From Gambling Den to ‘Necessary’ Institution in the Public Interest

During the Great Depression a significant change in the direction and philosophy of Federal Government intervention took hold in most areas of US business.² From the Crash of 1929 to the declaration of the Agricultural Adjustment Act (AAA) and the National Industrial Recovery Act (NIRA) as unconstitutional in 1935, there were greater priorities than the evolution of futures market regulation. To the extent that the futures markets were targeted at all, federal policymakers and their agents were keen to use regulation to stabilise grain prices. George Peek, chief of the AAA, informed the exchanges in a private conference in 1933 that ‘we are charged by Congress under the Agricultural Adjustment Act [with the …] raising of farm prices to parity’.³ Yet using self-regulation to boost prices was always going to be a pipe-dream.

1 J.A Pattern and Boyden Sparkes, “In the Wheat Pit,” Saturday Evening Post (Reprint Curtis Publishing Company, 1927).

2 There is a deep and contested literature about the New Deal. The traditional approach is best exemplified by William E. Leuchtenburg, Franklin D. Roosevelt and the New Deal, 1932-1940 (New York:

Harper, 1963) and Arthur M. Schlesinger, The Age of Roosevelt (Boston: Houghton Mifflin, 1957).

3 Transcript, Informal Conference with Chicago Board of Trade, other Exchanges and the Federal Government, 10am, Reporter Mr. Sharkey, 24 July 1933. CME. III.850.1.

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The failure of all efforts to negotiate a voluntary code of conduct for the futures markets set the stage for an unlikely coalition of the GFA and the American Farm Bureau Federation (AFBF), the powerful farm lobby group. This chapter shows that the AFBF, in sponsoring futures regulation at least, was not interested in raising grain prices for the American farmers, as is claimed by Roberta Romano, but was more interested in punishing the CBOT and weakening its resistance to the farmer’s cooperative movement. Market efficiency – less manipulation , less fraud and more confidence in the markets in general - was always the goal of the eventual 1936 legislation, which focused almost exclusively on protecting the small and numerous ‘grain

gamblers’ from fraud and manipulation. Previously vilified by state legislators and academics, the small speculator was considered by the GFA and the AFBF to be the critical participant in the efficient functioning of futures markets during the marketing cycle.

Although the GFA was unable to gain the attention of an increasingly distracted and pro-business Secretary of Agriculture in the early 1930s, by the mid-1930s it was able to join with the AFBF to co-author a new bill that passed into law as the 1936 Commodity Exchange Act (CEA), which amended the 1922 Act. The GFA allowed the AFBF to dictate terms surrounding the cooperatives but otherwise had key clauses inserted that protected and encouraged speculators to enter the market. Here, as in 1921, the law did not curb futures trading in any meaningful way.

This time it was the powerful idea of the futures market as an efficient price setter and space for risk management that dominated any rent seeking motivations. The CEA protected speculators from fraud and unethical activities. Protections included segregating client margin monies from a firm’s general accounts and the requirement that a firm could not act as both principal and agent in a client transaction, effectively banning bucketing and limiting front-running and other conflicts of interest. These have become, like the earlier innovations of 1923 and 1926, required and routine practices in futures markets.⁴ The CBOT directorate was also privately in favour of these changes, even if publicly many in the membership protested any additional government involvement.

In the final analysis, a non-rent seeking special interest was able to work with a semi-autonomous government agency in the public interest, where that interest also benefited the industry itself.

4 However, CBOT members could still flaunt the rules, as the FBI raids of the 1990s demonstrate. For a fulsome explanation of criminal activity discovered in 1989-1991, see Davis Greising and Laurie Morse, Brokers, Bagmen, and Moles: Fraud and Corruption in the Chicago Futures Markets (New York: John Wiley & Sons, 1991).

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Once again, it is clear that the government versus markets debate is a false dichotomy, since it is shown here that they can function together to create stable and long-lasting institutions that are essential to modern business and finance. While the 1922 Act can be explained by a compromise between the ideas and actions of government and markets and the 1926 innovations are best considered as co-construction of a regime by both government and industry, the 1936 Act’s history is much more complex. Three key questions need to be answered when analysing the 1936 CEA; (i) Who was responsible for the successful legislative push in the mid-1930s? (ii) Why did the CEA come into being? and (iii) What is the explanation for the substance of the CEA?

The answers to the first two questions require an understanding of the multiplicity of interests within both government and industry and, of course, between the futures industry, different levels of the Federal Government and producer organisations. Without support, the GFA could not adequately advance its case for better regulation in the public interest due to political

constraints, as well as it not wanting to alienate the industry that it relied upon for the information necessary to supervise the markets.⁵

This chapter shows that the CEA of 1936 was born out of a marriage between a powerful private interest and a knowledgeable yet formally powerless government agency. The failure of the voluntary Codes in 1935 in the midst of a worsening depression finally opened a policy window whereby the GFA, working with one powerful farm lobby group, the AFBF, seized control of the process to produce legislation for grain futures that was in the interest of almost all market participants, thereby placing it in the ‘public interest’ and as far from rent-seeking as was possible.

The third question, regarding the substance of the Act, can be answered by understanding the outcome of the previous thirteen years of study. Government analysis indicated that futures markets were a key contributor to efficient grain marketing, in spite of the recent depression in futures prices, and the data and analysis together provided a knowledge base from which an entire field of study was launched. As it did in 1926, the information gathered and analysed by the GFA informed the government about the changes that needed to be made in 1936. This period offers many examples, therefore, of policy learning, common today yet also popular in

5 This latter conundrum is well understood in regulation studies. See, for example, Julia Black, “Critical Reflections on Regulation,” London School of Economics/Centre for the Analysis of Risk and Regulation Working Paper, 2002, pp. 3, 18; Christine Parker, “The ‘Compliance’ Trap: The Moral Message in Responsive Regulatory Enforcement,” Law & Society Review, 40, (2006): 591-622.

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interwar regulatory policy.⁶ Hoover, for example, considered the AMA and the Federal Farm Board intervention to be a grand policy experiment.⁷ Consequently, the 1936 Commodity Exchange Act established a key new concept in financial markets regulation in the US, and which did not exist elsewhere, which encouraged and protected the small speculator. While New Deal economics dominated FDR’s war on depression, the CEA, like the Securities Act of 1933, was remarkably free from the socialism attributed to farm relief programs.

This chapter first explains who was involved in the creation of the Commodities Exchange Act of 1936 as well as why and how the stage was set for the further institutional changes that survive into the present day. Secondly, the ground-breaking analysis of the GFA between 1923 and 1935 will be studied, especially with regard to its effect on the legitimacy of the markets, how it informed those interested in amending the 1922 Act and how it influenced a new generation of financial markets scholars. Thirdly, it will cover the political economy in terms of the fight for the 1936 Commodity Exchange Act, and fourthly, it will explain the changes that were made to the 1922 Act. The chapter concludes with a detailed analysis of the legacy of the Act by discussing the significant social turn, away from futures speculation as ‘gambling to be restricted’ and towards being considered necessary for the functioning of markets.