A stock market is a market for the trade of securities and
other financial instruments. Like a market in books, transcription services, or labor, a stock market need not have a geographic reference, and it can be more or less fragmented
into autonomous markets. More abstractly, the term stock
market refers to aggregate supply and aggregate demand
forces for securities. The supply of such securities is generally
fixed, although new securities are issued from time to time by
extant and new public and private corporate organizations.
The principal actors in stock markets are investors (representing themselves or clients), brokers (who act as intermediaries between investors and the exchange and who may, on
some exchanges, trade for themselves as well as their clients),
and regulators (who, depending on the exchange, may be either the brokers themselves or quasi-public or public bodies).
In contrast to the abstract stock market, a stock exchange is
the organization and institution at which trading in stocks
takes place—for example, the New York Stock Exchange.
A wide variety of institutionalist scholars have made the
reasonable argument that economic markets require certain
legal, social, political, or cultural institutions in order to function. For example, the Nobel Prize–winning economic historian Douglass C. North has argued throughout his career that
what distinguishes European and American economies from
those in the developing world are the superior economic institutions in the former. Such institutions can be formal (for
instance, legal property rights or government economic policies) or informal (for instance, norms, culture, or ideology).
As North and others have contended, superior institutions
structure human interactions so as to promote economic efficiency, minimize uncertainty, and thereby promote economic growth.
Recent research by Rafael La Porta, Florencio Lopez-deSilanes, and Andrei Shleifer (1999) has made a persuasive
case for the necessity of certain basic institutions for the operation of a stock market. These scholars created a database
of 49 countries that describes each nation’s basic shareholder
rights, creditor rights, and quality of law enforcement.
Through a systematic comparison of the countries’ legal
rights and the quality of their stock markets, La Porta and
colleagues argued that only countries with a legal system that
protects minority shareholder rights can allow dispersed
ownership of corporations to occur and thus have a thriving
stock market. The argument, as outlined in the first paragraph of their work, is quite intuitive. Who would voluntarily purchase an equity share in a corporation without legal
protection from the majority shareholders (or from the controlling management), so as to ensure that the company will
continue to behave as it has in the past? The scholars’ intuitive
finding was that only countries with strong minority investor
protection legislation also have vibrant stock markets.
An older and more historical literature agrees, as popularized in Michel Albert’s global best-seller Capitalism versus
Capitalism and in the academic research of Mark J. Roe.
These authors described a world in which countries can
choose to adopt one of two types of financial systems. One financial system is like that of Germany or Japan and is characterized by concentrated ownership of corporations and
bank-based capital markets. The other system features dispersed ownership of corporations within vibrant stock markets, as exemplified by the United States and United Kingdom. John C. Coffee Jr. summarized the conventional
wisdom of the two opposing forms of financial markets that
we see in the world today. The German model, he said, operates on a consolidated basis controlled by blockholders and
wealthy individuals with little accountability except to some
large banks. The antithesis is the American model, a decentralized system controlled by the Securities and Exchange
Commission with its stringent disclosure and reporting rules
and enforcement capabilities.
And yet, Coffee noted, the U.S. stock market, the paragon
of a dispersed ownership system, had strong securities markets in the eighteenth and nineteenth centuries but lacked
stringent reporting requirements and openness within the markets. Moreover, the nineteenth-century stock market in the
United States not only lacked federal or state legal protections
but also generally lacked an uncorrupt judiciary or legislature; this was especially true in New York City, where the political machine both selected and controlled local judges.
Through the placement of bribes or the movement of law-
suits between competing state jurisdictions, powerful economic actors had wide latitude to ensure that the few extant
laws concerning the stock market were interpreted in their
favor.
The early U.S. stock market was geographically fragmented
and operated without the benefits of exchanges or securityspecific legislation. Today, the term broker is narrowly defined
in securities markets as one who specializes in the purchase
and sale of securities, but the word had a far broader meaning in the late 1700s. Brokers in the early Republic were generalist middlemen who brought together buyers and sellers
and profited from a transaction’s commission. It was common for brokers to not only buy and sell securities but also
insure cargo, run a private lottery, and act as business partners in private banks, issuing their own notes to be used as
currency. With the exception of shipbuilding and pig-iron
production, there was practically no manufacturing at that
time, so most businesspeople were, in fact, brokers. Brokers
were concentrated where wealth was concentrated—in the
port cities of New York, Boston, and the nation’s temporary
capital, Philadelphia.
