Published by EH.NET (August 2000)
Ranald C. Michie, The London Stock Exchange: A History. Oxford: Oxford
University Press, 1999. xiii + 672 pp. $110 (cloth), ISBN: 0-19-829508-1.
Reviewed for EH.NET by Larry Neal, Department of Economics, University of
Illinois.
Among financial historians, it is now commonplace to regard the emergence of
today’s global capital market as a resumption of the progress that had been
made toward creating a global market in goods, labor, and capital in the period
from 1850 to 1914. Ranald Michie, the preeminent historian of the London Stock
Exchange in that bygone halcyon era, presents the story of how the London Stock
Exchange rose to preeminence in that earlier international capital market, but
then suffered through the disruptions of the international economy created by
two successive world wars and the financial crises that followed them, and is
now still struggling to retain a reputable place in the new global capital
markets that have emerged over the past thirty years. Written on the basis of
an intensive examination of the records of the London Stock Exchange, his work
will now be the standard reference on the London Stock Exchange, replacing old
classics such as E. V. Morgan and W. A. Thomas, The Stock Exchange: Its
History and Functions, (London, 1961), and even Michie’s earlier work,
The London and New York Stock Exchanges 1850-1914, (London, 1987). The
timing of its appearance is especially fortuitous as the current members of the
London Stock Exchange decide how to vote in September 2000 about the proposed
merger with the German stock exchange. Will the smaller members lose their
livelihood from the competition of the more efficient German firms? Or will the
merger preserve their incomes from the competition of electronic market makers
not constrained by the rules of a formal exchange? Or will the largest firms be
willing to buy them out on favorable terms in any event?
These are the questions today, but they have been faced in much the same terms
any number of times over the past two hundred years, as Michie documents. The
answers, though, have varied depending on both the nature of the external
competition and the nature of the internal composition of the exchange. Michie
argues that his kind of study, focusing on the decisions taken over time by the
members of the London Stock Exchange, can reveal much about the role of the
financial system in shaping the course of the real economy. It is not the
securities market in Britain as such, then, that concerns him, but rather the
specific role of the self-governing organization called the London Stock
Exchange in the securities market. This is certainly a worthy endeavor and
modern finance scholars are increasingly concerned about the implications of
what they call “market microstructure” in determining the efficiency of price
discovery processes as well as overall efficiency in financial intermediation.
For them, Michie describes and appraises the creation, operation and evolution
of the microstructure of what is still one of the world’s leading stock
exchanges and was the undisputed leader during the gold standard era. He does
not, however, deal with these arcane issues of market efficiency, to the
disappointment of some readers, but no doubt the relief of most. (The awkward
term “microstructure” never appears in the 642 pages of text.) But neither does
he entertain with stories of rascal behavior by the more opportunistic
participants of the “House,” to the disappointment of most readers and no doubt
his publisher hoping for more robust sales. Rather, he concludes each chapter
with a table showing the number and capitalization of the securities listed on
the London Stock Exchange for a benchmark date. These together show the
changing scale and scope of the exchange’s market over time. This is a solid
work of original historical research that gives the reader many interesting
insights and raises important questions for practitioners and policymakers as
well.
Michie begins his story, “From Market to Exchange, 1693-1801,” with an overview
of the rise of an informal, unorganized, secondary market in government debt.
This begins, in his view, in 1693 with the establishment of permanent debt that
could be transferred. As the amount of debt increased with each successive war,
so did the number of investors, encouraged by the government’s ability to
continue servicing at least the regular interest payments promised on the debt
issues. Gradually, specialists arose, both brokers and jobbers, both very
important to the operation of an efficient secondary market for any set of
products. Brokers made their money from commissions they charged to their
principals, who desired to buy or sell an amount of a particular security
within a specified price range. Jobbers provided the brokers the counterparties
to their principals, offering to sell to their buyer or to buy from their
seller the particular security. They made their money on the difference between
the prices they bid or asked, and saved the broker the time and expense of
finding a specific counter party to his original client. Both made more money,
the greater the volume of transactions. Brokers made a commission charged to
their principals; jobbers made a “turn” on the bid-ask spread always intending
to buy low and sell high. By the end of the eighteenth century, the number of
investors was large and a number of specialized brokers and jobbers seemed to
be making a living from their respective trading activities. Nevertheless,
asserts Michie, this was just a market, not an organized exchange that could
affect by its own rules and enforcement decisions the way the security market
would develop in the future. In 1801, however, the informal London stock market
ceased to be shaped strictly by outside forces and henceforth could determine
in part its own destiny through the decisions taken by its governing bodies.
