet-based market information service. In 1996 it introduced an electronic trading platform it called “Project A.”
Open Outcry Versus Electronic Trading in the Late 1990s
By the mid-1990s, it was clear that the CBOT’s open outcry trading system would have to make concessions to the march of technology. The Internet had opened the door to a variety of new electronic trading systems, which matched trades virtually instantaneously. Traders insisted that their face-to-face system worked well and should persist. Meanwhile, other exchanges were abandoning open outcry. In 1998, a German/Swiss all-electronic exchange called Eurex opened for business. Within a year, it had surpassed the CBOT for the title of world’s busiest commodities exchange. It also put pressure on the London exchange LIFFE, which had traded currency futures using open outcry. LIFFE adopted an electronic trading platform in order to survive. The French commodities exchange, MATIF, decided to experiment. It opened side-by-side trading floors, one open outcry, one electronic. Within only weeks, the open outcry system at MATIF was dead. The CBOT moved to expand use of its Project A electronic system. It had been designed for after-hours use, but in September 1998, Project A became available for daytime trades as well. Onetime CBOT Chairman Patrick Arbor proposed another solution: an alliance with the upstart Eurex, to build a new electronic trading platform the two exchanges would share. In January 1999, CBOT members voted down the Eurex alliance. A mere six months later, the members reversed their position and voted to go ahead with the plan, which would replace Project A. Meanwhile, the Board suffered a decline in trading volume and began trimming its budget and cutting staff. Total trade volume was 254 million contracts for 1999, down from 280 million in 1998. Eurex racked up 379 million contracts traded for 1999, passing the CBOT by a wide margin.
The situation was probably not helped by much acrimonious jockeying for the chairmanship of the CBOT. While the negotiations with Eurex were playing out, the CBOT also had to work out an arrangement with the Chicago Board Options Exchange, which it had created in 1973. The two planned to merge and, together, transform into a for-profit company with both electronic and open outcry trading platforms. The CBOE objected to the form of the restructuring and threatened to cut off CBOT traders’ rights at the CBOE. In December 2000, Nickolas Neubauer was elected chairman of the CBOT, upsetting the incumbent chairman by 7⅚ votes (the fraction occurred because some members only had ⅙ voting privileges). Neubauer wasted no time in hiring a CEO for the board. This crucial post had been open for months. When the new president and CEO, David Vitale, took over in March 2001, he announced that converting the CBOT to a for-profit company was his top priority. He resolved to work out a restructuring that would satisfy the fractious CBOE. As for moving to an electronic format, Vitale claimed to believe that it could co-exist with the open outcry system. “Competition is going to drive the exchange to the most efficient format,” he told Futures, an industry journal, in April 2001. The CBOT faced declining volume, budget cuts, and an uncertain path as it entered the new millennium.
Chicago Board Options Exchange; Chicago Mercantile Exchange.
Abbott, Susan, “Traders Sentenced,” Futures, July 1991, p. 50B. Allison, Melissa, “Chicago Board of Trade Surprised by Incumbent Chairman’s Upset,” Knight-Ridder/Tribune Business News, December 8, 2000.
——, “Chicago Mercantile Exchange to Become a For-Profit Firm on Monday,” Knight-Ridder/Tribune Business News, November 8, 2000.
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——, “Futures’ Past,” Wall Street Journal, October 19, 1990, p. R7.
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