The early national stock market was an ad hoc and transient creation of brokers who facilitated the trading of securities from their separate offices or by meeting in the streets.
In 1781, for example, a New Yorker who wished to purchase
equity in the new Bank of North America (the country’s first
blue-chip investment) could do so only from other New
York traders with the aid of one of the handful of brokers’
offices and curb traders located in the city. For a New Yorker
to trade with a Philadelphian, he would need to travel to
Philadelphia himself or have his broker communicate with
that city.
The First Catalyst of Development
Shortly after independence, the country was in financial
chaos and fragmented, with hundreds of private banks issuing their own currencies. The Continental Congress had issued fiat money, known as Continentals, of unproven value
and paid for arms with forced loans. In addition, the government had gone deeply in debt to France and the Netherlands
in order to finance the Revolution.
In the 1790s Secretary of the Treasury Alexander Hamilton restructured America’s debts by paying off the country’s
creditors (both foreign and domestic) and the debts of state
governments by issuing new bonds in the name of the federal
government. Market analysts viewed this positively; the
young country had enormous growth potential, and the new
national government was portraying itself by its actions as
fiscally responsible to its creditors. As a result, the United
States had the highest credit rating in Europe, with its bonds
typically selling at 10 percent premium over par (face value).
This massive issuance of high-quality public debt securities
dramatically altered the national stock market but provided
both quality listings as well as a large supply that was met
with increased demand. Trading volume surged, and many
brokers abandoned other forms of brokerage to concentrate
on the lucrative trading of government bonds. As a byproduct of fiscal prudence, Hamilton single-handedly created the nation’s first stock market bubble. (A bubble is created when stocks become overvalued, and when the bubble
bursts, the prices fall quickly and dramatically.)
The price bubble surged further with the issuance of stock
in the country’s first central bank, the Bank of the United
States. Manipulation in the unregulated stock market was
simple to accomplish and a common practice. Hamilton’s
former assistant at the Treasury, William Duer, profited
mightily with market manipulation that suggested there were
syndicates stretching to the highest levels of government. The
bubble finally collapsed in March 1792, and brokers returned
to their former businesses as generalist middlemen—but not
without seeing profound institutional change. The bubble’s
high trading volume provided sufficient motivation for the
more successful brokers to form exclusive trading cartels with
fixed commissions. This situation resulted in the creation of
the Philadelphia Stock Exchange, organized in 1790. And in
1792, with the Buttonwood Agreement, a group of New York
brokers formed the symbolic ancestor of the New York Stock
Exchange.
In the development of the U.S. stock market, a repeated
pattern can be detected: war financed with a rapid buildup of
government debt, an increase of demand due to the government’s reasonable debt management, and an escalation of
trading in response to this increase in supply. In each time period, such a pattern has led to an expansion of the brokerage
industry.
Another stock market bubble was created when the United
States entered the fiscally and militarily disastrous War of
1812. Government debt rose from $45 million in 1811 to
$127 million just four years later. This escalation was partly
financed with high inflation. The rising debt and inflation as
well as a proliferation of state-chartered banks all contributed
not only to additional monetary chaos but also to a brisk
business in the trading of both government debt and the
monies of private and state-chartered banks—particularly in
Philadelphia, where the large banks and the more organized
Philadelphia Stock Exchange were located.
The Civil War debt created a decadent atmosphere of unprecedented wealth from unprecedented trading volume on
Wall Street. The Union government borrowed on an extraordinary scale; the national debt rose from $64.8 million
in 1861 to $2.755 billion in 1865, an increase by a factor of
42. By the war’s end, the interest payments alone were twice
the size of annual government expenditures before the war.
This debt was in large part financed through the sale of federal bonds in the world’s first mass sale of securities to individuals. By 1865 approximately 5 percent of the population
of the North had purchased bonds. World War I and its debt
created a similar pattern, as did World War II (although the
stock market boom itself was delayed until after the war’s
end).
In sum, the skyrocketing government debt dramatically
increased the supply of securities that could be traded and
acted as a powerful stimulus for stock market development.