These were the Committee for General Purposes for the Members and the Trustees
& Managers for the Proprietors.
How they operated vis-?-vis each other to solidify the tradition and prestige
of the “House” is detailed in “From Money to Capital, 1801-1851.” Readers
familiar with Michie’s earlier comparison of the London and New York stock
exchanges, the two classic examples of financial capital marketplaces, will
find a familiar theme in his emphasis in this book upon the importance of the
governance structure of the London Stock Exchange as it coped with the
successive changes in monetary regimes, government controls and policies, new
communications technologies, and international and domestic competition.
Responding to the pressures of war finance in 1801 at the outset of the
Napoleonic Wars with France, one group of traders became the Proprietors of the
building that housed the market place for the Members engaged in actual
trading. The Proprietors, as owners of the market place, but not of the
products of the market place, were strictly interested in maintaining a large
membership paying annual subscriptions for the use of the facility while
keeping operating costs as low as possible. The Members, as users of the market
place, were concerned strictly with generating a large volume of trading while
keeping their own costs of business as low as possible. Faced with outside
competition from time to time, the Members would try to restrict access, while
the Proprietors would try to co-opt it into the House. Members, however, had
complete control over who could become a Member, although Proprietors set the
annual entrance fee that individuals had to pay to take up their membership and
determined the hours of operation and physical amenities provided. Once in
place, this method of operation proved self-sustaining and it endured through
all the travails and opportunities that ensued over the next two centuries.
In the first half century, the governance structure was challenged by two
shocks, the brief but intense interest in foreign government debt and foreign
mining shares in the early 1820s and then the longer and even more intense
investor enthusiasm for railroad securities starting in the late 1830s. In both
cases, the users of the exchange wanted to keep out competition by traders
specializing in the new securities but the owners of the exchange accommodated
them as soon as possible to prevent an alternative exchange from arising in
London. The resulting expansion of business benefited all members and
solidified their operating rules and governance procedures.
In the rest of the nineteenth century, which Michie labels “From Domestic to
International, 1850-1914,” the British success with financing domestic
railroads led to providing finance for foreign railroads and then for large
commercial and industrial firms both at home and overseas. The continued
expansion of the number and variety of securities listed on the exchange led to
enlarged memberships and increased pressure on the physical facilities of the
exchange. To finance a new building in the 1870s, the Proprietors increased
fees on the Members, who responded by demanding more voice in management. The
conflicting interests were resolved through expanding the capital stock of the
Stock Exchange by requiring all future members to become shareholders as well
as subscribers. The number of shareholders grew, as a consequence, from only
268 in 1876 to 2,366 in 1914 so that there gradually occurred an overlap
between Proprietors and Members. In his earlier work, Michie has argued that
the increasing voice of broker members in the governance of the Stock Exchange
was gradually undermining its flexibility in responding to competitive
challenges and its responsiveness to technological advances in communications.
Now, his appraisal is that the exchange was remarkably flexible and responsive,
especially, one infers, by contrast with its continued dithering over the
period 1945 to 1986, which came dangerously close to eliminating it entirely as
an organization.
What accounts for this earlier success? Internally, one factor was that dual
control by Proprietors and Members continued to be effective in offsetting
tendencies towards restricting access to the exchange; another was the
continued importance numerically of jobbers within the membership of the
exchange. Externally, the most important factor was the central role played by
the Stock Exchange in the money market of London. The ever-expanding joint
stock banks in London found that their loanable funds could be employed
profitably for short periods of time by lending to so-called money brokers who
were members of the Stock Exchange. They, in turn, could lend on security of
shares and stocks held by jobbers to allow them to settle differences at the
fortnightly settlements or to continue their positions to the next account.
Specialization in function within the Stock Exchange thus occurred that allowed
further specialization in function among the financial intermediaries of
Lombard Street. These nested specializations increased efficiency in the use of
funds by all concerned. They also allowed, however, increased efficiency within
the growing number of provincial stock exchanges, who could tap into the London
money market easily through the branches of the joint-stock banks.