These surges of investment volume occurred irrespective of
the quantity or quality of economic regulation in each time
period. The fiscally responsible financing of war repeatedly
resulted in a high amount of investment.
Capital-Intensive Corporations and
Speculative Industries
In addition to war and government debt, the U.S. stock market experienced rapid development from the growth of
capital-intensive industries (for example, financial services,
canal building, and the railroad industry) as well as speculative industries (for example, speculative mining and speculative Internet technologies). This essay will examine the effect
on U.S. stock markets of the following industries, in rough
chronological order: financial corporations, speculative mining ventures, and transportation corporations.
Financial Corporations
The banking and insurance industries dominated the
eighteenth- and early-nineteenth-century stock market because of their sheer numbers. Such early corporations date at
least as far back as 1791 with the widely distributed publicly
traded Bank of the United States, which was chartered as the
country’s first central bank. An exceptional proliferation of
regional banks (many corporately held and publicly traded
on stock markets) was prompted by three unusual economic
policies of the early United States. First, previous to the Civil
War, there was no federal currency, and thus, private banks
and many other organizations issued their own. Second, state
governments subscribed to a strategy of mercantilism that
opposed other states’ banks from competing within their
own borders, while at the same time frequently collecting
bribes and indulging in other corrupt practices in the granting of banking licenses. This situation created segmented financial and money markets. Third, because of competing
ideologies and national political maneuvers, the federal government’s two attempts at creating a central bank failed. The
effect was an enormous demand for banking services (including the use of currency)—a demand that was unfulfilled
by the government. The early private banks were often diversely owned corporations listed on the stock market. It is
instructive to note that as late as 1836, of the 81 corporations
listed on the New York Stock Exchange, 38 were banks and 32
were insurance companies whereas only 8 were railroads and
canal companies. In sum, the segmented state markets, with
politicized licensing requirements, resulted not only in monopoly profits in financial services such as banking but also
in the growth of U.S. stock markets that traded securities in
these corporations.
Mining
Like the California gold rush itself, the speculation of mining
corporations was conducted with little information in the
gamble for great riches. Security prices boomed and collapsed based on rumors, purported news, expert opinions,
new complications, and so on. The history of mining securities is an excellent case study of two competing pressures on
regulators. On one hand, there was the pressure to maintain
a stock exchange with relatively high-quality listings. On the
other hand, there was the high volume and corresponding
profitable commissions that could be realized by lowering
listing standards and including the trading of highly speculative securities.
Historically, the established U.S. exchanges have tended to
eschew such listings, thereby facilitating the creation and
flowering of competing stock exchanges with lower listing
standards. As mineral discoveries dried up, these competing
mining exchanges rapidly folded. The established exchanges,
though they lost a great deal of business during the boom,
nevertheless survived and prospered or merged in later years.
The 1860s were years of wealth and misery, laying the
foundation for the inequality and corruption of the Gilded
Age. The era suffered the slaughter of soldiers and civilians
during the Civil War and also saw a series of major discoveries of precious metals in the West. This combination of newfound money in the mountains and the rise and fall of gold
prices during successive Confederate and Union victories resulted in volatile markets in precious metals—and also enormous opportunities for speculative profit. In New York City,
demand for trading gold or for the speculative purchase of
moneymaking mines was so great that the established exchanges were unable to cope with the volume. Many brokers
were earning $800 to $10,000 per day from trading commissions alone, at a time when $1,500 per year was a middle-class
income. The demand for trading was so great that daytime
trading in the downtown stock exchanges spilled over into
the evening in fashionable uptown hotels. After the Civil War,
24-hour securities trading would not return to New York for
well over a century.
Despite this surge in volume, the more established exchanges, such as the New York Stock and Exchange Board
(NYS&EB), briefly even refused to trade in gold (as it was
viewed as unpatriotic), and the NYS&EB continued to refuse
to list the more speculative mining ventures, which, of course,
meant most of them. As a result, several new stock exchanges
formed in New York City to compete with the established ones
(among them Gilpin’s Gold Exchange in 1862, Gallaher’s
Evening Exchange in uptown hotels in 1864, the New York
Mining Stock Board in 1864, the Petroleum Stock Exchange in
1864, and the Wishart and Company’s Petroleum Exchange in
1865). The high volume also created the necessity for continuous auction trading rather than twice-daily auctions at 10:30
A.M. and 2:30 P.M. But even this financial innovation was resisted by the NYS&EB until a competing exchange forced it to
adopt the practice and merge with the competitor.
Outside New York, approximately 25 stock exchanges
opened in the 1860s. The majority of them were mining stock
exchanges, primarily formed in 1863 and 1864 in California
and Nevada. These western exchanges were located near the
mines seeking financing. The Nevada exchanges were
ephemeral, tending to close during the local depression of
1864 and 1865. In the Mississippi Valley, exchanges were set
up in Chicago, Cincinnati, St. Louis, and New Orleans to
cater primarily to local investors and local businesses and
specializing in speculation of gold trading. However, with the
exception of Chicago (with its vast trunk lines of railroad),
the Mississippi Valley cities that served as conduits for gold
were hampered during the Civil War. Although most of the
exchanges were short-lived, they paved the way for the creation of new exchanges in later years. As a result, each major
city with an exchange that opened in the 1860s found itself
with an exchange during the Roaring Twenties.
Transportation
More speculative than finance but generally with a higher
amount and quality of information than mining stocks, the
transportation industry and its high capital requirements
dramatically developed the U.S. stock market.
One of eighteenth-century America’s gravest political and
economic dilemmas was the high cost of overland transportation. The well-settled eastern seaboard had only expensive access to the agricultural produce of the West via two
river networks. Moreover, routes without rivers were terribly
costly. Before 1825 it would take three weeks and $120 for a
ton of flour (worth $40) to leave Buffalo and reach New York
City, effectively quadrupling the cost.
The Erie Canal was an elegant proposal to solve this political economic problem. The engineering task was monumental, however. The proposed route from Lake Erie to the Hudson River was 363 miles long and would descend through 83
locks and 555 feet. The entire canal, 44 feet wide and 4 feet
deep, was to be dug by hand. Were that same bag of flour to
float via a canal between Buffalo and New York City, it would
take a mere eight days at a cost of $6. To provide food and
goods in one-third the time and at one-twentieth the prior
cost would transform New York City and its environs into a
growth engine. The canal was by far the boldest engineering
project prior to the Civil War.
In 1792 two corporations were chartered to complete the
Erie Canal project. This arrangement was not unusual. In
fact, two-thirds of all chartered corporations between the
Revolution and 1801 were formed to complete infrastructure
projects such as bridges, turnpikes, canals, and wharves. Their
stock was rarely in demand, for the projects could tie up capital for years and the charters frequently restricted the tolls
that could be charged. Moreover, such infrastructure projects
were frequently fraught with labor, management, and engineering difficulties. Purchasers of stock in these corporations
frequently either viewed the investment as civic philanthropy
or viewed the infrastructure as an indirect means of improving the value of their businesses or land. The Erie Canal, constructed under such uncertainty and risk, could not be fully
financed through the stock market, even with the New York
State government promising to purchase shares. Insufficient
demand for the stock led to the project being underfinanced.
Engineering and management difficulties compounded the
problem, and both corporations failed.
Several decades later, after lengthy debate in New York’s
state legislature and after suave politicking by the mayor of
New York City, DeWitt Clinton, the state agreed to build the
canal itself and finance it with bonds secured by the state’s
credit. The Erie Canal bonds were marketed as low-risk securities because of the state guarantee to honor the bonds regardless of whether the canal was completed or not or profitable or not. The issue was an enormous success, with 42
separate flotations between 1817 and 1825. Despite the
doubts of many that the canal could ever be completed, it was
finished in only eight years, thanks, in part, to the adequate financing provided by state-secured bonds.
The successive financing of other canals was similar to that
for the Erie Canal. State and municipal bonds were sold overseas through merchant bankers’ personal networks or
through the Second Bank of the United States. Between 1815
and 1860, total expenditures on canals was an estimated $188
million, of which 73 percent was raised through the sales of
state and municipal bonds.