Whatever the dynamics of the emerging structure of finance and industry would
have created for the future of the British economy, the impact of World War I
changed everything, and mostly for the worse in Michie’s opinion. First of all,
it eliminated the foreign business of the Stock Exchange bringing that under
the control of the Treasury, now concerned only with raising money for war
finance. Second, it eliminated the money market role of the Stock Exchange by
eliminating dealing in options and even for account. Finally, it created a
comfortable source of easy commissions by the huge increase in government debt
traded on the Stock Exchange. Wartime restrictions on membership created by
military service for younger members and expulsion of foreign, especially
German, members were formalized by rule changes when peace returned. Minimum
commissions were rigidly enforced. In short, the war changed permanently all
the external conditions that had created prosperity for the members of the
Stock Exchange before the war. But it also strengthened the rigidity of
internal rules that protected the incomes of the surviving members.
Michie then treats the interwar period in two separate chapters, “Challenges
and Opportunities, 1919-1939,” and “The Changing Market Place Between the
Wars.” The first chapter details how “the rules of the Stock Exchange, designed
to create an orderly market, were increasingly used by the membership to limit
the competitive environment within which they operated. This was true both in
terms of outside competition, with restrictions on admissions, and internally,
with minimum commissions and other controls. The end result was a lessening of
those forces for change that had forced the membership in the past to respond
to challenges and to seize opportunities” (p. 234). This is exactly the
conclusion one expects, given Michie’s earlier study. The second chapter argues
that, nevertheless, the ossification of the Stock Exchange was not the key
problem for the finance of British industry during the interwar period. Rather,
the increased rate of taxation needed to service the huge increase in
government debt, the decline of profitability of older industries, and London’s
diminished international role all limited the potential supply of finance,
irrespective of the reduced efficiency of the Stock Market in providing
financial intermediation. While researching the current book, Michie has become
more sympathetic to the efforts of the Stock Exchange as an organization and
more critical of the external forces that limited its potential service to the
British economy.
In “New Beginnings: The Second World War, 1939-1945,” the changes that the
exigencies of war finance had inflicted upon an unsuspecting and unprepared
Stock Exchange in 1914 were now adopted quickly as a matter of course. The
Stock Exchange willingly became an administrative arm of the government,
helping the Treasury to market its burgeoning debt issues and receiving in turn
the protection of the government against competitive forces in the government
debt market. Dual control was finally ended informally, as the Committee for
General Purposes for the users and the Trustees and Managers Committee for the
owners were combined into a Council, dominated by the members, or users, of the
Stock Exchange for the duration of the war. This streamlined governance
structure made the postwar Stock Exchange an effective arm of the government,
but ossified the responsiveness of the organization to the competition of
provincial exchanges and of the joint stock banks in dealing on the securities
markets in Britain. It did, however, enable the members to buy out the
proprietors and formally end dual control in 1948. Thereafter, the business of
the Stock Exchange was not to make a profit for the owners, but to render
services to the existing members. On the expense side, however, it was
committed to pay out ?160,000 annually to buy out the previous Proprietors and
committed to enlarging its salaried staff to carry out the regulatory functions
it believed the government expected of it. On the revenue side, members were
not willing to vote increased subscriptions fees, much less stock assessments,
on themselves, especially as the incomes of many firms fell after the war.
“Drifting towards Oblivion, 1950-1959,” “Failing to Adjust, 1960-1969,” and
“Prelude to Change, 1970-1979,” are the chapter titles that follow and they
convey well the encompassing malaise that overcame the Stock Exchange and most
of its members, steadily declining in number and consolidating into fewer and
fewer firms in each succeeding decade. During the 1950s, however, the London
Stock Exchange found a new role despite its hidebound governance and
administrative structure. This was serving as a market place for the rising
volume of domestic corporate shares. These were not, Michie argues, a new
source of finance, but a substitute for business debt with fixed interest,
which was increasingly unattractive to British investors in the persistently
inflationary climate of the 1950s. These didn’t match in total volume the size
of government debt, but in terms of trading commissions earned by member firms
they were just as important as those earned on placing and trading issues of
government debt. Moreover, government debt trading became increasingly
concentrated among fewer firms while corporate equities could provide niche
markets for a variety of the member firms. In the 1960s, this trend established
in the 1950s continued to the benefit of the Stock Exchange and its members.