The creation of railroad tracks and a steam engine capable
of speeds of up to 18 miles per hour transformed the economics of transit on a scale equivalent to the canals. Unlike
the canals, however, the early railroads were not nearly as constrained by nature’s topography. The earliest railroads of the
1840s and 1850s were short local lines intended to more rapidly connect a town with a river or port. These roads were generally financed locally by the sale of corporate bonds, which
were purchased by the businesses and families located along
the route. The railroad company would organize public meetings, circulate petitions, canvas from door to door, and organize propaganda parades and other public functions. For residents with little cash, bonds were frequently sold in return for
labor or goods, and loans were offered for the purchase of
bonds using the family farm or property as collateral.
The demand for railroads and the entrepreneurial energy
to create them quickly outstripped such local financing and
was, of course, ineffective on routes passing through unsettled territories. By the mid-1850s, numerous investment
banks had opened in New York City specializing in the trade
of railroad bonds to European investors. In the years following the Civil War, between 1865 and 1873, railroad mileage
doubled, and the total capital invested more than tripled. By
the Civil War, the financing of railroads had been transformed so that such investment bankers became critical middlemen. Investment bankers designed the menu of financial
instruments with which to purchase existing tracks and build
connections between them, underwrote the new issues, and
orchestrated syndicates to disseminate the securities to
bankers and wealthy investors.
In the post–Civil War decades of the nineteenth century,
the railroad industry was easily the largest consumer of capital on the nation’s stock exchanges. Unfortunately, the rapid
construction of railroad track was creating ruinous competition. During the 1880s, approximately 75,000 miles of track
were laid, by far the largest amount ever built anywhere in the
world in any decade. By the late 1890s, the industry began
consolidating through a combination of foreclosure sales,
mergers, and acquisitions organized by the great investment
banks, such as the House of Morgan, or through alliances between competitors cemented with cross-ownership of equity
and interlocking directorships.
The Peak of Nongovernmental Regulation and
Continued Abuse
During the 50 years from 1880 to the end of the Roaring
Twenties, the U.S. political economy was dramatically transformed by increased urbanization and large-scale migration
to the cities, the creation of great industrial and manufacturing corporations, and the consolidation and concentration of
corporate power. Between 1897 and 1904, 4,277 U.S. firms
consolidated into 257 corporations. The largest was unquestionably U.S. Steel, as engineered by J. P. Morgan and a syndicate of investment bankers.
Shortly after 1900, new forms of equity began to be sold on
the stock market by the investment banking houses, including
dual class stocks, voting trusts, and pyramid holding company
structures. The effect was to further separate stock ownership
from voting rights; majority stock ownership was no longer
necessary to control a corporation. Since the beginning of U.S.
stock markets, control of a corporation by stock ownership
had been a partial illusion given the ability to manipulate
many corporations’ stock prices and dilute share ownership at
will. But with the institutionalization of these new forms of
stock, corporate control became a fiction entirely unrelated to
stock ownership. By 1930 a famous study by Adolf A. Berle
and Gardiner C. Means determined that in 21 percent of the
200 largest corporations, such legal devices, rather than majority share ownership, held corporate control. In 1925 it was
exposed that agents owning less than 5 percent of the total
stock controlled several leading corporations.
Under such extreme circumstances, why would individuals invest in the stock market without minority rights protections or even an uncorrupt judiciary to protect them? A partial answer involves the existence of powerful representatives
to protect investors’ interests. In the large railroad corporations and large merged manufacturing corporations, the
great investment banking houses acquired seats on the boards
of directors. By holding these directorships, the money trusts
represented their clients’ interests, monitored the controlling
management, and, most important, protected the value of
their investors’ share ownership by preventing predatory raids
by outsiders seeking to purchase controlling shares without
paying a premium for acquiring control.
A second institution functioning as a substitute for insufficient minority rights protection was the self-regulation of
stock exchanges where securities were traded. For example, in
1868, in response to the battle for ownership and control of
the Erie Railroad, the New York Stock Exchange (NYSE) required that all listed corporations divulge yearly financial information so that investors could appraise the value of those
corporations. In practice, this was ineffectual until the development of double-entry bookkeeping, the accounting industry, and the credentialing of accountants in the 1890s. A more
successful example of the way in which investors were protected by new stock exchange regulations was the NYSE’s implementation of the bright-line rules in the 1920s. These
rules included prohibiting listed corporations from issuing
nonvoting common stock or permitting a transfer of corporate control without an explicit shareholder vote. However,
the alleged strengths of self-regulation should not be exaggerated. In retrospect, it was largely ineffective in preventing
market manipulation, profitable trading based on insider information, or abuse by brokers of trading in front of their
client’s orders. In sum, despite the inability of the NYSE (or
other stock exchanges, for that matter) to prevent market manipulation and the abuse of broker’s power over their customers, the NYSE took clear steps toward making corporate
financial information transparent and a few steps toward
shareholder democracy.
An Attempt at State Regulation
Prior to 1933, with the significant exception of the federal
postal laws that contained antifraud provisions, there was no
federal regulation of the national stock market or the states’
stock exchanges. Stocks were traded like any other commodity, in spite of significant differences between financial markets and other product markets.
Despite a century of reports by historians, journalists, and
industry commentators about notorious public stock market
scandals, cases of grievous yet licit market manipulation, and
numerous acts of fraud; despite similar findings by the congressionally established Industrial Commission in 1900 and
again in 1902; despite the 1913 public reports by the congressionally established Pujo Committee or the popular summary of the committee’s findings by jurist Louis Brandeis in
Other People’s Money, the public debate in each case did not
lead to federal government legislation. States, however, took
the lead with so-called blue-sky laws, intended to protect investors from fraudulent investments—speculative schemes
that had no more basis than so many feet of blue sky (as described by Supreme Court Justice Joseph McKenna in 1917).
Broadly speaking, such nineteenth-century state legislation was almost exclusively designed to regulate the business
activities of corporations chartered by the state. Only rarely
did legislation seek to regulate the securities transactions
themselves. For example, the first blue-sky law was enacted by
a progressive bank commissioner in Kansas in 1911. Kansas’s
merit-based regime required that all securities of businesses
incorporated in the state had to be licensed by the state.
Moreover, the bank commissioner was permitted to withhold
licenses not only to businesses that were deemed fraudulent
but also even to those deemed to be a poor investment and
unable, therefore, to promise a fair return for investors. Thus,
Kansas’s blue-sky law, though allegedly designed to prevent
fraud within the state, contained wide powers to ensure the
quality of listed companies incorporated in Kansas. Within
two years, 23 states adopted their own blue-sky statutes, and
by 1933 every state with the exception of Nevada had also
adopted some form of blue-sky legislation.
In practice, such legislation was ineffectual. States had no
means of enforcing the legislation against financiers residing
out of state. Moreover, the states failed to create administrations charged with investigation and enforcement. By the
early 1930s, only eight states had full-time commissions
charged with enforcing blue-sky laws. A skeptic could easily
argue that the main practical effect of blue-sky laws was providing an additional source of state revenue through securities licensing.
This is not to say that blue-sky laws were inconsequential. They produced numerous pragmatic case studies of
merit-based securities licensing. And when the first federal
legislation was enacted, it closely mirrored extant blue-sky
legislation.
The Era of Federal Regulation
The reversal of the long-standing federal government policy
of laissez-faire with regard to securities markets was reversed
during President Franklin Roosevelt’s first hundred days and
the avalanche of legislation enacted in that period to pull the
United States out of the Great Depression. When federal legislation of the national stock market began in 1933, it was
rapid and radical. Within the space of just 15 months, the
federal government implemented the Securities Act, the
Glass-Steagall Act, and the Securities Exchange Act. These
three acts in concert required material financial information
about corporations to be disclosed in annual financial reports
and quarterly earnings statements (what the NYSE and individual state blue-sky laws had tried to do with only partial
success). They created a new federal administrative organization to oversee securities markets, the Securities and Exchange Commission (SEC), something states with blue-sky
laws generally failed to do. And they legislated the full separation of commercial and investment banking, thereby forcing banks to choose to either take deposits and provide commercial loans or engage in the lucrative business of
originating and distributing corporate securities as investment bankers.
In 1934 the NYSE, under its elected president, Richard
Whitney, attempted self-reform so as to convince the public
that further federal legislation was unnecessary. The NYSE
governors voted to prohibit market manipulation syndicates, forbade specialist brokers from giving inside information to others, and prohibited brokers from purchasing options in stocks for which they made a market. In the public’s
mind, such late reforms merely amounted to an admission
of grave moral failures on Wall Street. Whitney proved to be
a poor role model for the moral stature of Wall Street: In
1938 he was indicted for defrauding his wife’s trust, for stealing from the New York Yacht Club (for which he was treasurer), stealing from his brokerage clients’ accounts, and even
embezzling from a fund for widows and orphans of deceased
NYSE members (for which he had been appointed a
trustee).