But it also elicited increasing interest from foreign investors, whose demands
were quickly met by foreign firms, both banks and investment houses, located in
London, rather than by the Stock Exchange. Further, provincial exchanges and
non-member stockbroking firms found it easy to enter this growing market,
especially as the Stock Exchange became increasingly restrictive in its listing
requirements for corporate equities. As a quasi-regulatory arm of government,
the London Stock Exchange felt it was important to protect outside investors
from the risks of smaller firms in new industries, but this was precisely where
the largest potential profits could be made. The circumstances of the 1970s at
first confirmed the wisdom of this strategy to the leadership of the Stock
Exchange when the equities market collapsed in 1974. This led to a formal
merger with the provincial exchanges, enlarging the membership of what was now
called the International Stock Exchange within the same rigid set of rules as
before. The country jobbers were forced to become single-capacity brokers, so
they helped strengthen the support within the membership for enforcing minimum
commissions. Moreover, the Stock Exchange was now a much more effective
regulator of the British securities marketplace. But the cost of this
consolidation was that the Stock Exchange was further constrained from
responding to challenges by foreign exchanges and firms, and from initiating or
even imitating financial innovations taking place within non-member firms and
the major financial intermediaries in the City of London.
The breakthrough that eventually led to the “Big Bang” (chapter 12) in 1986,
the once for all elimination of minimum commissions and restrictions on the
size and functions of member firms, Michie argues, was the elimination by the
Thatcher government of exchange controls in 1979. Now the customers of the
brokerage houses, increasingly the banks, insurance companies, and investment
houses, could readily invest abroad with foreign exchanges and stockbroking
firms. Foreign banks and brokerage houses in London could now bypass the high
costs of the Stock Exchange without incurring the penalties imposed by exchange
controls. The response of the Stock Exchange to this challenge was delayed
until 1986, however, not because of the rigidity of the governance structure,
but because of the Thatcher government’s attack on the privileges of the Stock
Exchange brought before the Restrictive Practices Court. While this action was
on the docket, the Stock Exchange officers felt compelled to defend the entire
corpus of Rules and Regulations that had accreted over the decades, according
to Michie. Not until the case was dismissed by the government in 1983, did the
officers feel free to move forward to modernize the rules of the Stock
Exchange.
In the penultimate chapter, “Black Hole,” Michie begins by stating that “On 3
March 2001 the London Stock Exchange, as a formally organized securities
market, will have existed for two centuries.” That, we now know, remains to be
seen! Michie documents the difficulties faced by the venerable institution for
survival, but seems to think they stem mostly from continued hassling of the
securities market in general by government regulators. Given the City’s success
previously in attracting the business of foreign international banks, mainly to
deal in the Euro-dollar and Euro-bond market that developed outside the Stock
Exchange, the Big Bang’s removal of restrictions on membership allowed the
entry of the most innovative firms and practices from around the world. At his
most optimistic, Michie opines, “In fact, what emerged from Big Bang was akin
to the dual control which had worked so well in the past, with responsibility
now shared between the Stock Exchange, representing its members, and the
regulatory authorities, reflecting the needs of the wider financial community”
(p. 634). General readers could more easily share this optimism if they had
confidence that the regulatory authorities would reflect the needs of the
financial community rather than the needs of their political masters to be
re-elected within five years. Indeed, Michie’s final lesson that he draws from
his historical account is “that self-regulation without monopoly power has
produced the most satisfactory solution in the past. Otherwise governments
operate to their own agendas, distorting the market and destroying innovation
in the process, while self-regulating monopolies abuse their power for their
own self-interest” (p. 642). The challenge is clear; how it will be met is not!
Larry Neal is Professor of Economics at the University of Illinois at
Urbana-Champaign and Director of the European Union Center at Illinois. He is
past president of the Economic History Association and the Business History
Conference. From 1981 through 1998, he was editor of Explorations in
Economic History. He is author of The Rise of Financial Capitalism:
International Capital Markets in the Age of Reason, Cambridge University
Press, 1990 and The Economics of the European Union and the Economies of
Europe, Oxford University Press, 1998 as well as numerous articles in
American and European economic history.