The Postwar Stock Market
Prior to the 1940s, stock brokerage firms were uniformly
small boutique companies of perhaps 50 accounts or less;
their clients were primarily the friends and family of the brokerage’s partners. But in the early years following World War
II, firms such as Merrill Lynch pioneered a mass-market
business model featuring small accounts and a high trading
volume. By the end of the 1940s, Merrill Lynch was the
largest brokerage house on Wall Street. By 1960 its gross income was nearly four times the size of the second-biggest
brokerage house and roughly as large as the next four firms
combined. Players in the industry referred to Merrill’s
540,000 accounts as the thundering herd. Individual investors participating in the stock market tripled between the
war and the mid-1960s, and they doubled again over the following 20 years.
Capital poured into the U.S. stock market after the war,
not only from the reentry of the middle classes into the stock
market but also because of the inflow of institutional investors. Previously, institutional investors were concerned
about the uncertain value of listed corporations and wary of
the routinely practiced market manipulation and insider
trading. But one by one, they reappraised the developing
stock market. With the institutionalization of uniform and
comparable quarterly earnings between corporations, the accuracy of that information confirmed by independent auditors, and the market’s first constraints on market manipulation and insider trading given the surveillance of the
Securities and Exchange Commission, institutional investors
determined that the stock market was no longer as risky or
uncertain as it had been in the past.
The new records of high trading volume, although welcome, were drowning the smaller and less administratively
capable brokerage houses. Not all brokerage houses could afford the transition from paper trades to electronic trading. In
1975, with the elimination of fixed commissions on trading,
the volume of trading increased further—but at the expense
of weaker brokerage firms that drowned in the paperwork.
Expensive mistakes were routinely made. Money was lost. In
December 1968 investigators discovered that $4.1 billion in
securities simply could not be accounted for.
As a result, brokerage houses with fewer accounts and undercapitalized or administratively disadvantaged houses
began to go bankrupt or merge with more successful brokerage firms. The federal government stepped in again in 1970
and founded the Securities Investor Protection Corporation
to insure customer funds placed with brokers. In return for
this valuable protection, stock brokerage companies were
later subjected to greater surveillance, auditing, and regulatory requirements.
In the last quarter of the twentieth century, numerous economic sectors were deregulated, including the railroad, airline, utility, and telecommunications industries. By 1999,
when the Financial Services Modernization Act was enacted,
the death knell of the Glass-Steagall Act of 1933 had been
sounded. Over time, the regulatory power of the Securities
and Exchange Commission, that other great creation of 1933,
has swelled and ebbed with strong or weak presidentially appointed chairpersons. Moreover, although the stock market
has grown in complexity and size, the SEC has, in recent
years, been unable to keep pace with its strong surveillance,
investigation, and prosecution goals because of an insufficient budget set by Congress.
It is reasonable to believe that this power imbalance between financial capital and its regulators led, in 2001, to the
$50 billion collapse of Enron Corporation, the largest bankruptcy in U.S. corporate history, because of fraudulent accounting and securities market manipulation. Yet Enron
pales in comparison to the largest one-year loss in U.S. corporate history, which occurred when AOL Time Warner
wrote off nearly $100 billion from its books in 2002 because
of excessively creative accounting in previous years.
It is a paradox of eighteenth- and nineteenth-century
stock market development that investors were repeatedly
willing to invest with so little oversight. The second half of
the twentieth century demonstrated that federal regulation
and oversight could create a stock market with sufficient protections so as to significantly encourage institutional and individual investors to invest. The fundamental regulatory
question for much of the twenty-first century will be how to
successfully reregulate after 25 years of experimentation with
deregulation.
—Aaron Z. Pitluck
References
Abolafia, Mitchel Y. Making Markets: Opportunism and
Restraint on Wall Street. Cambridge, MA: Harvard
University Press, 1996.
Banner, Stuart. Anglo-American Securities Regulation:
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